Lillie Ramage
Managerial Accounting
October 13, 2003
The Enron Corporation/Arthur-Anderson Accounting Crisis
On November 8, 2001, Enron Corporation disclosed that it had overstated earnings by
$600 million dating back to 1997, and in December of that same year the corporation
collapsed and produced the second largest corporate bankruptcy to date in U.S. history.1
Suffering a domino effect from Enron’s disclosure of corporate wrong-doing was the
accounting firm of Arthur-Andersen, Enron’s auditor. In March of 2002, the Department
of Justice indicted Andersen, citing obstruction of justice and stating that Andersen had
tried to undermine the justice system when it shredded documents related to the Enron
case, even while they were aware that Enron was the target of an investigation by the
Securities Exchange Commission2. In June of 2002 Andersen was found guilty of these
charges.3
In looking at the history of these two companies, there is nothing to suggest that they
would suffer the downfalls that they did. Enron had begun as a small energy company in
1985, and by 1999 it was the seventh largest public company on the NYSE, and
Anderson was one of the world’s five leading accounting firms with clients all over the
globe.4
How did these two previously highly respected and successful corporations find
themselves as “casebook studies for corporate wrongdoing”?5 This paper will address
that question by examining what might have led to the decline at Enron and Andersen.
After looking at some of the causes of Enron’s and Andersen’s problems, some
implications for corporate America and the accounting profession will be given.
First, in trying to determine what led to the decline of these firms, an analysis of the
ethical dilemmas faced by Enron and Andersen is necessary.
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Managerial Accounting
October 13, 2003
Upon first examination Enron would appear to be a company that would make ethical
choices when faced with a dilemma. They had an official code of ethics in place,6 and
they were regarded as highly successful. But the firm’s “success turned out to be based
on artificially inflated profits, dubious accounting practices, and – some say – fraud”.7
Due to the aforementioned “dubious accounting practices”8, Enron had convinced
stakeholders that debt and risk had been removed from its financial statements, and they
had created phony income.9
As for Andersen, they were faced with an ethical dilemma from their partnership with
Enron. Not only were they the company’s auditor, they also received millions of dollars
from Enron for providing them yearly consulting services.10 In addition their dilemma
came from the fact that “there were early fears among partners at Andersen regarding the
Enron accounts; because Andersen had taken at face value the findings of Enron’s
lawyers over a complicated off- balance-sheet set-up, later considered a primary factor
behind Enron’s collapse”.11
On first examination, it would appear that the downfall of
these two companies came both as a result of Enron’s accounting practices and
Andersen’s less than close scrutiny of these accounting methods.
However, upon closer examination the downfall of these two firms can be traced to
something deeper than simply improper accounting practices. The root of the problems
at both these firms was a result of their “unwritten” corporate cultures.
As suggested by Robbins in Organizational Behavior a company’s “unwritten”
culture can override any written code of ethics they may have.12 According to Robbins,
these two companies’ downfalls came as a result of unwritten cultures that pushed
executives into unethical behavior. 13
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Managerial Accounting
October 13, 2003
Robbins theorizes that when there is a culture with an “unrelenting emphasis on
earnings growth…it encourages unethical corner cutting”14. Robbins then provides some
specific examples of how companies develop cultures that encourage this unethical
corner-cutting, and many of these behaviors can be seen among the decision makers at
Enron and Andersen.
According to Robbins, the foremost problems with cultures like those at Enron and
Andersen is that they pressure executives to make their numbers and then they instill lax
controls over how those numbers are created.15 That this culture existed at Enron is
evidenced by their creation of phony assets in off-balance sheet accounts to increase
profits and inflate earnings.16
Robbins’ theory of how this culture pressures executives to engage in unethical acts is
supported by Bill George, former executive at Litton Industries. George says, “At Litton,
I learned that young managers are promoted not for espousing high-minded values but for
making their numbers…The higher you go in the company the more the pressure to make
the numbers increases”.17
Andersen also appeared to have been pressured into cutting ethical corners to make
the numbers. Otherwise, they would have walked away from the Enron account as soon
as they realized the leadership would not listen to their warnings. According to
Andersen executives, their firm had warned Enron about possible illegal acts after Enron
withheld crucial data about its finances from Andersen,18 yet Andersen continued to
certify Enron’s accounting figures.
This leads to another factor that Robbins believes comes as a result of the unrelenting
emphasis on earnings growth, which is the creation of a “yes-man” culture. In this
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Managerial Accounting
October 13, 2003
atmosphere people are afraid to speak out on questionable practices for fear it will affect
their compensation.19
There was obviously a “yes-man” mindset among Enron’s internal accountants, as
they were allowing their company to establish special partnerships which allowed them to
shift their liabilities off the books, recognizing profits and removing large amounts of
debt.20 There had to have been a point when the internal accountants knew what they
were doing wasn’t right and did not meet Generally Accepted Accounting Principles, but
instead of speaking up to put a stop to it, they continued to benefit directly from the
corrupt practices.
This “yes-man” mindset can be seen from the Andersen auditors as well. As was
previously mentioned, Andersen did question some of Enron’s numbers at first, but the
Enron executives “pressured Andersen to certify maximum-risk, questionable accounting
practices, in part to retain their lucrative consulting business.”21 What this points out is
that Andersen basically had two choices, certify Enron’s questionable numbers, or lose
millions in consulting fees, and they obviously kept quiet and chose the former.
