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Enron faced financial difficulties during the early years of its establishment (Sims and Brinkman, 2003) But, nevertheless, they argued that in 1988 “deregulation of the electrical power’ had resulted in a promising strategy n the field of energy resulting in a new era for Enron. The financing process of the power plant projects was not mature during the time of the deregulation occurrence. The banks which were experiences in this kind of financing had already started to develop of which Enron as a major energy firm then built strong and solid relationship with the capital providers, such as Citibank and Barclay (Baker, 2003).
In the mid cays, Enron had started making a shift in it corporate strategy. The idea was to move the focus on its fixed assets, as the main stream of revenue, to the intangibles assets. Following the result of the government deregulation and the establishment of “Gasbags’ company as an intermediary for the natural gas contracts, which then allowed Enron to be the leader of the natural gas derivatives market (Assistant, 2005). According to Enron’s annual report (Enron, 1992, p. ): “Physical assets play a strategic, but not central, role in the way we earn money and this reduces emphasis on merely earning a return on physical assets and allows us to divest non-strategic assets and re-deploy capital into higher growth and stronger-return business” The company’s revenue multiplied from 1996 till 000 by 1000%. The assets value increased from $13. 2 billion to $65,503 billion. Although the increase in the revenue was not gradual and kept fluctuating but it definitely showed an increase in a very short period of time.
The core business of this “Gasbags” entity was to create a market for the future of natural gas and eventually became the matchmaker in the power industry. (Baker, 2003) “Gasbags has grown substantially and as a result Enron became the largest merchant for the natural gas in U. S. However this may have been the start of the end. 2. ENRON’S FINANCIAL BACKGROUND 2. 1 Liquidity As Enron wash shifting its main activities into energy derivative it was important to ensure there was sufficient level of liquidity. (Enron, 1999) In year 2000 Enron’s liquidity improved compared to in 1999.
It grew from $288 million in 1999 to $1374 million in 2000 showing an increase of 377% and at the same time the deposits in the bank grew from $81 million to $2433 million in this year. However the current ratio did not improve. This showed a five times increase in revenues in a mere three years (Lee, 2001). It is argued that the current ratio for larger companies should be less than one as this shows efficient use of capital. And the increase in the level of liquidity is taken into account as a decrease in level of profitability. 2. Debt (Leverage) The change in Enron’s business style was reflected in its ratios. A total of 44. % of assets were invested in property, plant and equipment (P. P. E) while in 2000 it was 17. 9% only (Enron, 2003). Due to excessive derivatives transactions, the cash flow level rose. Another factor adding the reduced percentage of the P. P. E is the transfer of Enron’s ‘independent power projects’ to the Spec’s (Baker, 2003). In the early 1 ass’s, Enron had started expanding and diversifying all its investment. According to the General Accounting Office (GAO) report (2002), the company’s business was divided to 5 main areas: transportation and distribution, wholesale exercises, retail energy services, broadband services and others.
During the expansion plan, the debt acquired by Enron had increased substantially. The reason for this was that by issuing additional debt it would increase the company’s leverage and harm its credit rating. The alternative solution was to seek cash from external investors willing to invest in specific entities. When these entity was created, it could then borrow the capital separately from the pompons company whilst maintaining Enron’s debt ratio and avoiding it being recorded in the balance sheet. 2. The Special Purpose Entities (Seep) In order to cope with its growing volume of business, Enron needed a mechanism that could borrow an ever increasing amount of money but yet maintained an acceptable debt/equity ratio. Enron succeeded in hiding its debt by resorting to off-balance sheet financing. Ronald of Management Research, AAA. ). Enron saw a creative use of special-purpose entities (Seep) similar as that to the “Gasbags”. Enron exploited this immature accounting area which used the SEEP as on off-balance sheet item, to keep liabilities and assets of the entities separated from Enron’s statements.
