Enron Corporation and Corporate Governance Issues

Executive Summary

Enron Corporation is a good example of how corporate governance issues can make or break a company. This report focuses on various issues that apply to corporate governance and Enron. The report begins by offering pertinent background issues about Enron. The paper then uses these principles and standards of governance: auditing, accounting, governance institutions, and ethics. These principles are then used as the basis for a critical review of the practices and structures that apply to Enron Corporation. Finally, the report offers recommendations on how corporate governance issues at Enron can be sorted out.

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Introduction

The Enron Corporation is an American based company that was first created in 1986. At one time, Enron was one of the biggest companies in the United States and also on global proportions. The company’s founder is Ken Lay and he sought to centralize his company on the oil business. Although Lay was the company’s founder, it was Jeff Skilling who propelled the company into new heights. Before filing for bankruptcy in 2001, Enron was the leading electricity and natural gas company in the world.

The company was also “a major supplier in major supplier of solar and wind renewable energy worldwide, managed the largest portfolio of natural gas-related risk management contracts in the world, and was one of the world’s biggest independent oil and gas exploration companies” (Vinten 2002).

The enormity of the company’s storage facilities served to reassure traders who were used to price shocks in the oil industry. Enron’s operations expanded rapidly throughout the 1990s and they grew to include innovative products to include weather and gas futures. The company also had a global presence in areas such as Mumbai, South America, and China. Observers have pointed out that having a global reputation was important to the company’s unprecedented expansion. Nevertheless, Enron had a strong presence in the United States where it was one of the best-performing companies at the stock exchange. Skilling is the most prominent personality in Enron’s early expansion drive.

By the year 2000, the Enron’s Board of Directors had above-average expertise and it includes ethical, legal, economic, and political experts. Although Skilling and Lay were the most prominent personalities in the board, there was an addition of fifteen directors with an experience of over one hundred years of board oversight. This essay analyses the corporate governance issues that apply to Enron specifically the events that led the company to file for bankruptcy in 2001. The company’s Board of Directors plays a central role in regards to upholding key governance institutions and practices.

Company Background

By the beginning of 1998, Enron had already grown to epic proportions through the strategic acquisition of related companies. Consequently, Enron Capital and Trade Resources became the biggest gas and electricity trader in the world. The company’s revenue also rose from a gross of two billion to seven billion dollars. The company also had a market presence in over 40 countries around the world. Skilling’s massive expansion drive and his label of Enron as a ‘wholesaler’ meant the company could trade in any commodity and not just electricity and gas. Nevertheless, Enron’s rapid expansion was relatively premature and the company was struggling to fund it.

The company’s executives relied on competitive Enron share prices to facilitate off-the-book financing activities. Unconventional accounting practices were also used to keep Enron at the top albeit undeservedly. For instance, “the use of mark to the market valuation on contracts produced artificially large earnings, disguising for some years underlying poor profitability in major parts of the business” (Dembinski 2005).

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With time, Enron began getting into cash flow problems mainly because the company was spending extravagantly while its newly acquired ventures were yet to be profitable. Soon, financial experts began to question the corporation’s profitability and these concerns were followed by a collapse of the company. The company’s share prices fell sharply, its credit rating plummeted, and in 2001, the company filed for the biggest bankruptcy in history. Enron’s collapse also took down its auditing partners who were the main enablers in the company’s illicit financial practices.

Principles and Standards of Governance

Accounting and Auditing

Transparency in the accounting and auditing activities of any organization is pertinent to corporate governance. Consequently, the performance of auditors and accountants is important to the successful corporate governance of any company. Good accounting and auditing should be part of a company’s code of practice. Like in other corporate scandals that have been witnessed in the United States, Enron’s case indicates accountants and auditors are major contributors to bad principles.

