ENRON’S SCANDAL
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Contents
1. INTRODUCTION ...................................................................................................... 2
2. THE ENRON’S SCANDAL ....................................................................................... 2
3. IMPACT ON STAKEHOLDERS ................................................................................ 4
4. OUTCOME OF THE SITUATION ............................................................................. 6
5. HOW FAIR WAS THE PUNISHMENT? .................................................................... 7
6. THE ROLE ETHICS WOULD HAVE PLAYED.......................................................... 8
7. CONCLUSION .......................................................................................................... 9
8. REFERENCES ....................................................................................................... 10
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1. INTRODUCTION
According to Li (2010), Enron was formed in 1985 from merger of two
companies; Houston Gas and InterNorth Inc. by Kenneth Lay. It grew to be among the
highly innovative companies throughout 1990s. Its unique business strategy made it
known. Initially, the company’s objective was to sell electricity and gas but by 1990s it
had ventured into other businesses such as pulp and paper companies and
communications (Li, 2010). Its success was indicated by the rise in annual revenues;
between 1995 and 2000 Enron recorded a revenue rise of $91 billion dollars. However
in 2001 as Li (2010) notes accounting fraud was revealed in its financial reports. It was
established that the company had indeed experienced a loss of more that $500 million
dollars (Li, 2010) for the previous five years; contrary to its audit reports. The company
fell bankrupt later in 2001. This essay examines the scandal, its effects and critically
gives an ethical analysis of the situation.
2. THE ENRON’S SCANDAL
According to Giroux (2008) Enron scandal is the worst to have ever happened in
the US business industry. As Li (2010) states Enron’s bankruptcy was a result of
accounting fraud which was substantially institutionalized and creatively crafted within
the management. As Giroux (2008) put it, the list of scandals within Enron is endless:
the executive earned gigantic packages as form of incentives; the management focused
on converting all the strategies into success to maintain their heavy compensationsthrough accounting manipulation; a greed financial officer with underground agreements
to enrich himself; a collaborative law and auditing firms in Elkins and Arthur Andersen
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respectively; corrupt investment bankers- they structured all the financial deals in favor
of Enron; deceptive financial analysts who would rate Enron high for attraction of
investment, regardless of the reality of the economy; and a strong political system
behind the company.
The introduction of US deregulation policy in gas exposed gas producers to trade
risks and banks became reluctant to provide loans for gas production. In 1989, Enron
formed the Bank of Gas in order to, as Giroux (2008) argue, stabilize the gas market. In
this strategy, Enron would contract gas producers to supply gas at specified future
prices, then they would loan them money which was paid through gas; rather than cash.
Meanwhile, Enron would contract to supply gas to traders at a future set price. The
result was a relative stability; Enron as the only profiting. Enron made huge gains in this
strategy.
Mark-to-market technique of accounting introduced by Skilling (Giroux, 2008)
revealed Enron successful in escaping losses which were associated with volatile prices
of gas and inaccurate predictions. In this way, Enron valued long-term trading contracts
at market value instead of the traditional historical cost. Mark-to-market is an accounting
technique applied where developed markets for financial instruments exist and where
there are obvious closing prices (Giroux, 2008). Essentially the profit is determined from
the actual contracts. While it is clear that the market for gas was not obvious, Giroux
(2008) notes that Enron went on to use it; Enron recorded big gains before even any
gas sales were made.
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Enron also used SPEs and structured financing to conceal their debts off the
book and camouflage their existing debts. The officers manipulated the financial
analysts to rate the company as ‘the strong buy’. With the SPEs and structured
financing, Enron was successful to hide losses even when it ventured into other markets
which were in reality recording losses. This attracted huge public investment.
Enron influential capability in the political class earned it loans of billion of dollars
and other benefits for several international projects from the Federal government. In fact
as Giroux (2008) notes, Lay, CEO, financed some powerful politicians and was involved
in some key government appointments especially in the energy sector.
As a result of these fraudulent strategies the company was able to record high
annual revenue rise until 2000 (when it recorded $100 billion dollars). However, in 2001
Enron reported big losses. This attracted scrutiny from SEC and rating agencies for
bonds. The valuation by these bodies discovered problems with the corporation.
Meanwhile due to publicity in the scandals of Enron, banks became unwilling to offer
loans to Enron. As a result the company declared bankruptcy by the end of 2001.
