Corporate governance Enron Case study

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CORPORATE GOVERNANCE: ENRON CASE STUDY 13

Corporategovernance: Enron Case study

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Corporategovernance: Enron Case study

Contents

Abstract 3

Enron Scandal summary 4

Criteria for the review of organization’s governance 6

Moral theories in the Enron Case 7

Enron’s corporate governance and related issues 8

Recommendations 9

Conclusion 10

References 11

Corporate governance: EnronCase study

Abstract

Thesuccess of any institution is highly dependent on how the managementgoverns its operations. In the current business setting, corporategovernance has taken the center stage of any leadership. Manycompanies have been criticized in regards to their respectivecorporate governance. Corporate governance, according to Kimand Nofsinger (2007), is a set of rules that shareholders se to makesure that firms in which they hold shares in, are governed in linewith their individual interests. Theconcept of corporate governance is currently being much moreformalized through enterprise agreements across the world. The greatcrisis and bankruptcy which started to come out in the diversesystems and corporations in the recent days have caused the need totransform the practices of corporate business. Due to these factors,it is a norm that any government that comes into a corporate worldhas to make every attempt to normalize its market functioning payingmore attention on capital markets. This paper focuses on the idea ofcorporate governance in relation to Enron which has had a scandalthat has been publicly criticized. The paper will employ theaccounting and audit practices in the company to come up with anintensive report on corporate governance.

Enron and its Background

In 1985,Kenneth Lay saw an opportunity and implemented it to form Enron. Thecapitalization was a result of the deregulation of the natural gasindustry in the United States of America. The company grew up tobecome one of the leading energy companies in the country. In 2001,Enron was ranked as one of the best companies by the fortune magazine(Sterling, 2002). In that year, the company had the marketcapitalization of about five hundred corporations biggest in the US(Sterling, 2002). Shareholders of the company rose from $19.10 in1999 to $90.80 by December 2000, making the company to appear as themost profitable companies.

It tookthe company only seven years to become a successful company in theindustry. By the year 1992, Enron was the largest dealer of thenatural gas in the region of North America. By that time, thebusiness of gas trading became the second largest contributor to thenet income of Enron, with earnings before interest and taxes of $122million (Sterling, 2002). The company further developed as a resultof the invention of online trading model, which was known asEnrononline in November 1999. This creation enabled the company toextent its capabilities of negotiating and managing its tradebusiness. In what is termed as an attempt to attain further growth,the company pursued a diversification strategy. By 2001, Enron haddeveloped to become a conglomerate that owned and operated gaspipelines, pulp and paper plants, electricity plants, broadbandassets and water plants globally. The corporation also traded infinancial markets for the similar products and services. The stock ofthe company as a result, rose from the beginning of 1990s to end year1998 by 311%. This is a substantial increase over the rate of growthin the standard and Poor 500 index. The stock increased by 56% in1999 and an extra 87% in 2000, compared to a 20% increase and 10%decline for the index during the same years. By the end of the year2000, the stock of the company was prices at $ 83.13 and its marketcapitalization exceeded $60 billion (Thompson,2010).

EnronScandal summary

This isa scandal that is considered to be the most notorious in the historyof America. Many economists and historians consider this scandal tobe an unofficial blueprint for a case study on White Collar Crime(Zandstra,2002).This is a crime is a non-violent, financially-based illegitimateactivity naturally undertaken within a setting in which its partakersretain progressive education with regard to employment that iswell-thought-out to be prestigious. In the midst of the scandal,various issues took place. Lay’s company had experienced a swiftand abrupt collapse in the value of their market. In regards to thischange in value of the giant energy company, there have been variouseffects that affected all the shareholders of the company includingemployees of the creditors as well as auditors. The economy of theUnited States was greatly impacted by the failure of Enron. As aresult of the failure of the economy, many investors as well asbusinesses also felt the impact (Sehgal,2011).Prior to its failure, many institutions in the country including theCongress Representatives were in favor of the deregulation ofbusinesses. While the collapse of the company offered a momentumdebate of deregulation vs. regulation, it has become a vivid factthat the collapse of Enron gave birth to some severe consequencesthat have had an effect on political, social and economic aspects ofUSA (Thompson,2010).

(Hatch,2006)

Thecollapse of Enron caused severe effects to a number of partiesincluding banks, stockholders, former employees and politicians. Withthe company being liable for up to $3 billion in debt to variouspartnerships, its collapse was assured. The value of stockholdersequity was reduced by $1.2 billion by Wall Street which the companydid not announce at the time. As a result of this, there were stocklosses in the billions. The devaluation of the equity of the companyled to its delisting from the New York Stock Exchange. The employeesof Enron found themselves unemployed with valueless 401k accounts,which left their retirement funds nearly empty. As a result of itsbankruptcy, JP Morgan Chase and te Citibank grop announced losses of$ 456 million and $228 million. Furthermore, political parties whoaccepted contributions from the company found themselves in positionswhere refunding Enron or bequeathing them to a generous cause was theonly options. Even though various stockholders had lost a lot, themost injured people were the employees of the company (Freeet al, 2007).The employees were given and encouraged to invest in the stock of thecompany which was worth nothing at the moment. The irresponsible andselfishness acts of Enron have cost many of their loyal workers theirearned security and intolerable thoughts of what their future willhold.

