Case Study: The Collapse of Enron

Enron Corporation is an energy trading, natural gas, and electric utilities company located in Houston, Texas that had around 21,000 employees by mid-2001, before it went bankrupt. Its revenue in the year 2000 was more than $100 billion and named as “America’s most innovative companies for six consecutive years by Fortune. Enron was a company that was able to profit by providing the delivery of gas to utility companies and businesses at the fair value market price. Enron was listed as the seventh largest company in the United States and had the domination in the trading of communications, power, and weather securities. In 2002, the company used to be a member  of the top 100  fortunes companies but later on after facing an accounting scandal, the company started to collapse. The scandal of Enron has been the largest corporate scandal in history, and has become emblematic of institutionalized and well-planned corporate fraud; the Enron scandal involves both illegal and unethical activities.

The Collapse of Enron

The CFO Jeffrey Skilling and the CEO Ken Lay played major roles in the Enron scandal. Both of them committed securities fraud and conspiracy to inflate profit. In disguise debts of Enron, Lay and Skilling used off-the-books partnerships, after that they lied to investors and employees about the company’s disastrous financial situation while selling their own company’s shares. Enron’s top level management has violated several accounting laws, SPE laws, and bent the accounting rules to satisfy their own desires of profit in the short term but ignoring long term repercussions for investors, stockholders, employees and the business itself. The close relationships that were formed among top leading executives and the board of directors grew arrogant, thinking they were invincible and causing them to act in an unethical manner. Enron allowed Andrew Fastow, the Chief Financial Officer to control two SPE’s (special purpose entities) that were knowingly connected to Enron, and gave him an opportunity to abuse his power.

Enron has transformed its company from being an old economy company focusing on hard assets to a new economy firm focusing on a strategy of creating new markets HFV (Hypothetical Future value). Enron’s strategy to differentiate in the market was through reducing physical assets, keeping key assets (peak demand generators) and developing a core competence of risk arbitraging. With its core competency on risk management, managing the risk of commodities through purchasing electricity at a fixed price with suppliers and then sell electricity to customers with the new price, Enron was able to increase its profits, some thing Enron called M2M (Marked to Market Accounting).

Enron also parked some of its debt on the balance sheet of its SPVs and kept it hidden from analysts and investors. When the extent of its debt burden came to light, Enron’s credit rating fell and lenders demanded immediate payment in the sum of hundreds of millions of dollars in debt. It means that Enron’s decision makers saw the shuffling of debt rather as a timing issue and not as an ethical one. They maintained that the company was financially stable and that many of their emerging problems really were not too serious, even though they knew the truth and were making financial decisions to protect their personal gains.

The collapse of Enron would be complete without a discussion of the involvement of Enron’s accountants, the firm Arthur Andersen. Arthur Andersen was one of many causes of the Enron collapse when they were the conflict of interest between the two roles played for Enron, as auditor but also as consultant. Andrew Fastow, the Chief Financial Officer of Enron pushed many deals across where he had a vested interested on both sides of the deal. By creating and knowingly participating in these deals, he put his financial greed above the responsibility to his position for the company. Arthur Andersen earned $25 million in audit fees and $27 million in consulting fees, this amount accounted for roughly 27% of the audit fees of public clients for Arthur Andersen’s Houston office. The auditors’ methods were questioned as either being completed solely to receive its annual fees or for their lack of expertise in properly reviewing Enron’s revenue recognition, special entities, derivatives, and other accounting practices. Due to these relationships that Enron had with Arthur Andersen, it was just too easy for both Enron and the accounting firm to work together in covering up financial losses and debt. Andersen was also responsible for some of Enron’s internal bookkeeping, with some of Andersen’s employees eventually leaving to work for Enron. The result of the accounting scandal was that many of the losses that Enron encountered were not reported in its financial statements. In November, 2001, Enron revises financial statements for the previous five years to account for $586 million in losses.

Now the question is how Enron has collapsed? The collapse of Enron was the largest bankruptcy in the US history. The stock’s price dramatically collapsed from $80 per share to 30 cent per share. The collapse was mainly due to the management’s fraudulent practices. Enron lied about its profits and when the deception was unfolded, investors and creditors pull back their financial resources, which finally cause the company to face bankruptcy. Over expansion and excessive borrowings have also contributed to the company’s eventual demise. The finances were a disaster, this happens because of poor management and due to intentional deception and fraud. Poor management, we referred this as a systemic corporate governance failure.

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