In Enron’s case, Anthony Anderson’s relationship was controlled at management levels. However, Anderson as an institution was a complete failure irrespective of the pressures that surround accounting and auditing activities. The stakeholders at Enron were riding the wave of ‘new business practices’ and they, therefore, neglected to focus on basic accounting and auditing principles. Furthermore, “there is a need for greater flexibility in both the preparation of financial statements (which will thus be capable of accommodating new business practices) and in audit attestation standards” (Mitchell 2014).

Governance Ethics

Good corporate governance is in charge of the maintenance of functional relationships between a corporation and its stakeholders. After the financial scandals that have dominated corporate America in the last three decades, the focus has shifted to the role that can be played by management. According to Tricker, “stakeholders in corporate governance such as Board of Directors act as the gatekeepers to any organization” (Tricker 2015).

Various standards apply to corporate governance including how Boards of Governors should be in the frontline when it comes to safeguarding the rights of shareholders and uphold transparency in their wheel dealing. There is a certain degree of complexity that applies to multinational companies that operate under different corporate regimes. The passivity of Enron’s Board of Directors requires the principles of corporate governance to be used in the review of this company’s governance.

Institutions of Governance

Experts agree that “financial engineering and its instruments can be used to get around regulations and other operational constraints, such as banks’ credit limits to particular borrowers” (Schwartz 2009). These instruments were used to cover up Enron’s cash flow problems. The company’s ability to avoid regulations is proof that institutional structures can be used to circumvent industry standards.

Credit controls are an example of a tool that has been used to institute checks and balances within organizations. The Sarbanes-Oxley Act stipulates the standards that are necessary to uphold transparency when it comes to a firm’s balance sheet. Nevertheless, legislation such as this one has not had any significant success in preventing organizations from using ingenious financial engineering tactics.

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There is also the concern of corporations using derivatives to bypass institutional checks. Modern companies depend a lot on “on tradable instruments and the associated reduction in face-to-face relations between creditors or investors and those they finance” (Solomon 2007). Failure of institutional structures facilitated various oversights at Enron. Consequently, the company’s governance needs to be analysed concerning the institutional structures applied to it.

Critical Review of Enron’s Corporate Governance

The first aspect of Enron’s corporate governance that requires analysis is the fact if any clear goals were shared by all stakeholders. The main personalities behind Enron were the company’s founder Lay and the Skilling, the Chief Executive Officer. These two executives pushed the company’s employees to do all that they could to push the corporation’s share prices. On the other hand, other company’s goals were sacrificed at the expense of this sole goal of pushing the share prices upwards. Tricker forwards a theory that creates a connection between psychological and organizational perspectives (Tricker 2015).

Enron’s employees were unable to recognize that they were ignoring other management goals in favour of a single purpose. For instance, the drive to achieve long-term goals was easily eclipsed by the need to keep forming expansion drives. Consequently, most of the customers who were supposed to bring revenue to Enron ended up being exploited. The lack of blend between psychological and organizational perspectives was a major factor in Enron’s ultimate failure. This factor was also manifested from within the company where the CEO pursued his interests at the expense of his employer.

Good governance in any organization is dependent on crucial aspects of strategic management. On the other hand, corporate governance requires constant upgrades just like any other aspects of management. According to Tricker’s book, corporate officers are expected to formulate and maintain a company’s external relationships (Tricker 2015). Lay hired Skilling at Enron because he was a strategy expert of repute. On the other hand, Skilling came to Enron with a vision of capitalizing on new gas-trade regulations. However, it is important to note that Skilling did not utilize management tools when pursuing his goals.

The executive’s ignorance of corporate governance meant that Enron’s operational management ranks stopped functioning without the realization of the company’s Board of Directors. Skilling’s strategies appeared to align with his inexplicable desire for expansion while all other factors were ignored. For example, at one point Skilling led his company in the acquisition of a broadband-internet company even though he had zero experience in this line of business. Furthermore, he acquired this company in the full knowledge that his company did not have the money to finance his new acquisition. Enron failed to pursue strategic management actively, and this decision led to a systematic breakdown of the company’s institutions.

