Assignment 2

Question 1 What led to the eventual collapse of Enron under Lay and Skilling?

The eventual collapse of Enron under Lay and Skilling was due to leadership of  top management management and corporate governance governance issue that lead to the corporate culture of the company. It was not the doing of one person but a group of them and an ineffective system. The exercises done by Lay and Skilling is hard to prove that they were violating laws, but it is the two of them that created the corporate culture culture that portraits their belie fs and instill them into the corporation. corporation. But it would be safe to say that the two were the one who were portraying as pushing the envelope. What Lay and Skilling practices in the corporation is a total contrast with the code of ethics of Enron. Enron¶s et hics code was based on respect, integrity, communication communication and excellence. The core of these values was to enhance trust and transparency to the public by gaining their confidence through the integrity of its workforce. The activities of top management, Lay and Skilling, not only did not adhered to the values of respect, integrity, communication and excellence articulated in the Enron Code of Ethics but totally undermine undermine the foundational values of Enron Code of Ethics. The problem does not lie within the Code of Ethics of Enron; in fact, the code of ethics of Enron is well structured and strong, but is that the top management did not walk the talk. Lay and Skilling sidestep to the Code of Ethics and conducted the business of  Enron under their own corporate culture. That is with greed and intimidation. The top management was constantly pushing its employees to meet the sales target regardless of ethical behavior. The unspoken message message was, µMake µ Make the numbers ± if you steal, if you cheat, just don¶t get caught. If you do, beg for second chance, and you¶ll get one.¶ This aggressive earnings management style forces employee to try to achieve targets regards of any moral and ethical value. To the employee¶s employee¶s understanding understanding is that if the top management management and other employee employees s are doing it, then it must be alright. The T he leadership leadership of Enron plays an important part in defining it employee¶s ethical behavior. A perception that if  everyone is doing and is being rewarded then it is alright, it is not about illegality but about the morality and ethics of all of those involved. Lay and Skilling has made it culture where it influenced employee into believing that what they were doing was legal although it was immoral and quite unacceptable in normal circumstances. circumstances. Besides that, Skilling also implemented implemented a very rigorous and

threatening performance evaluation process for all Enron employees known as the µrank and yank¶. This evaluation process uses peer evaluations and each of  the company¶s divisions need neither rhyme nor reason to fire t he lowest raking one fifth of its employees. This created a dividend corporate culture as employees would frequently under rank their peers in order to enhance or maintain their own positions in the company. Employees became very aggressive towards each other as the working environment became the survival of the fittest. What was worst is that Enron¶s compensation plan was seemed to enrich executives rather than generating profit for shareholders. Employees were encouraged being creative and thinking out of the box; breaking rules, and inflate the value of the contracts even if there was no actual cash generated. This trend became so widely spread that employees were using this method to hide losses and avoid the consequences of taking responsibility to the problem. The integrity of the company was tarnish as a result and employees are working on understandings that if no one finds out, keep quiet. By alienating employees and the separation business unit and other division, information flow within the company became limited and blurry. Only a hand full of executive in the company would have the µbig picture¶ in perspective of the company¶s operations. This decentralization created an information asymmetry that lead to the inefficient and ineffective management , accountants, auditors and lawyers. Lay and Skilling¶s action is total contrast of the code and ethics, instead of  empowering employees with information, they separated and alienated the workforce so that top management would be able to manipulate them ea sily. The lack of information on the company¶s actual performance and the trust employees have for Lay and Skilling resulted in the investment of employees pension fund into the complex financial instrument. These blind trusts and ignorance eventually lead to the loss of all employees pension fund when Enron collapsed. As said before, the problem did not lie within the code and e thics of  Enron, but the leadership from top management that creates the corporate culture. Aggressive, intimidation and greed were the main culprits that lead to the down fall of this giant. (Total word count: 794words)

Question 2 How did the top leadership at Enron undermine the foundational values of the Enron Code of Ethics?

