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Abstract

This is a detailed case analysis of Enron scandal which took place in FY-2001 because of bad
and poor accounting practices of senior management of Enron. In which there was a conflict
of interest between the management and shareholders. Enrons CFO Andrew used company
resources illegally and unethically without telling anyone and due to that company almost
everything and filed bankruptcy according to chapter 11. Andrew was auditor of company
who deals with internal as well as external accounts.
Introduction:

Enron was 7th largest company in America in just 15 year time period (Fortune 500).
Company started its operations in 1985 and doing business of more than $0.1 trillion in 2000.
It was most attractive company for investors as well as for employees. The reason was that
company share prices shoot up to $90 in 2000 also 25,000 employees were working in
company before the time of crises. Crises of Enron occurs in 2000 because of senior
management and board. In this draft I did a detailed analysis internally as well as externally,
due to which company went into crises. Reason of crises was that board allows Andrew to do
what he liked most in investing. Also Andrew actions was not according to code of ethics and
thats why billion dollar company failed. I discussed the culture of Enron also which also a
reason of becomes a reason of company failure. At last I discussed the effect of such scam on
society.

1. Internal and External Factors influence on the fall of Enron in 2000:

1.1. Internal Factors

1.1.1. Unethical Accounting Practices


Enron is a firm with different business units so there is a complex accounting process to
handle accounting details of all assets, operations and debts for national and international
level business. But this complex business model has expanded the accounting model by
including hedging contracts and accounting reports to support company annual financial
reporting system. In this system of accounting they performed unethical actions like altering
the balance sheet to hide the debt but the income statement was showing the revenues instead
of increase in liabilities.

1.1.2. Use of Pension Funds for Hedging


JEDI deals with the pension funds of employees and Enron had a joint venture with them so
they could deal with the pensions funds of their employees by themselves instead of any
outsider. And it was for the interest of some top level executive of company because they
were using it for hedging purposes. This led to a huge loss that management tried to cover up
but it ends in the fall of company in 2000.
1.1.3. Unethical Conduct of Auditors
Enron had hired Andersen as the auditor of company from 1985 who has been working till
2000. Andersen was responsible for external auditing but in 1993 they were hired to work as
an internal auditor as well (Healy & Palepu, 2003, p. 8). During different period of time
several members of Andersen were working in the office of Enron that was for the Andersen
and they received a remuneration of $25 for the auditing service and an amount of 27$ for
non-auditing services. Thus they were relying on the information provided by the internal
management of Enron so they could keep the malpractice accounting record. A firestorm
happened in Houston office of Andresen and they lost most of the relevant documents of
Enron and they recorded malpractice accounting.

1.1.4. Board of Directors


The boardroom of Enron includes members from both external and internal members of
company. Where, the external board of directors didnt put much focus on the conduct of
executives and policies made by the internal members as they were among the highest paid
board of directors of the world. They even didnt concentrate on the accounting practices of
firm and this negligence led to a malpractice of executives and auditors.

1.2. External Factors

1.2.1. Investment Banks


Enron has paid $50 million as underwriting fees to raise the public market of $27.7 billion
during the time duration of 1986 to 2001 (Healy & Palepu, 2003, p. 4). They also paid so
many advisory fees as well to do the acquisitions and merger transfers those were around 209
and were done during the same period of time. Additionally there was several investment
banks gained from the success of Enron because they were employed as analyst and were
partners in the partnership of firm.

1.2.2. Credit Rating Companies


The malpractice accounting of Enron was even not identified by the credit rating firms as
they were relying on the information about the company provided by internal management
instead of investigating the accounting reports. They were getting a good amount from Enron
to rate them high.
1.2.3. Government
Government bodies of accounting accountability also had some black holes those unable
them to identify the malpractice accounting record of Enron. And some bills were passes by
government to allow dealing in the energy derivatives. The basic reason behind the
negligence of government towards action of Enron was that Enron paid $5.95 million for the
democratic and republican parties campaigns (Healy & Palepu, 2003, p. 3).

