CORPORATE GOVERNANCE AND THE FALL OF ENRON
Introduction to the Enron Case
Enron was one of the world’s leading energy traders born from deregulation of these markets in certain US states. It rapidly grew and the world followed suit. It was nominated ‘World’s Most Innovative Large Corporation’ six years in row and valued at 64 times its earnings and 6 times its book value. It had one of the highest paid CEOs in the world in 2000. It led an aggressive and apparently effective expansion model from its creation in 1985, as an interstate pipeline operator based in Houston, until secret cracks split wide open and the corporation was engulfed in a dramatic implosion. The climb to greatness took all of fourteen years, its fall was brief and brutal. On 02 December 2001, Enron filed for bankruptcy.
I - The Skilling Way:
A- ‘Light asset’ trading: a risky business model
Enron sells off heavy assets and sets its sights on ‘light asset’ trading. Assets were kept based on the reasoning that they generated key information for the business. It expanded focus from trading energy to all highly inefficient markets with the following characteristics: single commodity, fragmented/undergoing significant change (deregulation); complex distribution channels, capital intensive, lengthy sales cycles, loose contracts for supply/service quality and standards; opaque pricing, no public disclosure; buyers with limited flexibility to manage key business risks. In every new market, it acquired the assets necessary to guarantee delivery then offered customers contracts which allowed them to manage the business risks. Enron would offset market price volatility and hedge risk using a variety of future and forward contracts.
B- Innovation, ‘benefit of doubt’ talent management and immediate gain gratification Enron pushed for innovation and creativity. Its staff were among the best and brightest business and science graduates. They were encouraged to move to business units where they felt they could add value. Achievement was compensated by generous bonus systems (potentially doubling the annual salary) while traders received bonuses on the current value of assets traded (even though they were trading for future payment on contracts). In short, Enron was staffed with hungry competitive achievers who were driven by the company’s bonus system, eventually leading them to overlook sustainable business processes due to the gratification system compensating rapid gain. Decentralised decision-making processes encouraged action but reduced oversight by senior management. Skilling’s Performance Review Committee classed staff according a grading system where the ‘superior’ staff would receive the ‘benefit of doubt’ when attempting something new. A late internal AA memo notes the personnel’s aggressive accounting strategies to comply with firm reporting (something they did not bring up with their client).
C- Corporate Controls to Minimise Risk
RAC - Risk Assessment and Control was created by Skilling to offset the high risks of trading in these hazardous markets, notably after the North Sea project $675 million write-off. It was charged with analysing the financial and non-financial risks of Enron businesses, projects and transactions for which it implemented an array of reporting programmes to monitor trading risks, providing up to day-to-day reporting on different portfolios. RAC also evaluated new business ideas based on proximity to corporate core competencies. Staff were required to sign off on a 64 page Code of Ethics. Investments by senior management with potential conflicts of interest needed to be signed off by Chairman of the Board and CEO (Ken Lay). The RAC became a ‘speedbump’ many would have preferred to avoid and manifestly found a way around according the AA internal memo but also when considering the management of Enron SPEs.
II - Accounting, Finances and Hedging
A- Precarious accounting
Enron’s books were at best,...
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