Assignment On CORPORATE GOVERNANCE

SUBMITTED BY: B.UDAY KUMAR PGDM-BIFAAS ROLL NO: B4-60

ENRON CASE What lessons can be learned from the Enron saga Any organization has an obligation to all of its stakeholders, not just its shareholders, and those obligations were not met in this case. Executives at Enron made decisions that contained question of llegality. Many people also are beginning to question the professional conduct of auditors Arthur Andersen. This scandal demonstrates the need for significant reforms in accounting and corporate governance in the United States, as well as for a close look at the ethical quality of the culture of business generally and of business corporations in the United States. It will teach executives and the American public the most important ethics lessons of this decade. Among those lessons the following are important: 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. Financial cleverness is no substitute for a good corporate strategy. 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. 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. Government regulations and rules need to be updated for the new economy, not relaxed and eliminated. Judgment on the independence of board directors used to depend primarily on whether "family relations" exist or not. This measurement, however, has been deemed insufficient and it has been mandated to check the independence of respective board directors even when they are not family members. Board members should be renewed from time to time so as to prevent the same members to serve too long and objectivity must be given due consideration in doing so. Someone who joined a company board as a total outside would develop close relations with the company after serving as its board director for 10 years. Also, there has been a growing awareness that the presence of board directors would be meaningless if they are appointed by the chief executive officer. As to the specific case of Enron, the next focal point is how liabilities for damage will be settled. The very fact that Enron's chief financial

officer had been allowed to make improper investments shows the company's failure to fulfill its accountability and whether or not the CFO will be personally held liable for the damages will become a point of disputes. There is also a question whether or not to allow former Enron directors and executives to collect liability insurance if they were found to have violated law. There is no guarantee that they did not. They would be found guilty in a criminal trial and held liable for damage in a civil court case. As a means to strictly condemn Enron executives, court procedures are proceeding first on litigations against Andersen. But it is hard to understand why no internal punishment has been internally imposed within the Enron headquarters. Enron's financial statements themselves were not in violation of the accounting standards but it is questionable whether auditors are able to keep their independence when they get too close to their clients. In this regard, a new watchdog organization should be established to supervise the accounting industry. And those who use corporate financial statements should recognize that the accounting principles provide them with no scientific answer and they must make their own judgment based on the information written there. Rating agencies offer various rankings but there are both pros and cons about such rankings. Under the light of the accounting principles, how should we consider the conflicts of interests concerning consulting services by auditing firms? Some people say that listed companies should be prohibited from using the same accounting firm for consulting services and auditing. There are four major accounting firms in the United States and they are called "Final Four" rather than "Big Four." In reality, it would be difficult to mandate listed companies to use different accounting firms for consulting and auditing services. Can we expect the emergence of new accounting firm sometime in the near future? Upon receiving a guilty verdict, Andersen lost its license across the 50 states and the firm disappeared in a matter of a year or so. Even if it was found not guilty, I think that the fate of Andersen was determined the moment it was indicted.

What do you think are the reasons for the sudden collapse of Enron The company has so spectacularly unraveled--and in such a way as a lot of little people have been hurt--these relationships will come under much more scrutiny. An often circus-like atmosphere (you know its a circus when the Right Reverends Al Sharp ton and Jesse Jackson

are also involved) will be the fare for months to come. Congressional committees, citizens groups and others will trip over each other in attempts to show that, by golly, theyre going to get somebody! And, some of them might succeed. God knows that there are probably scores of candidates for a couple years vacation at Ellenwood, Danbury, or one of the other minimum-security federal prisons. Perhaps well even see a couple people fairly close to the president offered up. In addition, well hear lots of talk (but will see little meaningful action) relating to making companies gives the public a more accurate picture of their finances. Well probably see legislation aimed at shoring up American workers retirement plans; Ill comment on those down the road as they come up. Other fallout will certainly come from all of this mess. Government will get bigger still to protect us from creative accountants and speculators. Well probably see some kind of lousy, so-called campaign finance reform now have a much better chance of passing; the alternative for Republicans will be that if either the House or the president stop this reform now so obviously needed, theyll be crucified in November. In all of this, though, a few key truths will unfortunately be lost, or swept under the rug. The biggest of these truths is that Enrons very character and growth as a company, which took on frighteningly speculative attributes over the last few years, was made possible chiefly by the Federal Reserve and our fractional reserve banking system. In fact, the nature of this system virtually required Enron to do much of what it did! Enrons big problem is that it was a few years late in building itself into the speculative trading vehicle that it eventually became. Had it embarked on its multi-faceted activities of arbitrage, derivative creation and trading and the rest during the 1990's--and then sat back a while--its timing would have generally coincided with that of the broader economy and financial markets. But while the latter peaked in early 2000 and have since been contracting, Enron apparently thought it could continue building what became a veritable skyscraper of cards with one risky scheme and one form of investment on top of another.