2. Reasons for the failure of Enrons internal checks and balances system:
There are several elements included in the multilayered system of Enron. Auditors, Financial
Institutions and Board of Directors are the key players to run a company and lead it to a
success or a failure same members of Enron have led to a fall. The major reason was the poor
boardroom and lack of concentration by external members towards policies and accounting
practices of companies suggested by internal members and executives of Enron. This lead to
further reasons like hiring of employees those were employees of the external auditing firm
of company. These employees made possible the keeping the internal information of
company hides from the external auditors (Dudzinski, 2014, p. 8). Boardroom created an
environment of unethical conduct that was followed by the employees of entire company.
Although, Enron had a code of conduct but that was not followed by any level in the
organization. Chief Financial Officer (CFO) of company was allowed to take all financial
decisions of company and he hedged the pension funding and investment gains of company
that was against the government law. Board was even not focusing on the performance of all
employees in the firm. Board just focused on the profits and policies suggested by CFO.
There was not as such employment motivation system applied to boost the performance and
the upper management was considering the monetary rewards only the way of motivation for
themselves and lower level of employees in organization. CFO of Enron took a great risk of
hedging to avoid loss but it led to more loss. Even after a great loss the CFO didnt stop to
hedge more company investments and there were incentives given to employees so they
would also be agreed to take risk of hiding the internal data of company from external
auditors. These all happenings were resulting in a lack of management and operational
policies designed by internal board members to get few monetary gains.
3. Board of Directors undermine Enrons code of ethics:

Foundational values of Enrons code of ethics were undermined by the board of directors, the
main players in undermining ethics were Jeff Skilling, Ken Lay and most importantly
Andrew, and they practiced illegal activities that raised crucial questions like how much they
are working within the lines of values, respect, excellence, communication and integrity. The
code of ethics was defined on 64-pages according to CEO Ken Lay which describes the code
of ethics in detail. According to the code there is a requirement for each employee to agree
and sign on the document of code of ethics with a promise that they all will follow these
ethics and report any misconduct or if any unethical activity is witnessed. The nature of
Enron was decentralized which led to communication barriers which prevented the people
working for Enron to see the big picture. The communication value was undermined when a
crucial and fraudulent activity was concealed by Andrew that how deeply he was involved in
trading to maintain high market valuation that led Enron to collapse. Moreover Andrew made
unethical investments and was involved in such activities which are not according to the code
of ethics, as any investment which does not follow the guidelines of code of ethics needs to
be approved by the chairman and CEO Ken Lay. The unethical investments made were
presented in a very efficient manner which was accepted by the board and he created an
effective image in front of the board which led him to become the head of investments (HBR,
2016).

Board of Enron strictly followed the rule of no tolerance for failure and set guidelines that in
the case of failure the employee would be replaced by the next best employee who have
better performance. Top leadership was somehow inactive in decision making, and the
company followed biannual feedback system. The performance appraisal was conducted on
upon six month performance targets. Code of ethics was entirely used for the private gains as
the activities supported the open environment. The communication barrier problem broke the
element of code of ethics to communicate effectively, where every individual had to share
and co-ordinate information with each other, but in the real case scenario was that all the
business units within Enron were acting independently which hid the actual fraudulent
activities for a long period as due to no link within department no one working could see the
bigger picture.
Moreover commitment to excellence practiced by Enron was the most ineffective
performance appraisal systems and reward/compensation systems that was beneficial to
executives, encouraged and fraudulent activities like inflating value of contracts, and
encouraged use and practice of non-standard accounting practices. These appraisal systems
and compensation methods were made and regulated by the top leadership of Enron. Overall,
the decisions and actions carried by the top leadership didnt support the values, respect and
integrity of the company. In addition, Andrew exemption from board and top management
indulging in unethical activities undermined the values of respect and integrity (Sanctuary,
2012).

4. Corporate culture of Enron promotes unethical decisions and actions:


Enron corporate culture promotes unethical notions in a way that the culture makes
employees believe that they can take extra risk and cannot encounter any danger. Enron
culture has been labeled as the culture of ignorance. They focus only on making more
money and net income regardless of any means. Enron corporate culture does not promote
respect and integrity. They dont promote code of ethics in their culture. The decentralization
in their corporate structure was very high which also encouraged employees to engage in
riskier or one can say fraudulent activities. Poor corporate culture of Enron was one of the
major reasons that results in the biggest business bankruptcy ever (Silverstein, 2013).
The performance appraisals and incentive programs of Enron was also very biased and this
results in escalation of competition among the employees and they all started find shortcuts in
earning money. Employees tend to give their subordinates low rank in their performance
appraisals in order to improve their position in the organization. The compensation plan was
made only for the benefit of the management and executive of the company and it rarely
focus for the benefit of the shareholders. This encouraged the employees the use of non-
standard accounting practices in order to get personal benefit out of it. The employees made
partnerships with in themselves so that they can avoid losses and hide unethical practices for
themselves. The division and business unit of Enron was also kept isolated from each other
and because of this no one sees the big picture of what is happening in the organization. Even
the main objective of management was to do the profit maximization and get better
performance appraisals regardless of any means. The aggressive management style has also
played substantial role for this biggest bankruptcy. The employees were asked to perform
well in any conditions and they were not allowed to ask any question from their bosses. This
aggressive style of management make it difficult for employees to perform well and they only
think about their threatening performance evaluations report (Kulik, 2005).
This bad culture was created by Lay and Skilling and they were responsible for this
bankruptcy. They have created the culture of deception and greed and ultimately the whole
company had collapsed (Wong, 2010). Employees knew that some of the things that they do
was unethical but they dont speak up because it was bringing profits for the organization.
Fear among the employees was also one of the reasons that results in unethical decisions and
actions for the organization.

