ENRON By G.# 09

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Enron Case Study

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Enron Case Study

History of EnronEnron traces its roots to the Northern Natural Gas Company, which was formed in 1932 in Omaha,

Nebraska. It was reorganized in 1979 as the leading subsidiary of a holding company, InterNorth. In

1985, it bought the smaller and less diversified Houston Natural Gas.

The separate company initially named itself "HNG/InterNorth Inc.", even though InterNorth was the

nominal survivor. It built a large headquarters complex in Omaha. However, the departure of ex-

InterNorth and first CEO of Enron Corp Samuel Segnar six months after the merger allowed former

HNG CEO Kenneth Lay to become the next CEO of the newly merged company. Lay soon moved

Enron's headquarters to Houston after swearing to keep it in Omaha and began to thoroughly re-brand

the business. Lay and his secretary, Nancy McNeil, originally selected the name "Enteron" (possiblyspelled in camelcase as "EnterOn"); but when it was pointed out that the term approximated a Greek

word referring to the intestines, it was quickly shortened to "Enron". The final name was decided

upon only after business cards, stationery, and other items had been printed reading Enteron. Enron's

"crooked E" logo was designed in the mid-1990s by the late American graphic designer Paul Rand.

Enron was originally involved in transmitting and distributing electricity and natural gas throughout

the United States. The company developed, built, and operated power plants and pipelines while

dealing with rules of law and other infrastructures worldwide. Enron owned a large network of natural

gas pipelines which stretched ocean to ocean and border to border including Northern Natural Gas,Florida Gas Transmission, Transwestern Pipeline company and a partnership in Northern Border

Pipeline from Canada. In 1998, Enron moved into the water sector, creating the Azurix Corporation,

which it part-floated on the New York Stock Exchange in June 1999. Azurix failed to break into the

water utility market, and one of its major concessions, in Buenos Aires, was a large-scale money-

loser. After the move to Houston, many analysts criticized the Enron management as swimming in

debt. The Enron management pursued aggressive retribution against its critics, setting the pattern for

dealing with accountants, lawyers and the financial media.

Enron was created by a merge between Houston Natural Gas and Internorth. Houston's Natural Gas's

CEO Kenneth Lay headed the merger of the two companies. Kenneth Lay became the CEO of Enron.

Enron was originally solely involved with the distribution and transmission of electricity and gas in

the United States. In the merger, Enron incurred a large amount of debt, and as a result of

deregulation, no longer had exclusive rights to its pipelines. The company had to find a way to

generate profits and cash flow. Kenneth Lay hired Jeffrey Skilling to work for Enron as an

accountant. Skilling suggested the practice of buying gas from a network of suppliers and selling it to

consumers at a fixed price with a contract. Enron was interested in the expansion, building, and

operation of pipelines, power plants, and other infrastructure worldwide. After just a year of operation


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Enron Case Study

Enron merged with a company called Spectrum Seven, a company whose chairman and CEO is the

former president of the United States, George W. Bush. In 1999, Enron tried to expand their company

by creating the Azurix Corporation, a water utility company. Overall the Azurix Corporation proved

unsuccessful financially. The Azurix Corporation, due to their failure to make an entrance into the

market, went under. By 2001, Enron announced plans to dissemble Azurix and liquidize the assets of

the corporation.

Enron allegedly became successful, trading over eight hundred different products worldwide. Enron

was named "America's Most Innovative Company" by Fortune magazine from 1996 to 2001. Enron

was on Fortune's "100 Best Companies to work for In America" in 2000. The company's future

appeared to be bright and promising continued success.

Enron faced many accusations of building links to political power. The company's connection to

George W. Bush, and Houston's local politics has received much attention in the recent past. In 1986,

Enron was involved with Bush's company in joint drilling for oil. There are reports that Kenneth Lay

and George W. Bush even shared friendship. The Enron Corporation was the largest financial

supporter of Bush's presidential campaign. Kenneth Lay has employed politicians who have worked

under George W. Bush. Bush also signed off on a law that deregulated Texas's electrical markets,

which coincidentally resulted in large profits for Enron.

The company also had political links that reached outside of the United States. Enron created a

massive and highly expensive power plant in India, even though many Indian citizens and the World

Bank strenuously objected. Allegedly protesters in India were beaten and arrested. The United States

ambassador to India, who opposed the plant eventually, joined the board of Enron Oil and Gas.

The screws came loose in August 2001, when Jeffrey Skilling, the CEO resigned from office for

unknown reasons. By October 2001, Enron experienced its first quarter where they did not report a

profit. On November 8th, 2001 Enron told the SEC it was restating its earnings since 1997, reducing

income by $586 million dollars.

In December 2001, Enron filed for chapter 11 bankruptcy. This was the biggest bankruptcy protection

case in United States history. It appears that Enron's problems were not in its energy operations, but

from "dot com" investments and in some foreign subsidiaries. The accounting system practices in placed failed to provide a clear picture of the corporation's financial status. Enron used accounting

techniques involving hiding debts to give the illusion of high profits. When the accounting practices

were revealed virtually all profit since 2000 had disappeared and the company plummeted.

