Ethics and Enron

Question 1: How did the Corporate Culture at Enron contribute to its bankruptcy? The corporate Culture at Enron could have contributed to its bankruptcy in many ways. Its corporate culture supported unethical behavior without question for as long as the behavior resulted in monetary gain for the company. It was describe as having a culture of arrogance that led people to believe that they could handle increasingly greater risk without encountering any danger. Its culture did little to promote the values of respect and integrity it instead rewarded ‘innovation’ and punished employees deemed week. The performance evaluation process for employees that was dubbed “rank and yank” utilized peer evaluations, and each of the company’s divisions was arbitrtly forced to fire the lowest ranking employees. This created cut-throat competition not only against Eron’s external competitors but also within the organization. It pitched employees against each other. The internal rivalry created in turn contributed to less communication between operations for fears of being fired. The “survival for the fittest” atmosphere reached the point where illegal activity was deemed necessary to stay on top of the game. Enron’s compensation plans also seemed less concerned with generating profits for shareholders than with enriching officer wealth. Its culture encouraged flaunting the rules and even breaking them. Each Enron division and business unit was kept separate from the others and as a result very few people in the organization had the big picture perspective of the company’s operations. All these aspects of the corporate culture at Eron contributed separately to its eventual bankruptcy.

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Question 2: Did Enron’s Bankers, auditors and attorneys contribute to Enron’s demise? If so, what was their contribution? Yes the bankers, auditors and attorneys contributed to Enron’s demise. This is because they took sides with Enron’s management instead of acting impartial and professionally. They contributed in Enron’s demise in the following ways:Banker – Merrill Lynch It facilitated Enron to sell Nigerian Barges therefore making Enron record about $12 million in earnings and thereby meet its earnings goals at the end of 1999. This was a sham. It facilitated Enron in fraudulently manipulating its income statements by entering into a deal whereby Enron would buy Merrill Lynch in 6 months time with a guaranteed 15% rate of return. Merrill Lynch replaced a research analyst after his coverage of Enron which displeased Enron’s executives. This coverage would have saved Enron from demise if Merrill Lynch would have prevailed upon Enron to implement it. Merrill Lynch gave in to threats by Enron that it would be excluded from a coming $750 million stock offering and instead, the replacement analyst is reported to have upgraded his report on Enron’s stock rating. This was unethical and unprofessional.

Auditors – Arthur Andersen LLP They were responsible for ensuring accuracy of Enron’s financial statements and internal bookkeeping. Potential investors used Andersen’s reports to judge Enron’s financial soundness and future potential before they decided whether to invest. Current investors used those reports to decide if their funds should remain invested there. As such, the investors expected that Andersen’s certifications of accuracy and application of proper accounting procedures would be independent and without any conflicts of interest. However, this was 2

not the case and the investors were deceived by relying on the reports of Andersen. On the other hand, Andersen was a major business partner of Enron and some executives of Andersen accepted jobs from Enron. This was a conflict of interest. Additionally, in March 2002, Andersen was found guilty of obstructing justice by destroying Enron related auditing documents. Moreover, Andersen failed to ask Enron to explain its complex partnerships before certifying Enron’s financial statements. This was purely unethical and unprofessional. Andersen were playing a very important role of ensuring that the financial statements and book keeping is accurate and should they have played their role well as professionals, then Enron should not have collapsed. Attorneys – Vinson & Elkins They helped to structure some of Enron’s special purpose partnerships. The firm supported the legality of these deals. They were a great facilitator of these deals through transaction opinion letters. As seen from the article, these deals are the ones that contributed to the demise of Enron.

Question 3: What role did the chief financial Officer play in creating the problems that led to Enron’s financial problems? In order to prevent the losses from appearing on its financial statements, Enron used questionable accounting practices. To misrepresent its true financial condition, Andrew Fastow, the Enron’s CFO, took his role by involving unconsolidated partnerships and special purpose entities - ”SPE’s”, which would later become known as the LJM partnership. Taking advantage from the SPEs’s main purpose, which provided the companies with a mechanism to raise money for various needs without having to report the debt in their balance sheets, Enron’s CFO directly ran these partnerships and designed them to purchase the underperforming assets (such as Enron's poorly performing stocks and stakes). Although being recorded as related third parties, these partnerships were never consolidated so that debt could be 3

getting off its balance sheet and the company itself could boost and have not had to show the real numbers to stockholders. Andrew Fastow was using SPE’s to conceal some $1 billion in Enron debt. Overall, according to Enron, Fastow made about $30 million from LJM by using these partnerships to get kickbacks which were disguised as gifts from family members who invested in them and enriching himself. His manipulation of the off-balance-sheet partnerships to take on debts, hide losses and kick off inflated revenues while banning employees' stock sales was one of the reasons triggered the collapse of the company and its bankruptcy.

Question 4: The role of corporate and personal ethics in a case scenario like this? Corporate Issues The Corporate culture: Corporate culture refers to the prevailing implicit values, attitudes and ways of doing things in a

company. It often reflects the

personality, philosophy and the ethnic-cultural background of the founder or the leader. Enron featured multifaceted and conflicting mores, which included: i.

A very competitive working environment:

where workers were

evaluated based on their performance. Each year, the worst 10% -2 0% would be fired, while the top performances would be rewarded lavishly. ii.

