Reflection on Enron Corporation’s Meltdown

It was mentioned during the case analysis report in our Lassallian Business Leadership class that the mighty Enron Corporation failed primarily because of its excessive corporate greed.

I refuse to believe, however, that its downfall was brought about by corporate greed. I refuse to use the word corporate greed because it does not connote any personal dimension in the ethical equation. It has no face.

I believe it was pure personal greed that ultimately brought down this huge corporation flatly on the floor.

Executives of the company individually held considerable volume of shares in the company.  Those shares had, most likely, influenced and impaired their decision-making faculties.  I believe that their decisions almost always took into account the price or valuation of the shares.

According to Wikipedia, “Although Enron’s compensation and performance management system was designed to retain and reward its most valuable employees, the system contributed to a dysfunctional corporate culture that became obsessed with short-term earnings to maximize bonuses.

Employees constantly tried to start deals, often disregarding the quality of cash flow or profits, in order to get a better rating for their performance review. Additionally, accounting results were recorded as soon as possible to keep up with the company’s stock price. This practice helped ensure deal-makers and executives received large cash bonuses and stock options.”

Because of this dysfunctional corporate culture, every employee’s goal would simply be for their own personal benefit. So the primary consideration in making decision is the short-term personal economic gain rather than the long-term viability of the business. Their decisions and actions were therefore ethically flawed from the very beginning:

Wikipedia, identified several causes why Enron finally folded. These appeared to have one single purpose—to keep the financials of the company appear to be so healthy to the eyes of the general public and to all shareholders, and therefore keep the value of the stocks up.

Revenue Recognition

Enron employed very aggressive accounting approaches. One of which was on revenue recognition. Since Enron was primarily into trading service, their income was the fees that they are paid for their services. The cost-of-goods or the selling price of the commodity, like the energy they were trading, were not supposed to be part of their income. But Enron opted to recognize it in their books. This made their income appear so pretty.

Mark-to-market accounting

Future receivable from signed deals were recognized regardless whether cash was already received or whether the deal would prosper in the long haul or would just go puff. Again this approach was meant to make the financial report of the company look so attractively good.

Special Purpose Entity

And when the company was facing the prospect of sustaining losses, they had a brilliant way of keeping those losses from the books of Enron by creating what they called special purpose entity like JEDI, Chewco, Whitewing, LJM and Raptors. These entities were just shell companies to which Enron dumped all the financial garbage generated by their botched deals. So Enron’s real financial condition remained under wraps.

Corporate Governance

Because of this false financial invincibility of the company, the company’s board was recognized as one of the five (5) best corporate board in 2000 by the Chief Executive Magazine. But looking at some key aspects of their corporate governance would show the insatiable appetite of people to profit and their hell bent approach of protecting their income to the point of covering up any tell-tall sign of corporate financial losses. Wikipedia cites the following:

1. Executive compensation

The executives of the corporation were so spoiled by their compensation package which included stock options. While many companies also use stock options as a tool to compensate their executive, in the case of Enron, it profoundly emphasized this type of compensation and every employee was always made conscious and aware of its price or value. It became some kind of fanatic indoctrination. As Wikipedia mentioned, “The stock ticker was located in lobbies, elevators, and on company computers. It caused the management to create expectations of rapid growth in efforts to give appearance of reported earnings to wallstreet’s expectations”

2. Risk Management

Perhaps because of the genius of the people behind Enron, the business community was never aware or did not have any idea that the company “was lauded for its sophisticated financial risk management tools.”

 Little did they know that Enron was engaging in some business paradigms that were teeming with so much risk. “Its reckless use of derivatives” contributed to its financial woes. Derivatives are a form of financial instrument which is akin to gambling because it is some kind of betting to the value of a certain asset.

 They also created entities to handle these derivatives and prevented loses of these shell entities to be recorded in Enron financial reports. The actual risks however remained with Enron being the owner of the entities.

3. Financial Audit

 Because of the prospect for financial windfall, even their external auditor, Arthur Andersen, which is supposed to help the company monitor its financial health so that the company can make sound judgment, succumbed to pressure of keeping their rewarding high-value engagement with Enron. “During 2000, Arthur Andersen earned $25 million in audit fees and $27 million in consulting fees.” Because of this conflict of interest, “Arthur Andersen, was accused of applying reckless standards in its audits.”

 4. Audit Committee

 The company’s audit committee could not seem carry out its mandate also. Members were probably so complacent and totally confident that the company was perfectly doing great. The committee “was holding brief meetings that would cover large amount of materials to go through”.  It was also contended that “the committee was also unable to question the company’s management due to pressures. There were also suspicions of the conflicts of interest in the members of the committee”.

So in a nutshell, people running Enron Corporation and their greed ultimately caused the death of the corporation.