Enron’s Collapse In the case of Enron’s collapse, many would blame the external auditor’s collusion with the management, the aggressive accounting policy it had adopted to manipulate its earnings or the Special Purpose Entity (SPE) it had created as a sham to conceal its debts. However, everything began from an internal environment with weak controls. The internal environment is the capstone of all other components within an organization’s ERM framework, influencing strategy formulation, objective setting, as well as risk management. The internal environment is largely shaped by the tone at the top.
And in the case of Enron, its failure was primarily attributable to the board and management’s failure to take responsibility for the risks inherent in the company’s business plan and strategy. Various elements of the internal environment had contributed to Enron’s failure. Risk Management Philosophy and Risk Appetite Enron had a huge risk appetite which can be seen from its speculative trading activities as well as the use of “mark-to-market” accounting and SPE to manipulate earnings and conceal debts. The source of revenue was vague and highly volatile. It was almost like Enron was engaged in gambling.
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However, well knowing the nature of income, the management still continued to carry out such activities. Management’s huge risk appetite reassured the employees that Enron could easily handle these risks. Hence, everyone in Enron became risk-seeking. Board of Directors’ Attitudes One of the core principles of Anglo-American corporate governance is that “the board should maintain a sound system of internal control to safeguard shareholders’ investment and the company’s assets”. Enron’s board had defended itself by claiming that they had no idea about the unethical conducts Enron’s management was involved with.
However, the board had, in the first place, failed to make an appropriate assessment of the risks to which the company was exposed of. And it did not put in place the procedures by which it could obtain the information needed to oversee and monitor the management. Moreover, the independence of the board was also questionable as they allowed own conflict of interest to get in the way of their monitoring role. The board members received substantial payments for consultancy service apart from their directors’ fees. In addition, they were indirectly compensated by receiving gifts made by Enron to their universities and hospitals.
As a result, the failure of board’s monitoring role further weakened the internal control of Enron. Integrity and Ethical Values Integrity and standards of behavior are required for the organization to achieve an internal environment with strong controls. There should be a strong corporate culture which guides the organization, at all levels to make risk-based decisions. Enron’s corporate culture was usually described as arrogant, where everyone in the company, employees, managers or directors, believed that they could handle increasingly toxic risk without danger of going bust.
Besides the arrogance, greed was as well evident across the organization. Top executives made use of “mark-to-market” accounting and SPE to manipulate earnings and conceal debts in order to further enrich their compensation which was tied to the performance of the company. Top executive’s actions of striving to enrich personal wealth rather than generate profits for shareholders had set the tone at the top which in turn led to employees’ efforts of maximizing individual wealth instead of creating value for the company as a whole. Assignments of Authority and Responsibility
Corporate officers owe fiduciary duties to the organization, hence they must act in the best interest of the company and avoid incidences where conflicts of interest would arise. Although this is not enforced by legislation, it is normally set out in the organization’s own code of conduct. A strong code of conduct is a critical element of assignments of authority and responsibility, not only in form but in substance as well. And Enron indeed had such code of conduct, explicitly restraining self-dealing. Fastow’s involvement in LJM SPE’s management would amount to self-dealing, which was a clear breach of Enron’s code of conduct.
However, the board had waived it under Ken Lay’s advice. Therefore, it can be seen that the tone at the top made Enron’s code of conduct form over substance, which as well contributed to the failure of Enron. Human Resource Standards Jeffery Skilling was usually credited with creating a system of forced rankings for employees, under which the bottom 20% was regularly dismissed on the basis of performance rankings drawn up by peers and superiors. Whereas those remained were rewarded with stock options and performance-based increments.
Thus employees attempted to crush not just outsiders but also each other. And it is not surprising that they would keep silent even that they well knew about the unethical behavior of management. As a result, the ranking policy contributed to the diminishing of the organization’s transparency and a widening communication gap between the board and the rest of the organization, making it even harder for the board to effectively carry out the monitoring role. An internal environment without proper checks and balances was fundamental to the collapse of Enron.
Board’s failure to monitor, its human resource strategy, code of conduct form over substance, lack of integrity and having an overly huge risk appetite while not able to deliver value to shareholders had collectively contributed to the ultimate fall of Enron. Reference: Robert R. Moeller, 2006, “COSO Enterprise Risk Management – Understanding the New Integrated ERM Framework” Simon Deakin, Suzanne J. Konzelmann, 2004, “Learning from Enron”, Corporate Governance, 12(2):134-143 Mclean, Bethany; Varchaver, Nicholas; Helyar, John; Revell, Janice; Sung, Jessica, 2001, “Why Enron Went Bust”, Fortune, 144(13):58-68