Like many other companies Enron offered a retirement plan to its employees, in which they could

substitute earnings for stocks in Enron. The benefits to this were that the employees were able to buy

the stock on a tax-deferred portion of their pay. When the company closed in December 2001, sixty-

two percent of the company's 401 k plan was held in Enron stock. The stock, which once traded at

eighty dollars a share, went for less then seventy cents a share when Enron folded.


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Enron Case Study

Former Management and Corporate Governance

Central Management

Kenneth Lay: Founder, Chairman, and Chief Executive Officer

Jeffrey Skilling: President, Chief Operating Officer, and CEO (February-August 2001)

Andrew Fastow: Chief Financial Officer

Rick Causey: Chief Accounting Officer

Rebecca Mark-Jusbasche: CEO of Enron International and Azurix

Lou Pai: CEO of Enron Energy Services

Forest Hoglund: CEO of Enron Oil and Gas

Richard Gallagher: Head of Enron Wholesale Global International Group

Kenneth "Ken" Rice: CEO of Enron Wholesale and Enron Broadband Services

Clifford Baxter: CEO of Enron North America

Sherron Watkins: Head of Enron Global Finance

Jim Derrick: Enron General Counsel

Mark Koenig: Head of Enron Investor Relations

Cindy Olson: Head of Enron Human Resources

2001- Bankruptcy)Greg Whally: President and COO of Enron (August

Jeff McMahon: CFO of Enron (October 2001-Bankruptcy)

Board Of DirectorsRobert A. Belfer: Chairman, Belco Oil and Gas Corp

Norman P. Blake Jr.: Chairman, President and CEO, Comdisco, Inc.

Ronnie C. Chan: Chairman, Hang Lung Group

John H. Duncan: Former Chairman of The Executive Gulf and Western Industries Inc.

Wendy L. Gramm: Former Chairman of US Commodity Futures Trading Commission

Ken L. Harrison: Former Chairman and CEO of Portland General Electric

Robert K. Jaedicke: Professor of Accounting at Emeritus

Charles A. LeMaistre: President Emeritus, University of Texas M.D. Anderson Cancer

Center

ndelsohn: President, University of Texas M.D. Anderson Cancer Center John Me

Jerome J. Meyer: Chairman, Tektronix

Paulo V. Ferraz Pereira: Executive Vice President if Group Bozano

Frank Savage: Chairman: Alliance Capital Management

John A. Urquhart: Senior Advisor to the Chairman of Enron

John Wakeham: Former U.K. Secretary of State for Energy

Herbert S. Winokur Jr.: President of Winokur Holdings Inc.


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Enron Case Study

Pro

more than 30 different products, including the following:

ducts

nron traded inE

Products traded on EnronOnline

Petrochemicals

Plastics

Power

Pulp and paper

Steel

Weather Risk Management

Oil & LNG Transportation

Broadband

Principal Investments

Risk Management for Commodities

Shipping / Freight

Streaming Media

It was also an extensive futures trader, including sugar, coffee, grains, hog, and other meat futures. At

e time of its bankruptcy filing in December 2001, Enron structured into seven distinct business

Water & Wastewater

th

units.


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Enron Case Study

Question No.1an unethical manner if so do you think that a

nswer:nron’s management behaved in an unethical manner and they adopted some unethical

nt policy

ch loyal employees who could not perform as per

al parties:

political campaign and spent about $ 2 million of

oject planning and it started lot of many projects at once.

roles:

se for Enron dishonesty but “if the truth is

ypocrisy pervaded the corridors of Enron

in the manner in which they promulgated

Do you think that Enron management behave in

better system of corporate governance check and balance would have detected their unethical

behavior before it was too late & avoided the company collapse ?

AI think that E

activities. These activities become the cause of failure of Enron.

Following are the unethical activities

Enron’s unethical employme

Enron had adopted a policy of ‘hire and fire’ in whi

the company yardstick were fired while those including unethical practices were able to make a fast jump. In the performance appraisal of employees bottom 10 % in the performance were dismissed

while they have very good score.

Heavy donation to politic

Lay president of Enron involved in state level

Enron’s money on 700 candidates in 28 states. The company and top executive used every power they

could gather to bring about energy deregulation that brought them great profit.

Poor project implementation

Due to the wrong implementation of pr

However many of them were poorly conceived and theoretical. Its failure revealed that many such

projects could not be funded by Enron s capital.

Accountants, Analysts and Lawyers

The accountants and analysts are certainly making the ca

not expected to be spoken” which certainly is the case, than it is their job to cut the cover. No

potential client thinks otherwise. The role of accountants and analysts is to serve shareholders and

potential shareholders in rectifying the information asymmetries that exist when shareholders deal

directly with the company but they did not fulfill the requirements of the shareholders and they

behaved in unethical manner.

