Enron was a publicly owned American energy company incorporated in the year 1985 and headquartered in Houston in Texas. The company was involved in an unprecedented scandal that came to the spotlight late in the year 2001. The company became bankrupt and its accounting partner was dissolved. The scandal made history as the worst failure of audit and one that caused the biggest revolution of the accounting regulations. The total losses incurred by different shareholders totaled about $11 billion due to a drastic drop in the share price from US$90 in July 2000 to prices below $1 at the close of the year 2001. The company had to file for bankruptcy with an asset base of $63.4 billion. Executives were charged in courts with some even serving jail terms. The Audit Company was also guilty but had closed even before the court’s ruling due to loss of confidence by customers (Paul & Krishna, 2003, p5).
According to experts, the scandal came about mainly as a result of the culture adopted by the company in motivating the employees and making sure that they performed highly. The company was formed in the backdrop of deregulation effected on the pipelines which carried natural gas. Two companies, InterNorth, and Houston natural gas. The company had to come up with an appropriate strategy with the ability to not only create profits but also improve cash flows in the face of competition and high initial debt.
Jeffery Skilling a young expert previously involved in managing assets was handed this responsibility. He revolutionized the companies operations by creating a ‘gas bank’ incorporating a wide number of suppliers and a large number of customers and establishing contracts that guaranteed the prices as well as adequate supply and other risks. This was a strong base for the company’s operations. Skilling was later made the head of a new department called Enron Finance Corp in 1990. Under his watch, the company established many more contracts with suppliers and customers hence grew. The fact that the company dominated the market made it possible to accurately predict prices hence it was possible to ensure huge profits (Paul & Krishna 2003, p7).
Skillings’s efforts to develop a new corporate culture were well-intended but are mostly responsible for the collapse of the company. First, he focused on hiring the best labor in the market and even out-competed investment banks in the talent search. The remuneration program was one of the highest. The company afforded luxurious facilities for the workers which soared up the paycheck and the company’s expenses. More importantly, there was an extremely generous bonus program that had no defined ceiling. A 29-year-old Andrew Fastow rose to become the Chief Finance Officer in the year 1990. He oversaw financing in very complicated ways.
With all these measures, the company’s reputation rose. However, the introduction of the famous performance Review Committee (PRC) known as the roughest rank method gave a huge blow to the company’s culture of integrity. The intention to assess employees based on Respect, Integrity, Communication, and Excellence (RICE) was overshadowed by the need to grow earnings. Employees were thus motivated to develop new deals at whatever cost. This is because poorly ranked employees were immediately sacked with little regard to the long-term effects (Paul, & Krishna, 2003, p9).
This being the case, the stage was set for a fierce and unhealthy internal competition. The urgent need to close deals led many employees to enter into deals containing confidential and restrictive clauses. Many contracts became secrets as they did not meet the basic criteria for feasibility. These kinds of contracts accumulated over time especially with the expansion into the electricity market. The final product was that most of the company’s contracts were overrated which meant that the company had overstated its profits for years. This shows that the culture which emerged from the aggressiveness was that of poor integrity to ensure survival in the well rewarding company by the employees.
The failure of the company can also be blamed on external parties such as auditors, bankers, and attorneys who facilitated the activities. The bankers continued funding projects with no clear and accurate financial analysis to determine the feasibility. They issued a credit to the company solely based on the healthy financial standing portrayed by the company. The auditing company Arthur Andersen was even found guilty of not conducting professional work with revelations that the company had successfully managed to underestimate liabilities by huge percentages (Paul & Krishna, 2003, p22).
The chief financial officer Andrew Fastow was the worst culprit. Basic financial principles dictate that despite the need to grow and expand the business both horizontally and vertically, there is the need to ensure proper financial analysis is conducted to determine the financial feasibility of the engagement. This is by the use of cash flows expected as well as the returns to investment for each and every contractual agreement more so with the presence of the information available for Enron. It is clear that this analysis was either poorly done or not done at all. The CFO always seemed to apply too complicated financial analyses which were difficult to understand even for the company’s CEO.
Reference
Paul M. Healy and Krishna G. Palepu. (2003). The Fall of Enron. Journal of Economic Perspectives. 17(2). pp 3–26. Web.