Enron Case
Enron entered the year 2001 as the seventh largest public company in the U.S, only to exit the year as the largest company to ever declare bankruptcy in U.S history.
a) What were the business risks Enron faced and how did those risks increase the likelihood of material misstatements in the Enron’s financial statements?
Enron faces most of the risk ordinarily faced by any energy company, including price instability and foreign currency risks. Enron operated in many different areas of the world with different regulatory and political risks.
The speculative nature of Enron exposed the company to much additional risk, which created pressure to adopt aggressive financial reporting practice. Enron acted as a broker of speculative energy futures, offered financial hedges. Further many of Enron’s deals (including the SPEs) depended heavily on a high and raising stock price. The company had guaranteed its obligations with stock and had contractually agreed that those obligations would become immediately due and payable if the stock price fell below certain levels. If the company were to report poor or deteriorating results its partners might begin to question the company’s ability to meet its obligations and consequently refuse to do business with the company.
b) Discuss the responsibility of i) the board of directors and ii) the audit firm, for the fall of Enron.
The boards of directors are responsible for ensuring that firms management is acting in the best interest of the owners. The board could have taken several steps to improve corporate governance. In the reports following the fall of Enron the committees placed a good deal of blame on the board of directors and the audit committee. They could for example have • Prohibited accounting practices and transactions that put the company at high risk • Prohibited conflict of interest arrangements that allow company transactions with a business owned or operated by senior company personnel
a) What were the business risks Enron faced and how did those risks increase the likelihood of material misstatements in the Enron’s financial statements?
Enron faces most of the risk ordinarily faced by any energy company, including price instability and foreign currency risks. Enron operated in many different areas of the world with different regulatory and political risks.
The speculative nature of Enron exposed the company to much additional risk, which created pressure to adopt aggressive financial reporting practice. Enron acted as a broker of speculative energy futures, offered financial hedges. Further many of Enron’s deals (including the SPEs) depended heavily on a high and raising stock price. The company had guaranteed its obligations with stock and had contractually agreed that those obligations would become immediately due and payable if the stock price fell below certain levels. If the company were to report poor or deteriorating results its partners might begin to question the company’s ability to meet its obligations and consequently refuse to do business with the company.
b) Discuss the responsibility of i) the board of directors and ii) the audit firm, for the fall of Enron.
The boards of directors are responsible for ensuring that firms management is acting in the best interest of the owners. The board could have taken several steps to improve corporate governance. In the reports following the fall of Enron the committees placed a good deal of blame on the board of directors and the audit committee. They could for example have • Prohibited accounting practices and transactions that put the company at high risk • Prohibited conflict of interest arrangements that allow company transactions with a business owned or operated by senior company personnel