H

There was a lot of hypocrisy in Enron and wide difference

policies and the way in they were implemented. There were dichotomy between percepts and

practices. There are four core values of Enron

Communication


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Enron Case Study

Respect

Integrity and

Excellence

But in fact these were all opposite by their names. If any employee adopted them was dismissed by

of good corporate governance through check and balances to avoid another

for the code of ethics to promote the importance of

er, guarantee accurate financial

of whistleblowers but the power of these was used by other like CEO and

Government plays its vital role to regulate the good

ipants in the corporate process signifies a move

magnitude, and

the management of Enron.

Recommendations:

I think that a better system

Enron collapse I recommend following measures.

Implementation of code of ethics

Management will be assigned responsibility

corporate morality and ethical standards. This will also put management in a leadership role rather

than in the cop’s role it currently plays in internal control systems.

Continuous attention by each group will rebalance corporate pow

reporting, stop management fraud, and encourage good corporate behavior. Under the concept of

empowered or reengineered organizations as the cornerstone of this comprehensive governance

structure, all three goals are shared visions and shared responsibilities.

Whistleblowers:

Enron had a committee

BOD. But with the passage of time one of them was fired by the Top management on this reason why

he started the investigation of other case without permission of certain body.

Participation of Regulatory body:

Mostly in developed and developing countries

practices of Corporate Governance in these days. Regulatory authority must check and balance the all

ethical practices regarding Code of Governance to avoid another Enron. Government should make a

committee for specially public sectors organization who will check the all unethical and other factors.

Recognizing the Role of Employees

The recognition of the role of employees as key partic

toward an progressive view of employees in general, which will promote a cooperative relationship

among shareholders, top management, and employees in the corporate environment.

The psychological impact on labor, individually and collectively, will be of historic

perhaps may be understood only sometime in the future. In the near term, however, the new self-

esteem of employees will probably lead to dramatic gains in productivity.


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Enron Case Study

Question No.2:le of non-executive directors, auditors, internal audit committee and the

nswer:ernance has become an increasingly topical issue in recent years. This has been fuelled

Do you think that the ro

board of directors are equally important as mechanism of good corporate governance? If not

which mechanism do you consider is the most important?

ACorporate gov

by such corporate collapses as Enron, Worldcom, Parmalat and One.Tel. The role and responsibility

of the board and directors has emerged as an important issue in examining the cause of these

collapses. This has created much debate on what the role of the directors is in 'directing', 'monitoring'

or 'advising' a company. Research indicates that investors are prepared to a pay a premium for good

governance. This raises a number of questions. What is governance? How do we determine what is

good governance? What role do directors have in this? Does the company's performance improve by

adopting good governance practices? There are numerous approaches to examining what makes a

good board. Quantitative techniques have included the use of such measurable concepts as the number

of executive and non-executive directors, directors' skill base (for example, accountancy, marketing

etc) and frequency of meetings attended. Researchers have also attempted to measure board

performance and effectiveness by using indicators such as share values and shareholder returns. There

is a lack of qualitative research in board behavior and effectiveness. This exploratory study adopts a

qualitative approach in order to provide richer data. It uses interviews to evaluate directors' views on

some aspects of corporate governance, specifically in relation to the executive and non-executive

director debate. The interviews were conducted with 11 directors from a variety of organizations in

the for-profit and not-for-profit sectors. Two major themes have emerged from the analysis of the

interviews. Firstly, directors are traditionally considered to be responsible for maximizing shareholder

wealth. However, directors are now expected to broaden their responsibilities to include other

stakeholders and to consider social and environmental issues in making their decisions. The findings

indicate that it is now more demanding to be a director due to increased workloads arising from the

regulatory and legal requirements. This has also impacted on director and board evaluations, multipledirectorships and directors remuneration levels. The second major theme that emerged from this study

is that directors' personal experiences did not necessarily concur with governance principles and

guidelines. For example, the widely recommended method of achieving 'best practice' by having a

majority of non-executive directors on a board is considered too simplistic. Further studies are

required on the behavioral and personality traits, technical skills of the directors, board structure,

composition and type of organization which make the best contribution to achieving boardroom

effectiveness.


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Enron Case Study

Non-Executive Director:

The term “non-executive director”, focuses on what they are not rather than what they are. Other

terms have been suggested. “Outside director” is a term used in the US and elsewhere but it is not

widely recognized in the UK. The term “independent director” is given a particular meaning in this

Review, and by no means all non-executive directors could, or need to, meet it.

Role of Non-Executive Director:

The Code of Corporate Governance emphasizes the role of Non-executive directors in the Board of

Directors.

Strategy:

Non-executive directors should constructively challenge and contribute to the development of

strategy.

Performance:

Non-executive directors should scrutinize the performance of management in meeting agreed goals

and objectives and monitor the reporting of performance.