Accounting Problems The conventional wisdom is that it was "innovative" accounting practices and their consequences that started the tide of losses that brought the energy giant down. Enron collapsed not so much because it had gotten too big, but because it was perceived to be much bigger than it really was in the first place. By decentralizing its operations into numerous subsidiaries and shell corporations, Enron was able to hide huge derivative losses that would have halted its growth much sooner if widely understood. Publicly traded corporations are required to make their financial statements public, but Enron's finances were an impenetrable maze of carefully crafted imaginary transactions between itself and its subsidiaries that masked its true financial state. In other words, losses were held off the book by subsidiary companies, while assets were stated. Taken at its word, this rosy scenario made the company the darling of Wall Street, and it was able to borrow almost endlessly and expand into e-commerce and other questionable ventures. Management Culture Of course, the Enron fiasco did not happen by accident. It was facilitated by a corporate culture that encouraged greed and fraud, as exemplified by the energy traders who extorted California energy consumers. Rather than focus on creating real value, management's only goal was in maintaining the appearance of value, and therefore a rising stock price

Was Enron having proper corporate governance in place? If not what precisely was lacking o The failures at Enron were so wide and deep, it is difficult to say which failed most. Clearly Enrons leadership its Board and senior executives, failed to protect all stakeholders in the company. o Internally, although there were a few cases proven of malfeasance and illegal activities and fraudulent reporting, much of the internal failure appears to have

been a combination of corporate culture failure and what many authors have characterized as massive incompetence. o Externally, it appears that nearly every institution which is part of the U.S. governance system failed as a result of self-interest and greed. o If pushed, it might be argued that the massive failures and internal culture of accounting earnings and self-enrichment at all costs led to a contagion of the external governance. o Because many of Enrons businesses such as power trading fell between the cracks of many regulatory systems, some failures were inevitable. In other cases, however, such as with its auditors and the debt and equity markets, the failures were in many cases related to the self-enrichment and profits at all costs culture which permeated many of these businesses inside and out. As it turns out, much of what Enron reported as earnings were not. Much of the debt raised by the company via a number of partnerships which was not disclosed in corporate financial statements should have been. Simultaneously to the over-reporting of profits and the under-reporting of debt, were the massive compensation packages and bonuses earned by corporate officers appropriate? What went wrong within the web of relationships composing the corporate governance of Enron? It appears that the executive officers of the firm were successful in managing the Board of Directors towards their own goals. Management had moved the company into a number of new markets in which the firm suffered substantial losses, resulting in redoubled attempts on their part to somehow generate the earnings needed to meet Wall Streets unquenchable thirst for profitable growth. o The Board failed in its duties to protect shareholder interests due to lack of due diligence and most likely a faith in the officers which proved unfounded. It is also notable that Enrons legal advisors, some of whom report to the Board, also failed to provide leadership on a number of instances of malfeasance.

Enrons auditors, Arthur Andersen, committed serious errors in judgment regarding accounting treatment for many Enron activities including the above partnerships. Andersen was reported to have had serious conflicts of interest, earning roughly $5 million in auditing fees from Enron in 2001, but more than $50 million in consulting fees in the same year.

Enrons analysts were, in a few cases, blinded by the sheer euphoria over Enrons latent successes in the mid to late 1990s, or working within investment banks which were earning substantial investment banking fees related to the complex partnerships. Although a few analysts continued to note that the companys earnings seemed strangely large relative to the falling cash flows reported, Enrons management was generally successful in arguing their point.

This may, in the end, be the most critical question related to Enron. Why did it happen? Was it indeed the perfect storm, in which the wrong combination of leadership, business evolution, market behaviors, and the times all combined to create a monster, or was it something else?

This is commonly the most hotly debated question in any classroom, and often is the concluding thought for further debate. Many argue that although many of the corporate governance and regulatory systems failed in the case of Enron, the core cause was human failure the failure of leadership in many organizations to do the numbers, know the law, and do the right thing.