The SEEP became a convenient vehicle to unload losing trading contracts and to borrow money from outside for Enron. According to (GAO,2002) ” A business may utilize a SEEP for accounting purpose, but these transactions must still be subjected to certain regulations”. (Journal of Management Research, Bibb. ) The interesting part of this scheme was the away Enron financed its Seep. They were formed with a small capital, provided mostly by Enron and a small part (about 3%) were provided by external parties. But who provided the 3% equity in the parties? It was Andrew Faster who was behind this idea (Bryce, 2002) 2. Creative Accounting – “Intelligent Gambling” Enron had implemented the creative accounting practice, by unconsolidated the financial figures of the Spec’s. Most of these Spec’s were established for the same reason. The important ones which afterwards resulted in the company’s financial scandal after the consolidation: they were Joint Energy Development Investment DIODE) which was established in 1993, Chew in 1997 and LIMIT in 1999. (Powers, 2002) The creation of over 3000 partnerships started in 1993 when it teamed tit Scalpers to create the JED fund. This was initially a temporary solution for temporary cash flow problems.
Enron later used SEEP partnership under 3% rule to hide had bets it had made on speculative assets of the partnerships in return for Ohio’s backed by Enron stock as collateral (more than $1 billion by 2002). In November 1997, Scalpers wanted to cash out of JED and in order to keep JED afloat, Enron needed a new 3% partner. It then created another partnership Chew to buy out Scalper’s stake in JED for $million. (Decking & Zimmermann, 2004) Enron plans to give back short term loan to Chew to permit tit to to buy out Scalpels stake. Chew needed $383 million to give Scalpers.
It then get $millions loan from Barclay bank guaranteed by Enron and $132 million credit from JED. Chew must still get 3% of $million from outside source. $125,000 form William Dodson & Michael Copper (an aide to Enron CUFF Faster). $11. 4 million loans from Big River and Little River (two new companies formed by Enron expressly for this particular purpose to get a loan from Barley’s Bank) At this juncture the bank doubted the strength for the new companies and it requires a cash reserve of $6. Minion to be deposited s security for the 11. 4 million loans.
All of these cash reserve is paid by JED whose net worth consisted of Enron’s stock hence, putting them at a risk-position for this amount. Everything fell apart when Enron’s share price started to fall in 2000 and shortly after Chew went bankrupt (Appendix 1) Enron’s operational troubles began to appear on the surface of the public in mid Cot 2001. Enron had announced a decline in its third quarter after tax income of $544 million. A week after that a group was formed form Enron’s Board of Directors, started a special review of the firm’s transactions with its partners.
As a result of this, a reduction on the shareholders equity amounting to $1. 2 billion. Subsequently three weeks later, the investor was in for another shock. It was announced that the accounting errors in Enron’s company statements from 1997 through 2001 and due to these errors a restatement of financial statements. This resulted to a decrease in Enron’s net profit of $96-1997,$113-1998. $250-1999, $million-2000 respectively (GAO, 2002). This consolidation had increased Enron’s debt y a total of $multimillion for the restated period.
According to (Wilson ; Campbell, 2003), These are the reasons that lead to dramatic hanged in Enron’s position and investors perception. From a most promising US firm, Enron faced the biggest collapse in the US history. And this was reflected by the stock price which fell form $80 to $1 . On December 2nd, 2001 Enron was filed for bankruptcy by the Security and Exchange Commission (SEC). All the major research on the case of Enron focused on the role of its auditors and their financial appraisal of the company or other corporate governance issues; ( Baker, 2003), (Vincent, 20020, and (Angler, 2008).
Hence, the role of auditors had been considered to have led the fall of Enron. CHAPTER 3 3. ENRON’S FAILURE 3. Arthur Andersen – The Public Accountants (Lee, 2002) Financial scandals have long been one of the main reasons of change in company law. Enron’s financial scandal of 2001-2002 had shocked the nation due to its scale and denials of the senior managers of any knowledge of the deceptions and wrongdoing. Enron hired Arthur Andersen as its auditor and consultant and had housed many of its members of its audit team in Enron building itself.