Risk:

Non-executive directors should satisfy themselves that financial information is accurate and that

financial controls and systems of risk management are robust and defensible.

People:

Non-executive directors are responsible for determining appropriate levels of remuneration of

executive directors and have a prime role in appointing, and where necessary removing, senior

management and in succession planning.

The non-executive director role is complex and demanding and requires skills, experience, integrity,

and particular behaviors and personal attributes.

Non-executive directors need to be sound in judgment and to have an inquiring mind. They should

question intelligently, debate constructively, challenge rigorously and decide dispassionately. And

they should listen sensitively to the views of others, inside and outside the board.

The role of the non-executive director is frequently described as having two principal components:monitoring executive activity and contributing to the development of strategy.

A number of consultation responses identified the personal attributes required of the effective non-

executive director. They are founded on:

Integrity and high ethical standards;

Sound judgments;

The ability and willingness to challenge and probe; and

Strong interpersonal skills.

It is important to establish a spirit of partnership and mutual respect on the unitary board. Thisrequires the non-executive director to build recognition by executives of their contribution in order to


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promote openness and trust. Only then can non-executive directors contribute effectively. The key to

non-executive director effectiveness lies as much in behaviors and relationships as in structures and

processes.

Executive and non-executive directors have the same general legal duties to the company. However,

as the non-executive directors do not report to the chief executive and are not involved in the day-to-

day running of the business, they can bring fresh perspective and contribute more objectively in

supporting, as well as constructively challenging and monitoring, the management team.

Non-executive directors must constantly seek to establish and maintain their own confidence in the

conduct of the company, in the performance of the management team, the development of strategy,

the adequacy of financial controls and risk management, the appropriateness of remuneration and the

appointment and replacement of key personnel and plans for management development and

succession. The role of the non-executive director is therefore both to support executives in their

leadership of the business and to monitor and supervise their conduct.

In practice, non-executive directors will pursue some of their activities through their role on board

committees. In smaller companies, non-executive directors may also often provide specific expertise

or experience to complement that of the executive team which may be valuable in coaching and

supporting management.

Role of Audit Committee:

According to the Code, the Board of Directors of every listed company shall establish an Audit

Committee, which shall comprise not less than three members, including the chairman. Majority of

the members of the Committee shall be from among the non-executive directors of the listed company

and the chairman of the Audit Committee shall preferably be a non-executive director. The Audit

Committee of a listed company shall meet at least once every quarter of the financial year. These

meetings shall be held prior to the approval of interim results of the listed company by its Board of

Directors and before and after completion of external audit. The CFO, the head of internal audit and a

representative of the external auditors shall attend meetings of the Audit Committee at which issues

relating to accounts and audit are discussed. The audit committee will also review quarterly, half-

yearly and annual financial statements of the listed company, prior to their approval by the Board of

Directors. Monitoring compliance with the best practices of corporate governance and identification

of significant violations is also responsibility of this committee.

The Audit Committee shall, among other things, be responsible for recommending to the Board of

Directors the appointment of external auditors by the listed company’s shareholders and shall consider

any questions of resignation or removal of external auditors, audit fees and provision by external

auditors of any service to the listed company in addition to audit of its financial statements. The terms

of reference of the Audit Committee shall also include ascertaining that the internal control system


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Enron Case Study

including financial and operational controls, accounting system and reporting structure are adequate

and effective.

Audit committees are an increasingly important component of effective accountability and

governance. An audit committee must have three important qualities in order to fulfill its duties:

Independence

Communication

Accountability

Independence:

In the public sector, the structure of entities does not separate the governing authority and oversight

responsibility from the day-to-day management. For example, a public university president may be

both the chief executive officer and a board member. Public sector audit committees should be

independent both in fact and in appearance, and have processes in place to ensure such independence.

Communication:

Communication between a governing body and its finance officers can be difficult at times. For

example, external financial reporting follows standard principles; however, budgets and expressions

of policy are unique to the circumstances of the organization and its jurisdiction. Communication may

be complicated when a governing body approves a budget but not the financial statements. The GAO

has indicated that audit committees can provide assistance if they have the necessary technical skills

in accounting and auditing and are able to communicate with finance officers and auditors on complex

issues.

Accountability:

An audit committee must be independent to contribute to the integrity of the financial reporting

process. An independent audit committee can help reinforce a culture with zero tolerance for fraud.

The combination of independent oversight and the technical expertise of audit committee members

enhance accountability.

Audit Committees and Internal Controls:

Although Government Auditing Standards (2003 Revision) does not include additional internal

control standards for financial statement audits, it emphasizes several aspects of internal controls that

are important for auditors and audit committees. Controls over the safeguarding of assets, controls

over compliance with laws and regulations, and controls over environment and risk assessment are

covered.