The top leadership at Enron undermines the foundational values of the Enron Code of Ethics by not walking the talk. The Code of Ethics of Enron was concern with integrity and respect. The 64 page long Enron Code of Ethics in accordance to Lay, was a reflected policies approved by the board and company, which enjoyed a reputation of being fair and honest. Another respected quote that the board highly respected was about the integrity, respect and excellence that every Enron employee should uphold. As it is noted, the code and ethics of  Enron is strongly emphasizing on the respect, integrity, communication and excellence. The top management first undermines the value of respect by integrating an aggressive peer evaluation. There was not tolerance for failure; failure only meant that the employee would be immediately replaced. The management did nothing to treat others as the way they treated themselves. Top management was abusive and ruthless in their decision making. Example of  this is the implementation of the rigorous and threatening performance evaluation process that is done for all Enron employees. This process alienated everyone as employees tend to rank their peers lower in order to enhance their own position or to their own benefit. The value of respect was not present in the working environment in Enron. The next core value of the code of ethics, integrity, totally ignored. The value emphasize on openly, honestly and sincerely when working together with customers to achieve their needs, and fore coming in the things they can or cannot do. In actual fact, the employees of Enron were told to do a whole different thing when it came to practical application. Management created a culture where they led employees to believe that there are no such things as too much risk or there is nothing that cannot be done. The statement was µget things done regardless of consequences, cheat, and steal if  you have to in order to achieve the goal¶. This working environment not only did nor promotes integrity of employees but encourage employees to do unethical and immoral actions just so that they could satisfy the financial numbers. The third value of the code was communication. The code address that the need to listen and exchange information with fellow employees, as it bel ieves information is vital for the company to further expand. But in practice,

management kept Enron¶ s divisions and business unit separated from each other. The departments were not integrated together but decentralized from each other to the extent that very few people in the company would have a the µbig picture¶  of the company. As a result from this decentralization, communication was not fluid and operations and financial controls did not work as efficient and effective as it hoped for. Information was limited or hard to obtain, creating a gap in the actual financial position of the company to the employees. That is why, when Enron collapsed, most employees were shock as they had no idea that the company was in debt and could not comprehend that all the ir life savings were gone. Excellence is also imbedded within the code and ethics of Enron. The code encourages continuous learning and expects the very best from its employees, but in actual fact, management did nothing to promote this. No further education, no team building projects, nothing. All the management did was decentralized and intimidate employees and brainwash employees to accept it is alright that what they are doing is unethical as long as it is legal . An example is the compensation plan that Enron created. The plan seems to be oriented in enriching executives more rather than maximizing shareholders wealth. Furthermore, this plan actually encourages the use of non standard accounting practices to inflate figure of the deals in the company¶s b ooks. Lay and Skilling had the power to shape the company¶s corporate culture to their liking and there was no regulators aware for the dealings was due to close relationship it had with its auditors and bankers. As the corporate culture was the management to shape, the values of the code of ethics were undermined. These values were undermined though the leader¶s emphasis on decentralization, employee performance appraisal and compensation program. Thus, the actions of Lay and Skilling were a total contrast on the vision and expectation of the Enron¶s code and ethics. (Total word count: 723 words)

Question 3 In retrospect: given Kenneth Lay¶s and Jeff Skilling¶s operating beliefs and the Enron Code of Ethics, what expectations regarding ethical decisions and actions should Enron¶s employees reasonably have had?

From the operating beliefs of Lay and Skilling and the Enron Code of Ethics, the employees of Enron would reasonably believe that what they were doing was legal even though it was totally immoral an d quite unacceptable did not worry them at all. Lay and Skilling¶s action were a total contrast of the Enron Code of  Ethics, but employees that follow the lead of Lay and Skilling were rewarded where as the other were either fired or was not able to get a promotion. This corporate culture created by Lay and Skilling made employee of Enron disregard morality and ethical decision by rewarding them with financial gains and acknowledgement. Like the unwritten statement, employees were expected to perform, disregard what methods and ways it takes. Management was just interested in results and not excuses. In retrospect, Enron¶s employees should have the qualities of a good employee that is to have integrity and honesty, strong work ethics and professionalism. Even though with the pressure given by top management, employees should not succumb to pressure knowing that it is unethical and immoral. Employees reasonably should have a strong work ethics, which is in addition to working hard; employees are expected to wo rk smart. It is important to care about the task and job that is being carried out and not just follow instruction to the word regardless of the actual intention. For example, if you find out that some of the figures in the books do not seem right, it is t he responsibility of employees to point out to management and inquire the nature of the transaction. Do not simply close an eye because it is the corporate culture of the entity. Employees must be confident in voicing out their concern. If the manager does not address the problem, bring the problem to the higher management until someone acknowledges the problem. Employees need to be proactive in solving problem and not passive just because it is the norm. Other than that, honesty and integrity is should be one of the core values that employees should have. It is the employees¶ responsibility to use their own individual judgment in evaluating the sense of moral and ethical behavior when working and serving others within