Criteriafor the review of organization’s governance

Reviewinggovernance structure and processes offers a significant turning pointfor any organization. Management roles and processes have a profoundinfluence on the ways organizations function and the way theyperform. In reviewing the governance of Enron, there are basicprinciples that will be assessed (Sehgal,2011).These principles are:

  • Owners, or their representatives in the company, need to institute, plainly, an understanding of success for the activity, including their anticipations of performance. Under this principle, the owners of Enron need to set the purpose of the company clearly and state their hopes of performance.

  • Governance ought to be present and the schedules should be suitable for the body given the ownership nature and its functions. The applicable organizational structure will fluctuate from entity to entity and will depend on roles, density of operations, ownership traits and objectives.

  • To be effective, power must be: in existence delegated restricted and exercised. Power frameworks will impact the efficacy and effectiveness of decision-making process and the ability of decision-makers to come up with quality outcomes (Hatch, 2006).

  • There has to be precision of roles within the governance activities of organizations to guarantee that efforts are focused towards success and that errands are performed in an effective manner. The owners, managers and governors of an organization ought to have a clear understanding of their roles and duties.

  • With accountability there needs to be responsibility (Kim and Nofsinger, 2007). Individuals should comprehend what they are required to accomplish, have the aptitude to attain and be held answerable for their performance.

  • For a board of managements to be operational, it must have the full authority to act, including the capacity to appoint, oversee and remove senior executive as well as approve strategy.

Inmaking this principles work for Enron, an executive board template isproposed. There are various benefits that can be achieved throughthese principles (Freeet al, 2007):

  • It will improve the transparency and accountability of legal authorities through:

– Clearand transparent lines of culpability

– Clearunderstanding of duties

– Clearlyvoiced and openly available aims and strategies

  • They will improve efficacy of statutory authorities through ensuring:

  • There is effective control of management

  • The management is answerable for its performance

  • The effort of authorities is focused towards the attainment of well-understood goals.

  • They will improve the effectiveness of legislative authorities through evolving a sound understanding of what they are required to attain resulting in:

– Higherquality services

– Betterguideline.

Moraltheories in the Enron Case

Themoral frameworks and theories that apply to this case study arefairness, common good, utilitarian, and agency approach. Although allof these theories apply to the case, each choice that was maderegarding them has been the incorrect choice. Enron has not yet seenany single example of an executive making a decision that isethically sound, and in the best interests of the firm, and itsstockholders (Thompson,2010).Due to accounting frauds of companies such as Enron, SEC has startedtaking great steps in averting loopholes within accounting anddisclosure system. The Financial Accounting Standards Board has begunto initiate regulations and standards that are more direct and easyfor the organizations to comprehend (Kimand Nofsinger, 2007).

It isbecause of the accounting frauds that happened in the Enron scandalthat several accounting firms have started reorganizing their staffstowards remaining loyal to the ethical standards that are demanded bySEC. These firms are taking the role of irregular auditors andadhering to a nonstop review process of every auditing report. Thereis a need to have some form of regulation of ownership of bothauditing and services of consulting by the same accounting firm. Thecase of Enron demonstrates a number of flaws in the reporting system,which needs to undergo thorough re-estimate and criticism beforemaking any instant alterations (Free et al, 2007).