Weaknesses in internal controls can cause many problems, including fraudulent activities, errors, and

noncompliance with laws and regulations. An audit committee should understand an entity’s internalcontrols and ensure that the five components of internal controls—control environment, risk


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Enron Case Study

assessment, control activities, information and communication, and monitoring—are present and

operating effectively in the organization. An audit committee’s activities should include the

following:

Understanding how the internal control objectives are achieved within the entity.

Considering whether the control environment and procedures can accomplish their

objectives.

Reviewing the auditor’s reports on internal controls and compliance with laws and

regulations.

Determining whether material weaknesses, reportable conditions, or other findings were

reported.

Reviewing suggested improvements to internal controls and following up to correct the

weaknesses in internal controls.

Audit Committees and External Auditors

Generally Accepted Auditing Standards (GAAS) and Government Auditing Standards require an

auditor to test an entity’s internal controls and deliver its report and recommendations to the audit

committee. The external auditor is required to communicate the following:

Its responsibilities for testing internal controls and compliance with laws and regulations.

Possible weaknesses in internal controls that are discovered prior to the audit engagement.

The effect that possible weaknesses in internal controls could have on the accuracy of

financial information or on compliance with laws and regulations, as well as any additional

testing of internal controls required.

The probability that internal control procedures are not sufficient to achieve a relatively low

risk that errors or irregularities would not be detected within a timely period by employees

in the normal course of their assigned functions.

Its knowledge of the risk control areas and the activities needed to address those risks.

Audit Committee Composition and Responsibilities:

Having an audit committee does not relieve governing bodies of responsibility for the matters

considered by the committee. An audit committee should have a charter that states its mission,

objectives, authority, organization, and methodology. In addition, the charter should establish voting

requirements, the liability of members, and their method of appointment.

Audit committees should have three to six members, with some or all of the following qualities:

Good communication skills and the ability to work with others;

Knowledge of the needs, interests, and concerns of the constituency;Accounting and auditing expertise and experience; and


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Enron Case Study

A willingness to ask hard questions and deal with controversial matters.

n audit committee may often be empowered by the governing body to select or recommend theA

external auditors, which would be formally approved by the governing body. In doing so, the audit

committee should consider the following factors:

Auditor independence;

The firm’s reputation and fees;

The firm’s scope of services and experience with the public sector; and

The firm’s quality-control standards.

he Role of the Board and Management:

ockholders, the owners of the corporation, in

T

The Board represents the interests of the corporation's st

optimizing long-term value by providing the corporation guidance and strategic oversight on the

stockholders' behalf. The paramount duty of the Board is to select a well-qualified and ethical Chief

Executive Officer (CEO) and to oversee the CEO and other senior management in the operation of the

corporation. In addition, the Board performs, directly or through its committees, the following specific

functions, among others:

Selects, sets the compensation for the CEO and evaluates the CEO and plans for senior

management succession

for the election, retention, evaluation and compensation of senior Oversees the procedures

management with appropriate qualifications and expertise to operate the corporation's

business

the key compensation, benefits and skill development programs governingOversees

employees of the corporation

ce and reviews and approves the corporation's strategic plan,Oversees corporate performan

annual operating plans, and budget

licies and procedures (including market, credit andOversees the corporation's risk po

operational risks)

ent on significant issues facing the corporationAdvises managem

Reviews and approves significant corporate actions

Oversees the integrity of the corporation's accounting and financial reporting systems and

relationship processes, including independent audits, systems of internal controls, and the

with the outside auditor

ontrol matters

Oversees an independent review, no less frequently than every five years, of the

corporation's organizational, structural, staffing, and c


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Oversees the process and adequacy of reporting, disclosures and communications to

stockholders and other investors

Oversees the corporation's legal and regulatory compliance program

Nominates directors and oversees effective corporate governance

At least once annually, reviews, with appropriate professional assistance, the requirements

of laws, rules, regulations, and guidelines that are applicable to the Board's activities and

duties

Members of the Board are expected to perform their responsibilities diligently, prepare for and attend

meetings, and participate fully in the Board's activities.

It is the responsibility of management, in the exercise of their fiduciary duty to the corporation and its

stockholders, to run the corporation's business in an effective and ethical manner. The CEO is the

leader of management and, pursuant to the Bylaws and a Delegation of Authority to the CEO, as may

be amended from time to time, the Board has vested the CEO with the authority to manage and

conduct the business of the corporation except where the Board has reserved authority or the right of

approval as specified in the Bylaws and its Delegation of Authority to the CEO. Officers and

employees (consistent with the provisions of their delegations of authority from the CEO) may retain

outside consultants and advisors, as necessary, to assist them in the performance of their functions.

Conclusion:In my point of view the role of non-executive directors, auditors, internal audit committee and the

board of directors are equally important as mechanism of good corporate governance. But the

condition is that there should be transparency in each activity of Enron and should be the

independency so that each department does his work without any restriction or any hesitation.

Another thing which is important there should be check and balance of each activity or transaction.

Everyone should be accountable to his higher authority.