Being on the audit team was the most prestigious audit assignments for a staff member at Andersen (Dugan and Spurge’s, 2002). Undoubtedly, Andersen’s long and close association with Enron had created a nod between the staff and executives of the two firms. (Brown and Well, 2002) Investigations had revealed that the Andersen did not fulfill its professional auditing responsibilities and failed in its obligation to bring concerns about Enron’s’ internal control and related-party transactions to the attention of Enron’s Board or its Audit and Compliance Committee (Powers, 2002, p. 5) Another classic example of financial scandal is the Dell Accounting Scandal in the 2007. Donald Carry, CEO acknowledged that some executives were fired as a result of accounting improprieties found during an investigation of the company Available at: www. Corn. Com. 2007). The investigation found that sometime business unit personnel did not provide complete information to corporate head quarters and in many cases, incorrect information about these activities were provided to internal and external auditors. 3. The Enron Culture Enron’s corporate culture developed inside its office during the heady days of its success and has revealed many signs of how things could go wrong. In general, the top management developed arrogance due to its success, the tone was set at the top and it percolated to the lower level and finally became a culture of the reparation. Enron’s top management, Kenneth Lay and it associates gave its executives freedom to pursue the corporate goal and left them to be and was only questioned when goals were not met. Powers, 2002, p. 10) “These controls were not rigorous enough, implementation and oversight was inadequate at Management and Board levels, as no one took responsibility for oversight; controls were not execute properly and structural defects became apparent over time. No one in Management addressed issues as it arose or brought it to the Board’s attention” Shilling instituted the performance review committee (PRE) which known as the harshest employee ranking system as associates had to “do deals” and post earnings to be ranked high.
Secrecy became order of the day for many of the company’s trading as well as disclosures”. (Thomas 2002, p. 42) 4. Leadership 4. 1 Leadership Philosophy According to (Scheme, 1985) if corporate leaders encourage rule-breaking and foster an aggressive environment, it is not surprising that the ethical boundaries at Enron eroded away to nothing as leadership is the critical component of the organization’s culture because leader can create, reinforce, or change organization culture. This applies to an organization’s ethical climate (Simi, 2000, Terrine et al. 2000, Sims and Brinkman, 2002). Good leaders develop through a never ending process of self study, education, training and experience (Ago, 1982) 4. 2 Leadership in Enron In Enron, the main trait of leadership is identified in the literature (Tourist and Pennington, 2002). (See Appendix 2) i) Charismatic Leadership The leaders usually cultivate a captivating image of themselves, enjoy a lifestyle of great luxury and having the luxury and authority to build and maintain their grip on their followers.
Such immense faith and commitments is invested in the leader. The leadership in Enron was aimed to creating an aura of charisma among the leaders and eventually creating major defects identified in (Conger, 1990). The leaders cultivates a compelling and captivating self image, enjoy a lifestyle of great luxury, has total authority and build their eminence and maintain their grip on their followers. As such immense faith and commitment is invested in the leader.
Enron’s leadership aimed at creating an aura of charisma among the leaders and eventually created major defects identified in (Conger, 1990). The image Lay and Shilling attempted to promulgate and allure spectacled to convince people that they belonged to a cause far greater than being part of a business or working for a living. The implication was that others could someday hope to obtain similar privileges for themselves, providing they embrace the value system articulated by the leaders. i) Compelling Vision – Intellectual Stimulation The leaders suggest that their vision is capable of transforming impure to reality, which constitutes inspirational new paradigm, dazzles and develop conviction and minimizes against doubt. Thus, a corporate vision whose truth is held to be self evident, which is complex in both form and function, cannot be questioned an whose acceptance provides intellectual stimulation and ideological totality (Alice, 2004) Enron’s vision was secular in nature; it promised people heaven on earth.
For those who achieved their goals, huge bonuses were available, to an extent the Houston luxury car dealers always visited Enron to exhibit every bonus period (Prentice, 2003). Thus, work regimes of up to eighty hours a week were regarded normal as employees sacrificed their today in hope for a better morrow. (Swart and Watkins, 2003, p. 58) commented on the widely held belief that hard work now may buy a liberated future. This mindset promoted by Enron leaders leaves those who adopt it more liable to escalate their commitment beyond rationality. Ii) Individual Consideration and the Process of Conversion a) Recruitment/limitation Recruitment is important for the expansion of their influence needs a growing army of enthusiastic followers. Prospective recruits are showered with attention which expands to affection. The leader wishes to allure the new recruit to the organizational embrace and habituating them into their ways (Jones, 1 990, p. 148). In Enron, recruitment was a grueling procedure. (Furans and Miller, 2002, p. 9) reported that job candidates had to demonstrate that they could maintain high levels of work intensity over an extended period of time. Some young candidates were willing to do whatever it takes to make partner. Within Enron, there was intense pressure to participate in a whole variety of rituals – including those associated with ostentatious consumption. B) Conversion When someone responds to intense individual consideration from higher tutus leaders and is desperate to affiliate with them, as the outcome shift in attitude can be regarded as conversion (Alice, 2004).