5. Respond as an accountant to whats going on in Enron:


Failure of Enron shows a huge impact on company itself as well as industry, stake holders
and society. This scandal made me to think more deliberately about it. So I came to the
conclusion that if I was an accountant at Enron and such unethical business practices that was
made by Andrew at Enron. I did respond towards this scandal according to the code of ethics.
Because in code of ethics it was mentioned that you have had to report if you saw something
wrong in the firm. So according to this it would be my responsibility to report Andrewss
unethical practices in front of board. This reason is simple because it is obligation of
everyone in the organization to report such unprofessional misconduct what eventually
effects the whole society in form of stakeholders, investors and people trust on any company.

Basic financial standards such like IFRS (International financial standards) and ISA
(International standards on accounting) were being followed by Enron. But still company
faced such horrible crises. But if I were the accountant in Enron then critical analysis along
with evaluation which will cover the gaps in the area of finance and accounting at firm level.
This detailed analysis helped me in decision making as well as actions against Andrew CFO
and other senior management on such poor ethical practices. So this analysis also might help
to prevent Enron form such a big scam. As the loss of shareholders, investors, stakeholder
trust and confidence on Enron, this effected the organization as well as the society. But as an
accountant at Enron, actions taken by me against such poor unethical business activities
would have be accordance to required financial framework. The reason of such behavior is
solely my responsibility both professionally and ethically.
6. Implications of unethical practices on society:

Enron was doing a one trillion business that failed due to poor corporate governance, lack of
management decision and unethical business practices. Due to all these issues company lost
everything and shares becomes worthless just in a year. Share prices fell 99% just in few days
and prices became 0$.20 per share. Such unethical business practices have a bad impact on
society.

Followings are key outcomes due to bad practices of Enron (Mack, 2003);

6.1 Confidence of investors:


Investors lost their confidence when they came to know that Enron is using such poor
business practices. But all companies always tries to maintain confidence of their investors.
But in Enron story all investors lost everything which they invested in the company. This we
can see form the share prices that was in $90 in FY-2000 and it shifted to $0.20 in FY-2001.
Loss of trust reduces customers loyalty not only to Enron but also in other companies due to
such business issues. Many large banks failed due to such kind of poor practices.

6.2 Diminishing of resources:


This is second most important element of poor ethical practices due to which profits and
resources of company collapse and no one is willing to give resources to such companies.
Many resources wipe out because of heavy losses (All 25,000 employee lost their jobs and as
well these members lost their pension funds which were wrongly used by the Andrew chief
financial officer of company).

6.3 Implementation of new rules:


Some companies use such bad practices then loses would be there in tem of financial and
non-financial. So after such huge losses the regulators tries to implement new code of
conducts to secure society form such losses same was the case in Enron where regulators
established the Sarbanes-Oxley act in 2002 and made it compulsory that every organization
have had to follow it in every case. This act defines that both employee and investors trust
should be aligned so no one could use any resources for themselves.

6.4 Unethical behavior:


Enron used it to show huge profits of company while they ignored what would be its impact
on society. In this company showed huge profits in income statements but at the same time
they hide debt which they took of $383 million. Anyone can see that in long run they lost
everything as well as their reputation.

Conclusion:
Enron collapsed mainly because the top leadership of the company was indulged in unethical
and fraudulent activities the main key player was the CFO Andrew which was made head of
investments and carried of activities which led to high market valuation and inflating
contracts, The top leadership designed appraisal and compensation systems and
managed/controlled the company in the most unethical manner in terms of respect and
integrity and finally led to collapse.
References
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