3. IMPACT ON STAKEHOLDERS
According to Li (2010) the stock price of Enron dropped in mid- 2000 from $90 to
less than $1 at the end of 2001 per share. The shareholders lost nearly $74 (US billion
dollars) of which more than $30 billion US dollars was attributed to financial fraud. On its
closure, Enron fired 4500 employees without compensation of their dues (Giroux, 2008).
Some major shareholders suffered financial losses such as Janus Fund who held 11
million Enron shares by the month of October 2001. As Shelley, Janus spokesman,
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notes (cited in Strauss, 2006) most of these shares were sold on loss. This
subsequently resulted into loss of 26.1% and Janus trailed by 14% or so points in S&P
500. Other shareholders who experienced huge losses include JAGIX who owned about
3.2 million Enron shares, JAMRX who owned 3.9 shares and Alliance capital who by
mid- 2001 owned over $40 million shares (Strauss, 2006).
Patrick and Scherer (2003) stated that Enron’s scandal had moral impact on both
the primary and secondary stakeholders. Enron’s top management involvement in
shareholder deception for short-term financial gains destroyed both their professional
and social standing (Patrick & Scherer, 2003). Officials such as Lay and Skilling were
indicted in 2004 and sentenced to jail after conviction (Giroux, 2008). Several others
including Lea and Kopper still face charges of financial frauds. The government was
also harmed. Since Enron was reputed to serve the public, the government had offered
a charter which in reality benefited the wealthy elite of the corporation and stakeholders
(Patrick & Scherer, 2003).
The scandal also caused harm to secondary stakeholders. Enron made other
corporations to lose professional credibility to their clients. By agreeing to involve in
questionable practices of accounting, as Toffler & 2003 notes, Arthur Anderson lost the
credibility of his consulting firm (Cited in Patrick & Scherer, 2003).Vinson and Elkins
legal firm was another corporation whose reputation was tarnished by collaborating with
Enron in condoning, against the legal mandate, frauds in employees and investors.
Generally Enron’s scandal created global fear in American’s corporate investment
(Patrick & Scherer, 2003).
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4. OUTCOME OF THE SITUATION
The immediate outcome of the Enron’s scandal was the declaration of
bankruptcy of the corporation and immense losses on shareholders (Li, 2010 & Patrick
& Scherer, 2003). The scandal elicited public discussion on the ethical behavior in the
financial management of public corporations. Cox et al (2009) argues that there is a
need for emphasize on ethical studies in business training. This, as Cox et al (2009)
notes, will increase the awareness of the student in ethical issues in their future careers.
Many studies have been done about the scandal in an attempt to understand extend of
‘financial immorality’ practiced by Lay and his accomplices. Many books have been
written about Enron and the scandal: Power failure which attempted to study the cause
of collapse of the corporation (Giroux, 2008), Smartest guys and others.
After the scandal was revealed, Justice Department indicted over 30 Enron
executives with Fastow charged with 78 cases of defrauding Enron and was jailed for
10 years (Giroux, 2008). This scandal brought a comprehension to the Federal
government that a lot was happening in financial management. According to Giroux
(2008) there are lots of unethical practices in financial corporation management. These
include, as Giroux (2008) notes, corrupt law firms, ruthless and greedy executives,
accommodating auditors, easily manipulated financial analysts and political influence. In
order to counter reoccurrence of such scandals in the market, Sarbanes Oxley Act was
constructed; the Act requires the corporation to hire independent CPAs as auditors
(Scarpati, 2003).
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According to Neuman (2005), the Enron scandal changed the public posturing of
managers. In his study, Neuman (2005) established that the Managers are now aware
that financial fraud can result into adverse impacts on their social standing, financial
losses to the stakeholders and even can tarnish the entire capitalist giant image of the
United States corporate. Managers, as Neuman (2005) asserts, have embraced the
provisions of the Sarbanes Oxley Act. As a result the demand of CPAs has increased in
the recent past with most CPAs unwilling to accept those auditing positions offered by
most corporations (Scarpati, 2003).
5. HOW FAIR WAS THE PUNISHMENT?
The punishment to serve in jail for Lay and the Enron’s scandal accomplices is
outright fair in my opinion. Lay and other executives breached moral accountability of
finance. It is the role of corporation managers to ensure positive outcomes and
according to Patrick and Scherer (2003), managers and the top executives should be
held accountable for any results of the corporation. As mandated by law the success of
the company should be fairly and truthfully achieved (Patrick & Scherer, 2003 & Patrick
& Quinn, 2001). Lay and accomplices defrauded investors by giving the wrong
information of the financial status of the company. As Giroux (2008) notes, Lay and his
financial officer pressurized financial analysts and auditors to give incorrect financial
information. This created good public image about the corporation and therefore
attracted many investors (Patrick & Quinn, 2000). This finally resulted into losses
incurred by these investors in the post-fall of Enron. In my opinion, these executives
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acted against the moral behavior of any normal society and therefore ought to be closed
behind the bars.
