Ethics Issues at Enron

Business ethics and corporate governance Assignment

“An ethical analysis of the ENRON scandal and learning’s from it.”

Submitted by-: Saurabh Singh Enrollment No: 08BS003021

Introduction

Corporate managers are expected to maximize investor returns while complying with regulatory standards, avoiding principal-agent conflicts of interest, and enhancing the reputational capital of their firms. The recent arrests and resignations of top U.S. managers, however, indicate an increasing level of managerial negligence and corporate irresponsibility on Main Street and on Wall Street that has eroded domestic and global trust in U.S. markets. The U.S. stock market volatility has added to the political pressure to bring 1930s-style regulatory reform to businesses. Corporate irresponsibility in the Enron scandal, for example, has provoked multiple lawsuits and unprecedented outrage from a range of stakeholders with demands for democratizing structures of corporate power, improving managerial accountability, and legislating regulatory reform . The Enron scandal involves both illegal and unethical activity and the courts of law will determine the precise extent of civil and criminal liability that accrues to the perpetrators. People commit fraud, for instance, for a wide range of motives including perceived lack of effective deterrent punishment and rationalization of acceptability of illegal activity (Albrecht and Searcy 2001). To control fraud by focusing on only one dimension, such as more effective deterrent punishments, is like trying to put out a skyscraper fire with a garden hose. In addition, people harbor myths, such as organizations cannot proactively detect or prevent fraud, which only result in disempowered resignation to the inevitability of corruption and more future Enron’s. The Enron scandal is one that left a deep and ugly scar on the face of modern business. As a result of the scandal, thousands of people lost their jobs, some people lost their entire pensions, and all of the shareholders lost the money that they had invested in the corporation after it went bankrupt. I believe that Kenneth Lay, former Enron CEO, and Jeffrey Skilling behaved in an unethical manner without any form of justification, but the whistleblower, former Enron vice president Sherron Watkins, acted in a way that upheld moral principles. There are many causes of the Enron collapse. Among them are the conflict of interest between the two roles played by Arthur Andersen, as auditor but also as consultant to Enron; the lack of attention shown by members of the Enron board of directors to the off-books financial entities with which Enron did business; and the lack of truthfulness by management about the health of the company and its business operations. In some ways, the culture of Enron was the primary cause of the collapse. The senior executives believed Enron had to be the best at everything it did and that they had to protect their reputations and their compensation as the most successful executives in the U.S. When some of their business and trading ventures began to perform poorly, they tried to cover up their own failures

Failure of the Market to Perform and Professional Dilemmas

In reality, there is nothing wrong with markets failing to fulfill their task of leveling the playing field between buyer and seller. Such market failures are in fact how many organizations make their money—through patents (temporary monopolies) and the use of expertise that is not universally available (competitive advantage). Yet there are certain forms of this type of market failure that are so egregious that they unreasonably interfere with the rights of others and endanger the credibility of all legitimate transactions. The most common form of market failure is information asymmetries—the business decisionmaker knows something that the person at the other end of the transaction does not. Most of the time this is fine but there are circumstances where the unfairness of this asymmetry exceeds simple competitive advantage and is a threat to the rights of others and to the effective operation of the free market as a whole. This appears to be the case at Enron. Insider trading is one of the indefensible exploitations of information asymmetries. In due course, we will have a legal determination regarding whether or not Enron officers or directors engaged in this practice. But legal determinations aside, Enron officers should have been far more alert to the perception that they might benefit from exploitation of information asymmetry. Again ethical literacy is all about recognizing potential ethical issues before they become legal problems. And incidentally, since the U.S. Supreme Court’s Texas Gulf and Sulfur case in 1969 it has been unlawful for directors, as the Enron chairman was, who have inside price sensitive information to trade in that stock.

