Q1. Summary of Enron Scandal.
Enron, a Houston-based energy firm founded by Kenneth Lay, transformed itself into the world’s largest energy-trading company over its sixteen years of lifespan. In 2001, Enron was one of the world’s largest energy groups, operating mainly in the USA. Though Kenneth played a smaller role in management, following the takeover, he soon became chief executive officer (CEO) and moved the headquarters from Omaha to Houston. During 2001, it had become apparent that a number of special purpose entities were not consolidated in the balance sheet and the company admitted that there had been a number of financial reporting irregularities over the period 1997 to 2000. This made a lot of people suspicious about the company when they heard about it. One of Enron’s employees, Sherron Watkins, raised suspicions about the company’s balance sheets and financial statements. And finally became the whistleblower of the Enron scandal. After the exposure, Enron was trapped in a severe cash crisis. Dynegy was trying to takeover Enron, but eventually the takeover was withdrawn, which meant that they no longer had any protection against bankruptcy. Consequently, profits were substantially overstated and in late 2001 the company had to file for bankruptcy.
Corporate Governance Issues in Enron: -
There were a number of issues in Enron such as-
a) SPECIAL PURPOSE VEHICLES (SPVs): Andrew Faslow (CFO) and Micheal Kopper had made partnerships creating a trading concern known as Special Purpose Vehicle (SPV). Enron then sold an asset to the SPV. The type of asset sold to the SPV was irrelevant and in fact the asset did not even have to be moved. The SPV would pay cash for the asset and Enron could show the transaction as a sale, which would inflate the profits. However, in reality the cash received from the SPV was in form of a loan, but by treating it as a sale, Enron benefited in two ways: firstly, by increasing its revenues and profits and thereby lowering the company’s debts. Enron executives received substantial benefits. In October 2001 it was revealed that Fastow personally made $30m from these transactions. It was also alleged that executives might have benefited from insider trading
b) Enron’s audit committee proved to be ineffective as they couldn’t prevent their collapse- Two of the members of the audit committee were highly questionable on their independence and three of the members were located outside U.S.A. They were highly questionable, because they were the ones who published the financials of the company. And as we read were wrong financial numbers that were been put in the company’s Balance Sheet. John Wakeham, ex-cabinet minister in the UK government, and secretary of state for energy was acting in the capacity of a non-executive director. But it was later discovered that he had been simultaneously doing consultancy work for Enron and had paid $72000 as fees for consultation for Enron’s European operations. John Mendelson was president of a University of Texas medical centre, which had received $1.6million from Enron.
c) Poor risk management: Lay had Jeffrey Skilling persuaded, to move from McKinsey and Co., management consultants to Enron in 1990. Jeffrey Skilling changed Enron’s strategy. He created a risk management model, which meant an emphasis on energy and commodity trading rather than actually owning large amounts of fixed assets. Skilling created derivatives, which allowed companies to hedge risks associated with fluctuations in weather conditions, especially through speculative bet. Enron’s wealth became dependent on its intangible assets. Deakin and Konzelmann (2004), argue that part of Enron’s problems could be attributed to its decision to become involved in derivatives trades, particularly in markets such as broadband. These markets were extremely volatile and Enron had no physical presence and no specialized knowledge that could give the company a...