The Board of Directors is the first line of defence for any publicly listed company and shareholders rely on this body for firsthand information. When investigations into the bankruptcy of Enron were ongoing, its directors claimed that they had no information concerning the company’s imminent collapse. This claim has been disputed over the years given that it is the prerogative of the Board of Directors to keep abreast with the activities of any company (Tricker 2015).

For example, in 1999 the Board was given credible information that indicated that Enron was engaging in risky accounting practices. In another suspicious development, the Enron Board of Directors did not find it suspicious that the company’s revenue rose from a modest forty billion in 1999 to an impressive one hundred billion in 2000. The Board appeared to be happy that the company was doing well thereby foregoing its duties and rights (Jennings 2002).

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Even the Enron Board of Directors vehemently denied any involvement in the company’s dubious deals, the investigation into this matter revealed that it knew more than it revealed. The investigating committee found that “the Board received substantial information about Enron’s plans and activities and explicitly authorized or allowed many of the questionable Enron strategies, policies and transactions” (Ide 2002). Overall, the Board was negligent in its ignorance of the facts that were presented to them. At one point, Board members tried to shift the blame to the company’s auditing firm Andersen. None of the company’s Board of Directors was willing to accept responsibility for the company’s collapse. However, corporate governance codes and principles would easily vilify the actions of the Board.

After embarking on an expansion agenda, the company’s sole focus turned to raise revenues and increasing the company’s share prices. The management also provided employees with good financial incentives if they assisted the company to achieve this goal. Observers have cited this pattern to be the reason behind the company’s ‘clever’ auditing and accounting practices. Throughout this process, the people behind the company’s deceptive accounting practices hid behind the rationalization that the shareholders were happy with their actions.

In a report that was released to the public, the investigators revealed that the shareholders through the Board of Directors were supposed to be privy to the company’s risky accounting practices. Throughout the Company’s practices, there was no record of directors or shareholders raising alarm over the accounting practices. By failing to recognize that the risky accounting practices were the cause of the company’s rapid rise to the top, the company’s Directors neglected to fulfil their role as the executive supervisors in matters of accountability (Tricker 2015).

Various governance issues also arise when observers question the motivation behind the inexplicable silence of the Board of Directors. Even if the directors were aware of the ‘risky’ accounting practices as they later claimed, they were expected to pass this information to the shareholders whose interests they represented. The National Association of Corporate Director’s chairman reckons that there was a blinding element as far as the actions of the directors at Enron are concerned. The audit committee of Enron’s board was said to be actively involved in the buying and selling of shares thereby raising the question whether their silence was bought (Sims & Brinkmann 2003).

The financial statements that acted as motivation to the shareholders were later found to have almost no aspect of truth in them. All the above facts have led some critics to conclude that Enron’s board was in cahoots with Skilling in his efforts to beguile investors. Tricker highlights the role of internal audit in corporate governance, and how this tool can stabilize corporations. According to his book, internal audits should not be fuelled by suspicious activities but they should be routine activities that serve as assurances to shareholders (Heath & Norman 2004). Furthermore, an external auditor is not an extension of the Board of Directors in a company.

Enron’s audit committee did their best to present Andersen as the villain while they remained absolved from any blame. Tricker’s assertions indicate that there is no possibility a scenario like this one transpiring where good governance practices are employed.

The corporate culture is a vital component of corporate governance. Consequently, how a company organizes and improves its corporate governance structures depends on various factors. All companies mimic their environments including the social contexts that surround them. Therefore, whether a company has a good or bad governance track record, its corporate personality will be manifested and not just in legal scenarios.

Companies that manage to create their distinctive characters have an easier time propagating their ethical agendas. One expert notes that when going about corporate governance it is important to take note of the fact that even though they do not have immortal souls, “companies, like human beings, live and die” (Cohan 2002). Enron’s management appears to be unaware of the fact that while the organization prospered, its ‘personality’ did the same.