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Question # 03

Summarize the corporate governance problems in ENRON. Do you think that they are all of

equal important if not which corporate governance problem do you feel contributed the most to

the company’s downfall ?

Answer.Every time you turn a stone, another worm creeps out. That seems to be the story of the Enron

disaster. I feel that the following all problems contributed to destroy the Enron.

Chairman and CEO:

It is considered good practice to separate the roles of the Chairman of the Board and that of the CEO.

The Chairman is head of the Board and the CEO heads the management. If the same individual

occupies both the positions, there is too much concentration of power, and the possibility of the board

supervising the management gets diluted.

In Enron, Mr Kenneth Lay was both the Chairman and CEO. For a brief while the two positions were

separated when Mr Jeff Skilling functioned as CEO, and when he resigned in August 2001, Mr Lay

again took on both roles. His recent claim that he did not know too much of the details of the

accounting falsification that was going on is, at best, disingenuous.

Audit Committee:

Boards work through sub-committees and the audit committee is one of the most important. It not

only oversees the work of the auditors but is also expected to independently inquire into the workings

of the organisation and bring lapses to the attention of the full board. The Enron audit committee

failed in this regard.

In the words of the Special Investigating Committee: "The Board assigned the Audit and Compliance

Committee an expanded duty to review the transactions, but the Committee carried out the reviews

only in a cursory way." The Chair of the Audit Committee since 1985 was Mr Robert Jaedicke, a

former accounting professor and Dean of Stanford University Business School. (Normally, it is good

for this position to rotate every three or four years.) He was there because audit committee's arerequired to have as its members, persons who are financially literate.

Mr Jaedicke, in addition to not using his expertise to perform his role as Chair of the committee,

seconded the motion in the board to suspend the `Code of Ethics' of the company in order to allow an

employee to set up a special partnership. (Audit committees normally oversee compliance of such a

code.) Setting up that entity amounted to a conflict of interest and was specifically prohibited by the

company code.

Mr Jack Welch, the legendary former Chairman of GE, commented recently in a television

programme that suspension of a code of ethics is unheard of. I would go a step further and say that it


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is the corporate equivalent of the `insanity defense' that we see in criminal cases. Apart from Mr

Jaedicke, the audit committee comprised of five persons, three of whom reside outside the country.

An audit committee is almost a `working' committee and needs to meet more frequently than a full

board. Having non-residents on the committee hampered its functioning. One of the members, Mr

Ronnie Chan, missed 75 per cent of the meetings in 2001.

Independence and conflicts of interest:

Good governance requires that outside directors maintain their independence and do not benefit from

their board membership other than remuneration. Otherwise, it can create conflicts of interest. By

having a majority of outside directors on its Board, Enron followed a good practice. But in the way

they behaved, they compromised their independence. Six of the 14 outside directors suffered from

serious conflicts of interest:

(a) Mr Robert A. Belfer, Chairman of Belfer Management, bought a stake in an energy company froman Enron partnership, thereby providing funds to start another.

(b) Ms Wendy Gramm (spouse of a Republican Senator) was formerly Chairman of the Commodities

Futures Trading Commission of the federal government. Enron's trading in energy derivatives was

exempt from regulation by the CFTC.

Shortly after that decision, she quit the commission and joined Enron's board. She is presently

Director of Regulatory Studies Program at George Mason University. Enron has donated $50,000 (Rs

24 lakh) to that centre.

(c) Mr John Mendelsohn is the President of the MD Cancer Centre at the University of Texas. Enron

and related entities have donated $1.5 million (Rs 7.2 crore) to the Centre since 1985.

(d) Mr William Powers, who also headed the Special Investigation Committee is the Dean of the

University of Texas Law School. Enron has given $3 million (Rs 14.4 crore) to the University since

he became Dean. The law firm that works for Enron, Vinson and Elkins, has endowed a chair at the

Law School.

(e) Lord John Wakeham, a former Minister for Energy in the UK was paid $72,000 (Rs 34.5 lakh) for

services as a consultant to Enron's European unit. When he was minister, he gave consent to Enron for

building the country's largest power plant at Teeside.

(f) Mr Herbet S. Winokur is also a Director of the Natco Group which is a supplier to Enron and its

subsidiaries. He is also Chairman of the Board's Finance Committee which recommended that the

board suspend the company's ethics code. The involvement of these Directors resulting in other

benefits compromised their independence making one wonder whether they acted in the best interest

of Enron.

Flow of information:

A board needs to be provided with important information in a timely manner to enable it to perform

its roles. A governance guideline of General Motors, for instance, specifically allows directors to


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Enron Case Study

contact individuals in the management if they feel the need to know more about operations than what

they are being told.

In the Enron situation, the directors are pleading ignorance of the murky deals as a way of excusing

themselves of the liability.