The management lacked truthfulness to both its employees (Patrick & Quinn
1997), shareholders and other stakeholders. Untruthfulness is unethical behavior which
usually results into damage into the victimized party (Li, 2010 & Patrick & Scherer,
1999, 2000). Enron’s executives untruthfully involved other corporations such as
Andersen audit firm into malpractices; this damaged the professional image of these
corporation and lost credibility to their clients. These are legal damages which the
executives such as Lay and Fastow ought to compensate their ‘complainants’. The
charges by the Justice Department for several years in jail for some of these executive
is a means to compensate the injured parties or/and corporations.
The political involvement by the Enron’s executives, in my opinion, is corruption.
Corruption results into unfair competition and share of government incentives. I think
these officials must have been using government agencies such as Department of
energy to cover their ill practices and to dupe the public. Corruption is the major
breakdown of economies of the world and should be fought to its ultimate root.
Therefore Lay’s conviction is fair to serve for the corruption charges to the government
offices and officers.
6. THE ROLE ETHICS WOULD HAVE PLAYED
In my own opinion, the lack of truthfulness (Rest et al, 1999) in the management
in the actual nature of the company was the major cause of Enron scandal. If the
management was truthful, there could be no dubious accounting techniques such as
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mark- to- market which covered the corporate losses and huge debts. If there could be
truthfulness, Enron’s officials would not be involved in the corrupt and fraudulent
financial deals which led to collapse of business. If there could be truthfulness, the
management would have hired transparent auditors; not the likes of Andersen, law firms
and investment banks. If there could be truthfulness the management would have put in
place an independent financial body to sensor the behavior of the financial managers
against malpractices.
7. CONCLUSION
As Patrick and Scherer (2000 & 2003) conclude managers can not ignore
integrity and morality for stability of the corporation, Enron’s failure was as a result of
moral ethics in the management. As Giroux (2008) states that the financial frauds in
Enron resulted into its downfall. Therefore business ethics should be a subject of
emphasize in both graduate and undergraduate business schools (Cox et al, 2009 &
Patrick & Quinn, 2001). The Sarbanes Oxley Act of (Scarpati, 2003)2002 should
therefore be unanimously embraced by the entire corporate world.
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8.
9. REFERENCES
Cox, P., Barry, F.& Edwards, L. (2009). Enron: The Smartest Guys in the Room-Using
the Enron Film to Examine Student Attitudes towards Business Ethics. Institute of
Behavioral and Applied Management, 260-290.
Giroux, G. (2008). What Went Wring? Accounting Fraud and Lessons from the Recen
t Scandals. Social Research, 75 (4), 1206-1238
Li, Y. (2010). The Case Analysis of the Scandal of Enron. International Journal of
Business Management, 5 (10), 37-41.
Patrick, J.A & Scherer, R. (2003). The Enron Scandal and the Neglect of Management
Integrity Capacity. American Journal of Business, 18 (1)
Patrick, J.A, & Quinn, J. (1997). Management ethics: Integrity at work. Thousand Oaks,
CA: Sage Publications.
Patrick, J.A. & Quinn, J. (2001). The challenge of leadership accountability for integrity
capacity as a strategic asset. Journal of Business Ethics 34(3-4):331-343.
Patrick, J.A. and Quinn, J. (2000). The integrity capacity construct and moral progress
in business. Journal of Business Ethics 23(1):3-18.
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Patrick, J.A. and Scherer, R. (2000). Global leadership, capacity for judgment integrity,
and acculturized organizational knowledge. Performance Improvement Quarterly
13(2):34.
Patrick, J.A., Quinn, J. (1999). Global leadership skills and reputational capital:
Intangible resources for sustainable competitive advantage in the 21st century.
Academy of Management Executive 13(1): 58.
Rest, D., Narvaez, M.J. Bebeau, and S.J. Thomas. (1999). Postconventional moral
thinking: A neo-Kohlbergian approach. Mahwah, NJ: Lawrence Erlbaum
Associates.
Scarpati, A. (2003). CPAs as Audit Committee. Business and Industry,
Strauss, L. (2006). The Enron Verdict: Always Diversity. Barron’s,86 (19), 35.