the job scope. As mention before, one should not just give into peer pressure. Last but not the least, professionalism should be always be conducted by employees. Employees like auditors and regulators should maintain their professionalism at all times. Meaning they need to be objective and ind ependent in making sound decision by exercising their professional judgment. A professional and responsible employee would be like Cynthia Cooper in the case of Worldcom. Employees of Enron should reasonably have had the qualities of  the above and more. Sometimes it is hard to voice out opinion when the crowd is so stuck on their comfortable believes, but it is the responsibility and duties of  employees to correct any wrong doing of the employers. Integrity and honesty should be hold closely to the heart of every individual, as it is every individual¶s responsibility to use their own judgment in deciding ethical issue and not just bend to the pressure of wrong doers. (Total word count: 528 words)

Question 4 How did Enron¶s corporate culture promote unethical decisions and actions?

Enron¶s corporate culture promoted unethical decisions and actions by implementing aggressive management style, aggressive earnings management and ignorant employees. The corporate culture that is formed by Lay and Skilling is a very aggressive goal orientated and performance driven environment. Not only does employees are expected to perform, they were also expected to not ask questions. The ag gressive management style occurs from the implementation of the strict, meticulous and threatening performance evaluation. The management emphasized heavily on results, and the performances of the employees are constantly under the evaluation of their peer s. Any underperforming employees would be sacked and replaced. This creates a very aggressive environment by nature and pushes employees to be hard headed on results, regardless of any ethical issue. When there is fear of losing the job driving the workforce, employees tend to make any decisions that would bring profit into the company. The corporate culture created by Lay and Skilling made, or I would say, force employees to forgo their moral and ethics in order to bring in profit to the company. Many of t he employees acknowledge the fact that their actions may be unethical, but as long as it is legal they have no problem with it. Intimidation and fear is one of the few factors that drove the unethical decisions and actions of Enron¶s employees. Other than that, the corporate culture of  Enron has been described as having a culture of arrogance that led to people believing they could handle greater risk without any danger. That resulted in aggressive earnings management, in which resulted the employee manipul ating and inflating the valuations of contracts. Due to the compensation plan, employees are encourage to be creative in adjusting and inflating and even rule breaking when it comes to financial figures, because the performance of the contract would in turn yield financial benefits to them. The compensation plan is seemingly drafted towards enriching employees more than to maximize shareholders wealth. Unethical behavior and actions is widely seen throughout the company as it was a norm to hide financial lo sses so that they need not own up to the responsibilities. Lastly, ignorant employees also resulted in the unethical behavior. Lay constantly made rosy result to employees through

internal announcement system, and because of his charismatic and inspiration al words, Lay is able to pull the trust of the employees to believe that the company is in fact doing very well. This lead employee to believe that the every act they are doing now, although unethical, is profiting the company and thus enriching themselves as well. The worries of any unethical behavior or actions would be instantly resolved as the fact that the company is making progress. This is how the corporate culture shaped by Lay and Skilling led to the unethical behavior and action of its employees. (Total word count: 484 words)

Question 5 How did the investment banking community contribute to the ethical collapse of Enron?