The Special Investigating Committee report says: "The board was denied important information that

might have led it to action, but the Board also did not fully appreciate the significance of some of the

specific information that came before it.' Here is another mea culpa. Moreover, if they did not have

sufficient information, they should have gone seeking it. Reports suggest that Enron operated about

3,500 Special Purpose Entities, that is, partnerships that shifted debt and losses off Enron's balance-

sheet. If the directors did not understand what was being reported to them, it was their job to educate

themselves more about it by asking the right questions and getting more information. This they failed

to do.

Too many directorships:

Being a director of a company takes time and effort. Although a board might meet only four or five

times a year, the director needs to have the time to read and reflect over all the material provided and

make informed decisions. Good governance, therefore, suggests that an individual sitting on too many

boards looks upon it only as a sinecure for he or she will not have the time to do a good job. Mr

Raymond Troubh, one of the directors, is a Director of 11 public companies.

Many successful companies suffer from one or more of the faults described above. When the

company performance is satisfactory, we tend to overlook these drawbacks. In Enron's case too many

of their faults came together at the same time to cause the company to implode.

The corporate governance model being followed was too weak to prevent the problems from

escalating. And this should be a lesson for all of us. Next time we receive a proxy statement from a

company in which we hold shares, we must read it carefully.

If we are unhappy with the directors being proposed for election, we must voice our complaint to the

company and vote against the slate being offered. If we are suspicious of the company's governance

structure, we should report to the stock exchange where the company's shares are traded. As a final

resort, we can exit the situation by disposing the stock.


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Question No.4What extent do you agree that, "When an apple is rotten there is no cure, but at least the rotten

apple can be removed before the contagion spreads and infects the whole basket? This is really

what corporate governance is all about. Discuss your views.

Answer:An apple is not rotten in a very short period of time. It always takes time to rotten because it is a

natural phenomenon that every thing takes time to being existence in its proper form. And when this

rotten apple puts in basket then it start to damage others.

Here key point is to identify this rotten apple before its damage to other once.

Now when we narrate this scenario with ENRON when it starts its controversial business practices no

one identifies them on major platforms and it continues to doing business in its own way. And it’s

exactly a time when ANRON leads towards a rotten apple.

This exactly happened with ENRON that when (rotten apple) not identify and puts it’s into a large

basket and its damage whole system. And all stakeholders effected badly by one rotten apple.

So the best time to counter any controversy is when its start to arise and handle it on that particular

time. Other wise its come forwarded us in a shape of ENRON.


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Q.No05Recalling the code of Corporate Governance What are the shortcomings and loopholes you

observes in Enron Case and also come up with practical recommendation to avoid an other

Enron?.

Answer:The Enron scandal is the most significant corporate collapse in the United States since the failure of

many savings and loan banks during the 1980s. 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.

Shortcomings in Enron

What makes the company an interesting case is its sudden demise from operations in2001 owing to

improper financial performance and bankruptcy. Whereas the main reason was financial

embezzlement and inaccurate financial disclosure, it was later revealed that there are many underlying

causes behind its downfall, most important of which wassailed corporate governance by top

management and board of directors who didn’t act to secure shareholder interest. Some of the key

attributable reasons are briefly discussed here:

Unbridle growth and expression

To begin with, Enron’s business concept was flawed. It was venturing into many divergent businessesareas such as water and broadband services, without having the relevant technical expertise and know

how about industry dynamics. Furthermore it was pledging beyond its capacity. Since the energy and

trading business is highly susceptible to speculation, and is extremely interlinked, hence collapse

through ripple effect was witnessed. Enron guaranteed supplies and uplifting in case if third party

partner companies fell back on their pledge. When many trading groups who were financially

unsecured fell back on their professional commitment, Enron had to bear financial losses for their

actions.

Financial reasons

Enron had accrual basis of accounting in vogue. Meaning thereby, revenues were realized when they

were earned. The previous CEO, Rich Kinder who was an expert on financial matters, always focused

cash flow from operations. All project managers were under scrutiny to meet cash generating targets

of the company. Hence the company had strong financials, and especially cash position was solid. The

company had the ability to have controlled growth.

Since revenues were sky high, hence management turned a blind eye to cash flow issues. The

company lacked the capacity to realize that the revenues reported were not actually earned. Whereas

profits were high, actual cash position was declining sharply. The company squandered resources, in


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maintaining top quality life style for its executives in the form of compensation and fringe benefits. It

also invested heavily in other activities outside its core business, without tangible cash basis. Cash is

lifeblood of a commercial company. When trading business started showing a downturn due to high

volatility of prices, the company realized that it didn’t have sufficient cash to pay back on its pledges.