Enron’scorporate governance and related issues

Theimplications of the collapse of Enron has led to a massive revisionsof inter alia, the role and independence of auditors, the role ofaudit committees, the role and independence of non-executivedirectors, the role of investment analysts and investment banks(Rapoport et al, 2009). Nearly all the existing economies are raisingquestions on business ethics, including the implications of theexcessive compensation paid to CEOs and executives in many cases.Most of the focus on the finances of Enron was emphasized on itsbalance sheet. To be specific, the focus was on how the company hiddebt by allocating it to allegedly self-governing private partnership(Hatch, 2006). During its inception, Enron used projectfinancing method for financing the independent power projects. In sodoing, the lender assesses the assets and cash flows of the projectand maintains it as collateral against the loan. It is essential toinitiate a long term contract in for selling the asset output, in thecase of Enron, the output was electricity. Bit by bit, the lenders’experience as well as those of the developers increased manyfinancial institutions and banks plays an active role in thefinancing of the project. In the course of 1980s, there were variousprimary institutions of finance that offered loans to power projectsincluding oil and gas exploration, and mining. The institutionsincluded Citibank, Chase Manhattan bank, and Morgan Guaranty. Thesewere the basic financiers for Enron Corp (Kimand Nofsinger, 2007). Theprinciples of excellence, ethics and corporate responsibility werethe hallmark of the business strategy of Enron. Nevertheless, thescandal began when the organization was using practices of accountingthat raised many questions in an effort of ensuring that its creditrating is maintained (Zandstra,2002).In this case, the culture of the organization was to be blamed forthe disaster of Enron. Organizational structure is a combination ofshared principles, assumptions, beliefs, attitudes, expectations andnorms. The culture enables managers to support the business strategyof the organization, make staffing decisions, and guide the nature ofconventional interpersonal relationships in the company among otherthings. It is through organizational structure that consistency to anorganization is provided through integrating different elements intoa coherent set of beliefs, assumptions, values and resultantbehaviors (Madsen &amp Vance, 2009). All through theexperience of the existence of Enron, there have been extremes oforganizations that work in global context and capitalist economies.According to Carroll (2009), within a span of one year, the companydrew from being a stamp of the most innovative company model ofethics, most focused and benevolent, social responsibility andsuccess driven company to an indication of greed, mismanagement anddeception. Enron represents one of the best organizations in the 21stcentury in economical and ethical terms. The company had a verymodest start in 1985 with a merger of two pipeline companies inHouston. In terms of strategies, Enron redefined its business in 1988from being energy delivery to energy broker due to deregulation inelectrical power market. According to Sims and Brinkmann (2003) Enronswiftly shifted from a surviving company to a company that isflourishing.

Recommendations

Inregards to the scandal surrounding Enron, various recommendations arehighlighted to be considered (Zandstra,2002).Some of the recommendations are:

  • There should be an independent audit partner that understands the role of being a &quotpublic watchdog&quot with &quotultimate loyalty to the creditors and shareholders

  • There should be a restructuring of professional operations by the regulatory environment in regards to the collapse of Enron. According to Ramsay (2000) report, the audit autonomous supervisor board ought to be launched to monitor audit processes of firms, and monitor agreement with non-audit service fee disclosure and the audit team should monitor the independence and effectiveness of the auditor.

  • The company should avoid putting pressures on balance sheet, which means that issuing shares would go to an associate and then go to the public, the cash of which would come back to the company through paying off the note or related receivable (Dnes, 2005).

Conclusion

Thispaper has addressed issues relating to the corporate governance ofEnron. The Enron scandals, among other corporate scandals in theUnited States have led to a wide ranging re-evaluation of standardsfor corporate governance with repercussions that extend to financialregulation. The actions and behavior of the executives at Enroncommunicated critical messages to others in the organizationconcerning the ethical environment of the company. Its cultureappears to have formed an environment that is suitable for theillegal and unethical conduct. Every industry incorporates acollection of entities that have unique cultural backgrounds andhence there is inevitability of conflicts when it comes toorganizational life. The complex structure of Enron was far away fromthe imagination of the people. The company, being one of the largestcompanies in the country, and whose businesses went across severalindustries and continents, it was almost impossible and veryexpensive to trace each transaction. This implies that an audit basedon transaction did not suit the company. Such a strategy would have avery huge risk. The predominant aspect behind the bankruptcy of Enronwas due to the illegal use and fraudulent practice at the company.These practices were employed by external auditors hired by Enron.

References

Carroll, A.B. 2009. A threedimensional conceptual model of corporate performance. Academy ofManagement Review pp. 497-505

Dnes, A.(2005). Enron, corporate governance and deterrence. Managerialand Decision Economics,26(7), pp.421-429.

Free,C., Macintosh, N., Stein, M. (2007), “Management Controls, theOrganizational Fraud Triangle of Leadership, Culture and Control inEnron”, IveyBusiness Journal Online,90(3), pp.54-69

Hatch,M. (2006), OrganizationTheory, Modern, Symbolic and Postmodern Perspectives,Oxford, Oxford University Press, pp.21-26

Kim, K.and Nofsinger, J. (2007). Corporategovernance.Upper Saddle River, N.J.: Pearson/Prentice Hall.

Madsen,S.&amp Vance, C. (2009), “Unlearned lessons from the past: aninsider`s view of Enron`s downfall”, CorporateGovernance,9(2), pp.216-227.

Rapoport,N. B., VAN Niel, J. D., &amp Dharan, B. G. (2009). Enronand other corporate fiascos: the corporate scandal reader.New York, Thomson Reuters/Foundation Press pp.125-135

Sehgal,B. (2011). Emergingtrends in corporate governance.

Sims,R., &amp Brinkmann, J. (2003), “Enron ethics (or: Culture mattersmore than codes”, Journalof Business Ethics,45(3), pp.243-256

Sterling,T. F. (2002). TheEnron scandal.New York, Nova Science Publishers. Pp. 145-150

Thompson,R. (2010). Corporate Governance After Enron: The First Year. SSRNElectronic Journal.

Zandstra,G. (2002). Enron, board governance and moral failings. CorporateGovernance: The international journal of business in society,2(2), pp.16-19.

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