The investment banking community contributed to the ethical collapse of Enron by assisting disguises to the company¶s deteriorating financial position. The banks either colluded or work together to the questionable transactions. Enron was able to lie to investors about its financial standing because it has assistance from its bankers. The banks were mainly Citigroup, JP Morgan and Merrill Lynch, and instead of protecting the stakeholders¶ interest, the banks colluded with Enron to commit fraud (Epstein, 2003). The banks not only willingly participant knowing the implication but also made a handsome profit from it. It all started off as a close relationship between Enron and the banks, most notably Citigroup and JP Morgan. The two have been good friends and very closely related to Enron from its early days, hence the diminishing of  independence. Because of the close relationship, Enron had an advantage over competitors in loans and is able to avoid takeovers. The independence of the bank was questionable right from the start as the banks gave preference loans and provided advice on the company on its businesses. Not only the banks assist Enron financially, they also assist them in increase income or removing losses from balance sheet, cooking the books for Enron so that they have a tidy and steady profit along the way. One of the findings from the news is that, these banks helped Enron camouflage more than $8 billions of dollars in loans, all without disclosing them to shareholders. Other than that, it was found that one of the banks intentionally misrepresented one of the transactions with Enron in the records of the deal so that accounting standards could be ignored and Enron is able to hide its true financial position. Not only did the banks understand the intention of Enron in fraudulent activities, they actively assisted them as well so that in return, the banks also manage to ea rn a handsome profit and other continuous profitable dealings . Due to the nature of relationship between the banks and Enron, the banks have already known that Enron was not performing as well as it was stated in the New York Stock Exchange (NYSE). So in o rder to safeguard the investment that they lend to Enron, these banks hedge various dealing that they transacted with

Enron with other insurers so that the insurers company would bare all the risk if  Enron ever goes under. For example, Citigroup started up complex financial instrument that acted like an insurance policy (Epstein, 2003). When Enron stay health, investors of the instrument would receive dividends or returns. On the other hand, if Enron goes bust, Citigroup stop paying the returns and keep all the investors¶ initial investment and pass Enron¶s debt to them. This means that investors are the owner of Enron and would receive steady return, but when during a downturn, these same investors are liable for all Enron¶s debt. Not only did the banks collaborated with Enron in to misleading shareholders, they profited by trading with insider information on the actual financial condition of the company, and the worst thing is that, knowingly that the company is losing money, in order to safeguard their own investment in Enron, the banks actually drew up complex financial instrument to mislead investors to take over the liabilities they have. The banks were unethical and immoral. There was no sense of responsibility towards the shareholders and stakeholders, bankers were only operating under the intention to safeguard themselves and profit from the mishap of others. They were greedy and selfish. Banks actually empowered Enron to be more daring in cheating shareholders money by collaborating in assisting Enron to cook the books to their advantage. (Total word count: 622 words)

Question 6 If the Sarbanes-Oxley law had been in effect, do you believe the Enron debacle would have occurred? Explain.

If the Sarbanes-Oxley (SOX) law had been in effect, I believe the Enron debacle would still occur but in a smaller scale. SOX mainly made up from rule based standards, meaning that companies needs to follow the law to the word. SOX seek to prevent future Enrons by empowering audit committee and redefine membership eligibility on this committee. For example, SOX gives audit committee more power in the sense that they now have more responsibility in the preparations of financial statements, independence of au ditors are taken more seriously, make sure that the entity complies with legal and regulatory law and demands more integrity from the committee. The word µindependent¶ is defined as not having any close relationship between the management; CEO, CFO and so on, and SOX want a minimum of three independent individual as audit committee. On top of that, these members must be financial literate; accounting or finance background, and at least one member who is a financial expert; ACCA, CPA or equivalent holder. SOX lack the fundamentals that require companies to proactively prevent and detach fraud; the act mainly requires just detailed documentation of procedures. All these rules set up by SOX intents to prevent future financial scandals but in actual fact, the core problem is greed, a human nature. All SOX has done is to minimize the impact of future scandals. The real problem in Enron was it management behavior and its corporate culture. Lay and Skilling¶s management method demands results over ethics and encourage its employees to bend the rules to their advantage. The top management did little to promote the integrity of the company and did more to tarnish it. The aggressive management of Enron employees causes employees to go against the corporate code of ethi cs. It was clear that if one did not perform, that person would be kick of out the company. And if a person who would achieve target regardless of the consequences would be promoted. The departments of Enron were all separated and decentralized, thus, no one employee has the big picture of the company¶s performance. As employees are ignorant, that made them gullible to invest their life savings in Enron shares with a clause. Other than that, the promotional method of Enron