What may have transpired is that company managers simply undertook aggressive interpretations of accounting principles then challenged auditors to demonstrate that such practices were not in accordance with GAAP accounting rules (Weil, 2002)? This type of practice has been going on since the early 1980s and may account for the proliferation of specific accounting rules applicable only to certain transactions to insulate both the firm engaging in the transaction and the auditor reviewing the transaction from subsequent litigation. In one sense, the Enron debacle represents a failure of the free market system and its current shareholder protection mechanisms,

in that it took so long for the dramatic Enron shell game to be revealed to the public. However, this incident highlights the remarkable resilience of the free market system. The free market system worked quite effectively in its rapid imposition of discipline in bringing down the Enron house of cards, without any noticeable disruption in energy distribution nationwide

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WORLD COM CASE

What are the advantages and disadvantages of an aggressive merger policy like that at world com? Advantages: Merger is legally simple and does not cost as much as other forms of acquisition

There is no need to transfer title to individual assets of the acquired firm to the acquiring firm Reduces the number of competition in the market and captures additional economic scales of the market Merger also enables the company to restructuring and strengthening the organization as firms involved in the transaction share strategies to strengthen the organization, thus eliminate weaknesses in the firm.

Results increase of new customers and also attract other parties to have relationships with the organizations. WorldComs stock had raised from pennies per share to over $60 a share. Through what appeared to be a prescient and successful business strategy at the height of the internet boom.

Disadvantages: WorldCom is just another case of failed corporate governance, accounting abuses, and outright greed. But none of these other companies had senior executives as colorful and likable as Bernie Ebbers. A Canadian by birth, the 6 foot, 3 inch former basketball coach and Sunday School teacher emerged from the collapse of WorldCom not only broke but with a personal net worth as a negative nine-digit number. No palace in a gated community, no stable of racehorses or multimillion dollar yacht to show for the telecommunications giant he created. Only debts and red ink--results some consider inevitable given his unflagging enthusiasm and entrepreneurial flair.

This case describes three major issues in the fall of worldcom: The corporate strategy of growth through acquisition The use of loans to senior executives

And threats to corporate governance created by chumminess and lack of arm's-length dealing. Senior management made little effort to develop a cooperative mindset among the various units of worldcom. Inter-unit struggles were allowed to undermine the development of a unified service delivery network.

Worldcom closed three important MCI technical service centers that contributed to network maintenance only to open twelve different centers that, in the words of one engineer, were duplicate and inefficient. Competitive local exchange carriers (Clercs) were another managerial nightmare. WorldCom purchased a large number of these to provide local service Disadvantages

The Growth through Acquisition From its humble beginnings as an obscure long distance telephone company WorldCom, through the execution of an aggressive acquisition strategy, evolved into the second-largest long distance telephone company in the United States and one of the largest companies handling worldwide Internet data traffic. According to the WorldCom Web site, at its high point, the company

Provided mission-critical communications services for tens of thousands of businesses around the world

Carried more international voice traffic than any other company Carried a significant amount of the world's Internet traffic Owned and operated a global IP (Internet Protocol) backbone that provided connectivity in more than 2,600 cities and in more than 100 countries

Owned and operated 75 data centers on five continents. [Data centers provide hosting and allocation services to businesses for their mission-critical business computer applications

Poor integration of acquired companies also resulted in numerous organizational problems. Among them were:

Senior management made little effort to develop a cooperative mindset among the various units of WorldCom.

Inter-unit struggles were allowed to undermine the development of a unified service delivery network.

WorldCom closed three important MCI technical service centers that contributed to network maintenance only to open twelve different centers that, in the words of one engineer, were duplicate and inefficient.

Competitive local exchange carriers (Clerks) were another managerial nightmare. WorldCom purchased a large number of these to provide local service. According to one executive, "(t) he WorldCom model was a vast wasteland of Clerks, and all capacity was expensive and much underutilized there was far too much redundancy, and we paid far too much to get it.

What motivations would explain the fraudulent account of world com In 1998 when Bernie was in the midst of acquiring the telecommunications firm MCI, Reverend Jesse Jackson, speaking at an all-black college near WorldCom's Mississippi headquarters, asked how Ebbers could afford $35 billion for MCI but hadn't donated funds to local black students. Businessman LeRoy Walker Jr., was in the audience at Jackson's speech, and afterwards set him straight. Ebbers had given over $1 million plus loads of information technology to that black college. "Bernie Ebbers," Walker reportedly told Jackson "is my mentor." Rev. Jackson was won over, but who wouldn't be by this erstwhile milkman and bar bouncer who serves meals to the homeless at Frank's Famous Biscuits in downtown Jackson, Mississippi, and wears jeans, cowboy boots, and a funky turquoise watch to work. It was 1983 in a coffee shop in Hattiesburg, Mississippi that Mr. Embers first helped create the business concept that would become WorldCom. "Who could have thought that a small business in Mississippi would one day rival AT&T?" asked an editorial in Jackson, Mississippi's Clarion-Ledger newspaper. Bernie's fall-and the company's-was abrupt. In June 1999 with WorldCom's shares trading at $64, he was a billionaire, and WorldCom was the darling of the New Economy.