New dress codes, behavior and models are being embraced and each reinforces the other. It is likely that in Enron that the focused selection process and subsequent induction into high performance work environment involved conversion process of which employees: * found themselves exposed to a high demand environment , which requires those hired to display high level of commitment * expose to notion that as member of Enron team represented high privilege and also impose high obligations. Were presented with the ‘vision’ proclaimed by Enron’s leaders, and needed motivation to persevere.
As many noted, those in Enron were frequently told that they are the brightest and best employees in the world and had to perform high standards in order to count on benevolent attitude from Enron’s leaders. C) Indoctrination What can be viewed as indoctrination which is flowing from the organization’s leader and becoming a normal part of the employee’s career in Enron. Communication was one way where from top leaders to those at the bottom. It’s purpose was to reinforce the demanding goals set by Enron but corrective dieback was not sought and to transmit a corporate code consistent with Enron’s leaders.
For instance, when Jeffrey Shilling turned a management conference 1999 which felt like a reeducation camp. He had stressed on the matter and prowled the ballroom making sure everyone was “getting it”. The purpose was to transform their attitudes to be consistent with the needs of Enron’s leaders (Tourist, 1998). Iv) Promoting Common Culture Organizational culture consists of cognitive systems explaining how people think, reason and make decisions (Pettier, 1979; 1990).
Thus, corporate culture initiatives (Sundae, 1992), performance assessment systems (Townies, 1994), teamwork (Barker, 1993) have been explored in this perspective. It has been argued that such approaches seek to regulate, discipline and control employee, while camouflaging such intentions in empowerment (Martin, 1999). When the group environment assumes that all change starts from the top, the leader knows the best and has a vision and that unifying culture is then considered leadership culture in many corporate organizations. ) “Rank and yank and the elimination of dissent Enron’s management regarded kindness as a show of weakness. The same rigors that was faced in the marketplace was brought into the company and destroyed morale and internal cohesion. According to (Fusers and Miller, 2003, p. 51) “Despite all the effort that Enron expended in selecting the right people to hire into the company, it was quick to fire them”. This can be seen in the appraisal system called ‘rank and yank’ as it was arbitrary and subjective and used by managers to reward blind loyalty and quash dissent. ) Deception and control of information Information flow within Enron was tight as it was to reinforce the authority of he Enron leaders, ( Prentice, 2003) as it is not surprising that Enron employees assumed that people like Kenneth Lay were abiding by the normal accounting procedures which eventually lead to the distortion of the future of the company ( Johan , 2002, p. 280) 5. Conclusion Enron’s collapse had serious impact on the world capital markets when the bubble had just burst open and it shattered investor confidence, trust in accounting and the accounting profession as well as the effectiveness of corporate governance.
The leadership of the firm was unethical as the leaders engaged in fraud for personal gain. In addition, the managers and auditors intentionally engaged in ethically and legally improper acts. Their intention is evidence by their attempts to conceal their actions by improperly manipulating financial statements and concealing the act by attempting to destroy documents. The behavior of the managers and the auditors at Enron was unethical regardless of the ethical framework used evaluating the events leading to the bankruptcy of the firm.
The debacle in Enron highlights the leadership style that had “break the rules’ and win at all costs that resulted in unethical and illegal consequences. The Enron leaders’ actions communicated important messages to others in the organization about the company’s ethical climate. It was clear that the only thing that mattered was the stock price; the leaders did not care how you got the number up as long as you were successful, and you would be rewarded. Personal gains increased Enron’s employee’s motivation.
Personal ambition and greed seemed to overshadow the top executives and leaders of Enron. As evidenced by their 2001 stock trades, the leaders were committed to maximizing their individual wealth, and the rules of ethical conduct and adhering were merely barriers to success. Enron’s collapse was clearly the result of agency and leadership problem as well as high level unethical conflict of interest.