seeks to enrich executives instead of generating profit of shareholders. Employees were configured and brainwashed to perform for their own benefit. Intimidation and greed was instilled in the corporate culture of Enron. Therefore, even with SOX at that time, the financial scandal of Enron would still be unavoidable because the root of the problem is the greed of top management. SOX may reduce the damage done, but it would not totally diminish the probability of it from happening. That being said, SOX has done a great deal in reducing anoth er Enron from happening. However, the main reason that fraud happen is because of human nature, greed. So in my opinion, there will always be future financial scandals but it would probably be less major than Enron due to compliance like SOX and others. (Total word count: 511 words)

Question 7 Could another Enron occur now? Why or why not? Explain.

Yes, in my opinion another Enron could occur and have occurred now even with so many regulations and standards because there is no amount of control that can prevent a determined individual or group from committing fraud. After the fall of Enron there was Worldcom, then followed by the fall of Lehman Brother¶s to the financial bailout of AIG and the more recent even the Goldman Sachs scandal, all this are evidence that another Enron would occur. Although after the collapse of Enron, the Sarbanes -Oxley act has had a positive impact on all the industries where by entit ies now are more aware of the importance of independence of regulators and leader and ethical awareness of  management, the Act can only act as measure to reduce the chances of fraud from happening and not total prevent it from happening. Regulators and auditors can only do so much as to keep guard on the dealings of businesses and ensure them to fall within the boundaries of the law and regulation, but if there was someone whose intentions are set on committing fraudulent activities, regulators and auditors may not be able to identify them. As the saying µwhen there is a will, there is a way¶, it also applies to fraudulent activities. Standards and regulations can only do as much as to monitor and pick out potential wrong doings, but if an individual is well verse in the regulations and standards, he/she would know how to manipulate the laws and regulations to their own benefit. The main issue that would cause another Enron to occur is the greed of humans. With SOX, the board and officers of the company have more responsibility in protecting the interest of stakeholders now, it would be foolish if they board were to succumb to the temptation of greed as the penalty would be more severe. Standards and regulations are only a set of guidelines and procedures to e nsure the preparation of financial statements are prepared in a truthfully represented manner. The problem that lead to Enron and other financial scandals were due to ethical behavior of top management. Management became greedy because directors remunerations are tired closely to the earnings of the company, so in order to get more money, directors have the intention to manage earnings and to cook the books to get figures they favor. There will always be people in high

positions who have too much ambition, power or ego. Therefore, besides implementing standards and regulations, educating the next generations leaders are also a must. Business ethics must be taught to the next generation as thi s is would increase the awareness of the after effects of fraudulen t activities. It is human nature to agree with the doing of friends and close members of the family. For example, the manager finds out that his sister, employee of his company, is stealing money from the company. It is a dilemma for him as whether to inform the management or protect his sister. Fraudulent activities are usually started up from a simply but ethically wrong act. People tend to look the other way when it requires them to stand up and voice out their concern. Therefore it is necessary to educate employees and employers on the gratification of fraud. In my opinion, to fight fraudulent behavior, we must first fix and build a strong foundation, in this case, a strong business ethics foundation. The setting up of SOX and other regulatory are just a way for auditors and regulators to keep the business in line. It is a check and balance method. In my opinion, scandals will continue to happen when there is greed, ego or too ambitious people around, laws and regulations just makes it hard for these people to commit the crime but will not be able to stop or put an end to fraudulent activities, but I doubt that anther Enron scale of scandal would appear with the proper education and guidance provided by society now. (Total word count: 692 words)

R eferences

Corporate Governance and Accountability 3th Edition, 2010, Jill Solomon Managing Business Ethics 4 th Edition, 2007, Linda K. Trevino & Katherine A. Nelson Structured Finance: The Enron Debacle website (http://www.uow.edu.au/~bmartin/dissent/documents/health/citienron.html ) How Not to Prevent another Enron, 2003, Richard A. Epstein What Caused Enron to Collapse? , 2005, Joseph Nicholson Wall Street Meltdown: Unlearned Lessons from Enron, 2008, Peter Galuszka