A culture of deception: where Enron used unjustifiable calculation methods to entice

investor to hold the company shares.

In assessing

the value of its assets (i.e. contracts), traders were pressured to use an unrealistically low discount rate and an overvalued future cash flows. This enabled the company to record a huge surge in profit creating an illusion to investors, enticing them to buy the company’s shares. Among 4

them

were

the

company’s

workers,

who

invested

their

entire

retirements and life savings into the shares. Enron used a deceiving mechanism to cash in the share value so as to obtain a source of cheap capital from creditors, therefore the company was highly geared in debt, and two years after its formation (1987), 75% of its stock value was debt. Further expansion of the company required more debt-raising. This would cause deterioration in the credit rating. As the risk of default increases, the creditors (banks) would charge them a higher interest rate. To get around the problem, Enron set up series of “Special Purpose Entities” (SPE’s) which were invisible from Enron’s balance sheet. Enron shares were then transferred to these entities and then used as collaterals to obtain cheap capital. The capital obtained was then channeled to the parent company in exchange for its debt, failing investment projects, and realizing the overvalued contracts. A culture of greed and injustice: The set up of the SPE’s enabled the

iii.

company to cash in on the share value. However, a

large part of the money

obtained was not used to distribute fairly among the shareholders, but went to reward the top managers who engaged in the deceptive and illegal practices gave themselves high rewards. Personal Issues i.

Deception and dishonesty: The Company managed to conceal its massive debts through questionable accounting. On knowing the accounting scandals of the company and the possibility of the collapse of the company, the CEO (LAY) publicly re-assured the future prospects of the company, but secretly he off-loaded his possession of the Enron share in the market. In doing so, he took advantage of the privileged information that was no available to the general public, and hence was guilty of insider trading. 5

ii.

Hypocritical and Irresponsible: Skilling claimed his (President and Chief Operating Officer. Served as CEO from Feb. – Aug.2001), abrupt resignation was motivated by "personal reasons" and not Enron's impending doom. He left without a pay-off, saying he wanted to spend more time with his children and participate in more charity work. But immediately after his departure he sold millions of dollars' worth of company stock. He claimed not to have any knowledge of the complex web of financial arrangements that became Enron's downfall.

iii.

Integrity and harshness: Fastow (Chief Financial Officer) was allegedly responsible for creating a web of off-balance sheet partnership with external companies that allowed him to hide Enron’s very large losses. He was also found by an internal Enron investigation to have

secretly

made $30m from managing one of the partnerships. He is said to have refused to answer questions at a December meeting with Securities and Exchange Commission officials. He tried to fire Sherron Watkins and to seize her computer

when he learned of her attempt to alert superiors

of impending trouble.

Ethical problems with Enron’s culture Virtue Theory: An action is morally right if in carrying out the action the agent exercises, exhibits, or develops a morally virtuous character, and it is morally wrong to the extent that by carrying out the action the agent exercises, exhibits, or develops a morally vicious character. There were positive aspects to Enron’s corporate culture, in focusing on stockprice performance, net present value (NPV) and financial innovation, managers were able immediately to apply the skills they had honed in 6

graduate school. Enron encouraged and rewarded innovation. However, the overwhelming drive for short-term personal wealth accumulation was the negative ethic. Managers were encouraged to pursue this goal with, if necessary, guile and deceit. Enron claimed to generate profits and revenue from deals with SPE”S that were actually limited partnerships that Enron controlled. Enron was claiming billions in profit when it was actually losing money. Enron was using these partnerships to sell to itself these contracts back and forth recording revenue each time to hide losses and debt that it suffered by not reporting them on its financial statements. It was shuffling much of its debt obligations into offshore partnerships. Lessons from the Enron Case 1. You make money by providing real goods and services i.e. real value for

money 2. Financial cleverness is no substitute for a good corporate strategy 3. Executives who are paid too much can think they are above the rules and can be tempted to cut ethical corners to preserve their wealth and perquisites 4. Government regulations and rules need to be updated not relaxed and eliminated. 5. Conflict of interest: Enron claimed to generate profits and revenue from

deals with SPE”S that were actually limited partnerships that Enron controlled. 6. Creation of false confidence i.e. Enron covered up the debt under the

separate accounting financial statements of the SPE’s that showed growth of business: growth of asset value: rise in Enron’s share price: rise to shareholders’ income. So long as the share price does not fall, the growth of business can be tremendous, but such cover-up sows the seed 7

of hidden disaster as the asset value of business depends primarily on the investors. 7. Collusion: the auditing firm was a partner, internal and external auditor

failing to provide complete disclosure, and unfair financial reporting. 8. Transparency in reporting is not an objective

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References 1. The Responsibility and Accountability of CEOs: The Last Interview with

Ken Lay Journal of Business Ethics _ Springer 2010 DOI 10.1007/s10551010-0675-y O. C. Ferrell Linda Ferrell 2. The critical role of ethics: recent history has shown that when individual

ethics are compromised, corporate ethics fail and financial disaster is not

far

behind

by

Marianne

M.

Jennings

http://findarticles.com/p/articles/mi_m4153/is_6_60/ai_111737942 3. Enron And Arthur Andersen: The Case Of The Crooked E And The Fallen

A Gary M. Cunningham

and Jean E. Harris

Accounting Education Volume 3, 2006, 27-48

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