Furthermore, it needed cash to pay back its day-to-day expenditures, debts and penalties for energy

banking initiatives.99

Creative Accounting

Since the company’s trading business depended substantially in gambling on future prices of energy

products, it required attractive financial statements so that the company could attract suitable business

opportunities, investors and creditors. However, when future guaranteed energy prices showed a

downturn, sending ripple effects on business models, the company was left with a weak cash position

and mounting debt. Hence to hide this debt and potential losses, the company formed new partner

companies, (associated with top executives of the company, thus violating its own ethics of no

personal interest of management in business operations of the company or its partner companies).100

Such partnerships would shift debt of Enron to that of the partner companies’ accounts, thus

improving balance sheet position of Enron Corporation as wellas shifting losses to partner companies’

accounts, showing them as sales for Enron thereby boosting profitability. 101

Failure in light of Agency Theory

The main reason of Enron’s downfall was that the board turned absolutely blind eye, as if they were

just a rubber stamp authority that approved anything that top management suggested to them. Thissuggests that they were not fulfilling their responsibilities as true agents of shareholders. Agency

theory clearly suggests that- any business association between agents and the company in terms of

conflict of interest and in terms of lack of professional conduct in protecting shareholder interest- will

lead to corrupt practices and systemic collapse.

Enron down fall in model of corporate governance.

Different forces associated different expectations from Enron. Each actor asserted his own pressure on

the corporation to grow in an unprecedented fashion. The external environment wanted to capitalize

on Enron’s resources, growth and reach. They also wanted to be strategic partners in Enron’s success

and to enter into a win-win relationship. It is to be kept in mind that whereas good corporate

governance is the prime responsibility of the Board, but it is equally imperative for stakeholders that

they help the company in fulfilling its obligations as a good corporate citizen. The internal

environment was a product of strict corporate culture which was marked by cut-throat competition

amongst peers. Since top management didn’t lead by example, hence other employees could not

prevent this disaster from happening. Since other employees also wanted promotions, bonuses and

privileges hence they acted as silent spectators while agents plundered wealth from the corporate


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system and thus violated their own code of ethics. Thus as a whole, the company collapsed because

the system had become self-destructive, owing to principal-agent conflict of interest.

Key lesson from Enron.

Enron had a global vision. To achieve this aim, it had an expansion oriented corporate strategy. Its

strategy was shaped by influence of external and internal stakeholders, with both being connected

through non-transparent, inappropriately disclosed information exchange.

Enron collapsed because its corporate strategy was not equally supported by its corporate

governance mechanism. Once the governance mechanism failed, strategy failed and the firm

collapsed as a whole.

In case of Enron key problem occurred because there was a problem of failed corporate

governance and groupthink. Since Enron was performing high, hence, Board had a blind faith in

the performance of top management and they generally endorsed, whatever the top management

proposed without exploring the tradeoff between risk, returns, and authenticity of information that

was communicated to them by the top management. The element of accountability was

immensely missing at Enron.

Enron’s top management consisted of people who had great industry experience, and the Board

consisted of people who had policy and government background as well as market experience.

The top management consisted of people who were mostly graduates from Ivy League

universities of USA hence there was this element of blind trust in each others judgment and

decisions. Since Enron was like a golden egg laying entity, hence none of them wanted to

question the Chairman, the CEO or performance of top management. Company was excessively

growing hence the Board found no need to turn things around, since the results were coming up

fine, hence the Board was not skeptical as to how this unprecedented growth was taking place.

Recommendations:

Main lesson to be learnt from Enron is that conflict of interest must not arise between principal

and agents. If such a scenario arises, it would be imperative forth agents to subordinate their

interest for the collective benefit of the system as a whole. Agents have a moral obligation to

ensure that principal’s interest is secured in ethical way and that principal is rightly communicated

about developments in the corporate entity.

Furthermore, conflict of interest should never arise amongst the agents i.e. the top management

and the board of directors or it may lead to systemic collapse. They should not have any business

association with the company. In the event of such violations, accountability should be done

speedily.


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Agents must ensure not to set precedents for corporate malpractice. Corruption travels down the

organization in through a trickle down mechanism. External and internal stakeholders must be

vigilant to ensure that the company is acting as a good corporate citizen.

They should not be lured by its growth rates but must be skeptical in wider interest of all

concerned.

The corporate culture of an entity plays a pivotal role in its ethical orientation as well as strategy

implementation. If culture is cut-throat in nature, it will not serve stakeholder interest as a whole.

A key point is that the Board Chairman and the CEO should be separate persons. In this way

appropriate blend of CEO’s aggressive strategies coupled with conservative thinking of the

Chairman board will work in the organizational interest as a whole.

Auditors being valuators of public funds must never connive with agents. Furthermore there

should not be a conflict of interest between the auditors and the organization.

Corporate strategy will only be successful if it is backed by a well-governed corporate system.

Since both these attributes have external and internal implications hence their mutually

complimentary role will serve as a unique competitive advantage for the corporation.


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References:

www.enron.com/

http://www.thehindubusinessline.com

http://hbswk.hbs.eduhttp://www.oecd.org/document/

www.oppapers.com/essays/Enron-Its-Shortcomings/

http://ezinearticles.com/?A-History-of-Enron&id=2082701

http://en.wikipedia.org/wiki/Enron

http://fpc.state.gov/documents/organization/9267.pdf



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