The Neglect of Integrity Capacity by Managers The neglect of managerial integrity capacity is at the moral root of Enron’s legal and financial problems. What is legally permissible today, but morally questionable, may well become legally proscribed tomorrow. Thus, it is important for managers to proactively understand and attend to the multiple dimensions and moral antecedents of illegal activity (Paine 1994). Integrity capacity is the individual and collective capability for the repeated process alignment of moral awareness, deliberation, character, and conduct that demonstrates balanced judgment, enhances ongoing moral development, and promotes supportive systems for moral decision making (Petrick and Quinn 2000). It is one key intangible asset that acts as a catalyst for reputational capital and its erosion can jeopardize the survival and credibility of organizations and markets (Petrick, Scherer, Brodzinski, Quinn, and Ainina 1999). The spectacle of top Enron executives “pleading the Fifth” in Congressional hearings about managerial immoral and illegal conduct is a vivid example of the consequences of the neglect of individual and organizational integrity capacity. Furthermore, the frantic effort of Arthur Andersen, LLP, one of Enron’s critical stakeholders whose integrity capacity and reputation were shattered by their unprofessional auditing services, to stem the tide of fleeing clients while negotiating with other “Big Five” accounting firms for sale of parts of its business, is another dramatic example of the costs of integrity capacity neglect (Toffler and Reingold 2003). The Enron scandal’s adverse moral impact on the primary stakeholders is evident in . Enron’s top managers chose stakeholder deception and short-term financial gains for themselves, which

destroyed their personal and business reputations and their social standing. They all risk criminal and civil prosecution that could lead to imprisonment and/or bankruptcy. (Board members were similarly negligent by failing to provide sufficient oversight and restraint to top management excesses, thereby further harming investor and public interests (Senate Subcommittee 2002). Individual and institutional investors lost millions of dollars because they were misinformed about the firm’s financial performance reality through questionable accounting practices (Lorenzetti 2002). Employees were deceived about the firm’s actual financial condition and deprived of the freedom to diversify their retirement portfolios; they had to stand by helplessly while their retirement savings evaporated at the same time that top managers cashed in on their lucrative stock options (Jacobius and Anand 2001). The government was also harmed because America’s political tradition of chartering only corporations that serve the public good was violated by an utter lack of economic democratic protections from the massive public stakeholder harms caused by aristocratic abuses of power that benefited select wealthy elite. The Enron scandal also harmed secondary and tertiary stakeholders. For example, Enron top managers pressured Arthur Andersen to certify maximum-risk, questionable accounting practices in part to retain their lucrative consulting business and, by acceding to this pressure, Arthur Andersen won huge contracts in the short run but ultimately lost their professional credibility and client base (Toffler and Reingold 2003). A parallel process occurred in the legal profession when Enron managerial pressure on Vinson and Elkins to legally condone investor and employee fraud prevailed. Again, Citigroup, J.P. Morgan, and Merrill Lynch made over $200 million in fees from deals that helped Enron and other energy firms boost cash flow and hide debt, and, by failing to exercise their own adequate due diligence, they multiplied the harm done to other stakeholders. The industry’s reputation, furthermore, was tarnished by Enron’s aggressive market leadership practices, the taxpaying public incurred additional shifting risk to eventually cover bankruptcy collateral damage, and ultimately America’s stature as a model of democratic capitalist practices was replaced by fear of the global export of Enron-like corporate irresponsibility and crony capitalism (Mitchell 2002; Sirgy 2002). These multiple stakeholder damages can be viewed as the result of serious lapses in the four dimensions of management integrity capacity–process, judgment, development, and system. Understanding and correcting these lapses provides a structured way to address the moral roots of current stakeholder remedies and reduce the likelihood of future Enron’s.