First, the Board went against Enron’s code of conduct and allowed its Chief Finance Officer (CFO) to start and sustain off-the-books business operation vehicles. On the other hand, this bleach of conduct “allowed an inappropriate conflict of interest transactions as well as accounting and related party disclosure problems…due to the dual role of the CFO as a senior officer at Enron and an equity holder and general manager of the new entities” (Becht, Bolton, & Roell 2003, p. 43). The CFO and the Board’s personalities merged and allowed the CFO to steal from both the company and its shareholders.

Recommendations

Here is a list of recommendations that would improve and solve the governance issues that apply to Enron Corporation. First, the company needs to utilize rating tools for gauging the performance of various departments within the company. Enron was able to operate for a long period without being rated by either its customers, financiers, suppliers, or any recognized experts. Consequently, the company’s governance went on unchecked for a long time. From this point onwards, the company needs to instil honesty as one of its core values. The public relations debacle that followed Enron’s bankruptcy revolved around the issue of honesty among its employees, external auditors, managers, and Board of Directors.

The Enron corporate governance spectacle that was witnessed at Enron should serve as a wakeup call for the stock market stakeholders and federal regulators. Internal audits alone are not enough to act as performance indicators. Furthermore, it is important for directors not just to show up but also do their job. The Board of Directors at Enron had the best chances of averting failure but its passivity ended up being a liability to shareholders.

Financial audits should have information that benefits their intended audiences (shareholders and regulators) and not a projection of a few managers. Consequently, the corporate environment should encourage the Board of Directors to be independent. Also, the directors should be conversant with all aspects of the business including its prospects and imminent risks. Of utmost importance is the fact that directors need to understand what is expected from them as far as governance is concerned (Abdel-Khalik 2002). Finally, corporate governance is no longer an appendage in the modern business environment.

References

Abdel-Khalik, R 2002, “Reforming corporate governance post Enron: Shareholders’ Board of Trustees and the auditor”, Journal of Accounting and Public Policy, vol. 21, no. 2, pp. 97-103.

Becht, M, Bolton, P & Roell, A 2003, “Corporate governance and control”, Handbook of the Economics of Finance, vol. 1, no. 3, pp. 1-109.

Cohan, J 2002, “I didn’t know and I was only doing my job: Has corporate governance careened out of control? A case study of Enron’s information myopia”, Journal of Business Ethics, vol. 40, no. 3, pp. 275-299.

Dembinski, P 2005, Enron and World Finance, Palgrave Macmillan, Washington.

Heath, J & Norman, W 2004, “Stakeholder theory, corporate governance and public management: what can the history of state-run enterprises teach us in the post-Enron era?”, Journal of Business Ethics, vol. 53, no. 3, pp. 247-265.

Ide, R 2002, “Post-Enron corporate governance opportunities: Creating a culture of greater board collaboration and oversight”, Mercer Rev, vol. 54, no. 1, pp. 829-830.

Jennings, M 2002, “Primer on Enron: Lessons from a perfect storm of financial reporting, corporate governance, and ethical culture failures, Cal Review, vol. 39, no. 3, pp. 163-165.

Mitchell, G 2014, “Case studies, counterfactuals, and causal explanations”, University of Pennsylvania Law Review, vol. 152, no. 5, pp. 1517-1608.

Schwartz, M 2009, “Tone at the top: An ethics code for directors?”, Journal of Business Ethics, vol. 58, no. 3, pp. 79-100.

Sims, R & Brinkmann, J 2003, “Enron ethics or: culture matters more than codes”, Journal of Business Ethics, vol. 45, no. 3, pp. 243-256.

Solomon, J 2007, Corporate governance and accountability, John Wiley & Sons, New York.

Tricker, R 2015, Corporate governance: Principles, policies, and practices, Oxford University Press, Oxford.

Vinten, G 2002, “The corporate governance lessons of Enron”, International Journal of Business in Society, vol. 2, no. 4, pp. 4-9.

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