Process Integrity Capacity and Enron Process integrity capacity is the alignment of individual and collective moral awareness, deliberation, character, and conduct on a sustained basis so that reputational capital results. The need to address lapses in process integrity capacity is manifest by the routine fragmentation of managerial moral attention and behavior that arouses stakeholder concern about the moral hypocrisy of management practices (e.g., Enron top managers tout their public relations images

as responsible corporate citizens while defrauding investors and employees and secretly lining their own pockets with diverted funds) . While it is unlikely that Enron executives failed to perceive the relevant moral issues, it is clear that they were not sensitive to them. They appeared to be erroneously and overly confident of their initial distorted perceptions of morally acceptable business conduct, and when challenged, as Fastow was regarding the appropriateness of his financial structures, retaliated against accusers and sought information in ways that confirmed what they already believed (Messick and Bazerman 1996). Since top management and board members ignored whistleblower feedback, they became morally blind, deaf, and mute, thereby diminishing their capacity for ethical awareness and eventual strategic responsiveness—for which they are held morally accountable (Cavanagh and Moberg 1999; Swartz and Watkins 2002). Moral deliberation, the second component of process integrity, is the capacity to engage in the critical and comprehensive appraisal of causal factors and recognized moral options to arrive at a balanced and inclusive reasonable decision/resolution/policy that provides a standard for future determinations (Petrick and Quinn 1997). The decision making style of the Skilling-FastowKopper circle demonstrated a tendency to suppress all but one aspect of a moral decision, i.e., its short term financial impact, and to exclude other parameters that might inhibit decisive action or constrain executive perks (Messick and Bazerman 1996). Enron managers and board members, who poorly analyzed and resolved moral conflicts of interest through self-centered policies also ignored or trivialized the harm caused to other stakeholders. For their diminished capacity for balanced moral deliberation Enron managers are held morally accountable (Fusaro and Miller 2002; Swartz and Watkins 2002). Moral character, the third component of process integrity, is the individual and collective capacity to be ready to act ethically. The greed, dishonesty, arrogance, selfishness, cowardice, hypocrisy, disrespect, and injustice that characterized top Enron executives’ intentions discloses their culpable motives and the corrupting workplace culture they created (Sennett 1998). The overemphasis on personal financial gain at the expense of others destroyed any remnant of employee trust. The visionless accumulation of rapid wealth exposed the absence of leadership wisdom and the deliberate obfuscation of financial structures to preclude a fair picture of the financial health of the firm eroded their characters; they de-humanized themselves and others with whom they interacted. The lack of the political virtue of citizenship is particularly damaging to internal and external character cultivation (Logsdon and Wood 2002). Moral conduct, the fourth component of process integrity, is the individual and collective carrying out of justifiable actions on a sustained basis. Managers that exhibit ethical conduct develop a reputation for dependability and alignment of moral rhetoric and reality but the duplicitous exploitation of employee retirement savings exposed the cruel behavioral hypocrisy of top Enron executives (Cruver 2002).

Judgment Integrity Capacity and Enron

Managers can attempt to evade full moral accountability by compartmentalizing and fragmenting their handling of management and ethics issues. One way to address this evasion is to enhance judgment integrity capacity, the capability of analyzing complete moral results, rules, character, and context in management practices (Petrick and Quinn 2000). The way Enron executives manage implicitly commits them to certain ethics theories, and just as simplistic, distorted managerial judgments produce poor results in handling behavioral complexity, so also do simplistic, distorted ethical judgments produce poor results in handling moral complexity (Paine 1994; Petrick and Quinn 2000). For business leaders and their firms, exhibiting judgment integrity means being held accountable for achieving good outcomes (results-oriented teleological ethics), by following the right standards (rule-oriented deontological ethics), while strengthening the motivation for excellence (character-oriented virtue ethics), and building an ethically supportive environment within and outside the organization (context-oriented system development ethics).

Learning’s from the Enron case I do believe Enron will be the morality play of the new economy. It will teach executives and the American public the most important ethics lessons of this decade. Among these lessons are: 1. You make money in the new economy in the same ways you make money in the old economy - by providing goods or services that have real value. 2. Financial cleverness is no substitute for a good corporate strategy. 3. The arrogance of corporate executives who claim they are the best and the brightest, "the most innovative," and who present themselves as superstars should be a "red flag" for investors, directors and the public. 4. Executives who are paid too much can think they are above the rules and can be tempted to cut ethical corners to retain their wealth and perquisites. 5. Government regulations and rules need to be updated for the new economy, not relaxed and eliminated