This leads to what Robbins gives as another attribute of a culture that encourages
unethical behavior; one in which bonuses and money become the “Almighty God”.22 At
Enron and Andersen this culture was emphasized by both companies seeking out and
rewarding people who placed a high value on money. “Jeff Skilling, who created Enron’s
in-your-face-culture, is quoted as saying ‘All that matters is money’”.23
Also, the fact
that the executives valued money over doing what is right is demonstrated by the way in
which they let greed rule their decision making. Executives at both firms made decisions
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Managerial Accounting
October 13, 2003
based on what was best for their own personal gain instead of what was best for the
company as a whole.
At Andersen, the emphasis of making money over doing what is right is demonstrated
by their involvement in shredding documents related to the Enron case even after they
were aware that Enron was the target of an SEC investigation.24 At this point, they
recognized that if Enron failed, then they stood to lose a lot of money.
It is apparent from the preceding evidence that the executives’ actions at both Enron
and Andersen did not encourage ethical behavior. In any company “employees will look
to top-management’s behavior as the benchmark for defining appropriate behavior”. 25
The emphasis to make the numbers without firm controls over how those numbers are
created, the “yes-man” mind-set, and the over-emphasis of money as a means to an end
all became an embedded part of the cultures of these two companies. That culture led not
only Enron and Andersen to suffer the consequences of their actions, but it also leads to
implications for corporate America and the accounting profession.
One of the most immediate consequences of the actions of Enron and Andersen has
been the loss of jobs. Anderson currently “has just 250 of their 28,000 U.S. employees
left on the payroll”.26 The lost jobs are a direct result of the loss in business that came
from Andersen’s questionable reporting of the Enron account and as a direct result of
their indictment on the obstruction of justice charges.27 At Enron, there has been a loss of
jobs that has come as a direct result of their bankruptcy filing.
Another directly observable and immediate consequence of the Enron/Andersen
scandal has been the effect on the stock market. Just a few months before Enron’s
collapse, its stock was one of the most prized on the stock market, with analysts giving it
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Managerial Accounting
October 13, 2003
high ratings.28 Since Wall Street bases the evaluation of a stock’s worth on public
accounting information, the scandals at Enron and Andersen have undermined investor
confidence in stocks offered by corporate America, have led to questions regarding how
well a company’s accounting records are actually scrutinized, and have had an effect on
share prices on the stock market.29
The implications of this for corporate America and
the accounting profession is that it has created a nationwide sense of mistrust, leaving
“investors wondering whether they can trust corporations, auditors, or stock analysts”.30
This aforementioned lack of trust has resulted in numerous lawsuits and investigations
against Enron and Andersen. Currently, more than ten Congressional committees are
pursuing inquiries into Enron and Andersen, over thirty Enron-related bills have been
introduced to address the scandal-related problems, and the full extent of collateral
damage to a wide range of Enron stakeholders is yet to be determined.31
For the accounting profession and corporate America, governmental agencies have
suggested reforms and proposals that will significantly change accounting standardssetting, auditing practice, and the legal and regulatory environment of financial reporting,
with the most famous of these reforms being the Sarbanes-Oxley Act.32 The
implications of the Sarbanes-Oxley Act for the accounting profession are that it “sets up a
Public Company Accounting Oversight Board that will supervise, audit, and adopt
auditing standards for accounting firms”.33 This will point out potential conflicts of
interest between consultancy and auditing work as well as affecting “hundreds of US
firms which used so-called aggressive accounting methods to keep debts or one-off
charges away from the headline figures”.34
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Managerial Accounting
October 13, 2003
For corporate America, Sarbanes-Oxley requires executives of publicly traded
companies to verify the accuracy of their financial statements or risk going to prison for
willingly and knowingly filing inaccurate statements.35 This will have an impact on
corporate America by holding executives of corporations responsible for wrong-doing.
Another legislative implication of the Enron scandal for corporate America may come
as a result of Enron CEO Ken Lay’s friendship with President George Bush. Enron
reportedly contributed thousands of dollars not only to Bush’s campaign, but also to
former President Bill Clinton’s campaign in the 2002 Presidential election.36 For
corporate America, this will likely result in legislation that provides for closer scrutiny of
the role of corporate funds in political campaigning and the extent of corporate influences
on the national policies.37
As can be seen from the preceding, the downfall of Enron and Andersen had both
immediate effects on corporate America and the accounting profession, and will continue
to affect them based on pending legislative and political acts.
A final implication of the Enron/Andersen scandal for corporate America and the
accounting profession is the lessons they should learn Perhaps the greatest lesson they
might learn is the following. When executives of a corporation create a culture that
emphasizes making the numbers above all else, create a “yes-man” environment, and
create a culture where money becomes the “Almighty God”, they are not only setting
themselves and their own firms up for a downfall. They are in for a downfall that will
send ripples throughout corporate America, the accounting profession, and the whole of
society for years to come.
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Managerial Accounting
October 13, 2003
Endnotes
J. A. Petrick and R. F. Scherer, “The Enron Scandal and the Neglect of Management Integrity Capacity,”
Mid-American Journal of Business, Volume 18, no. 1, (Spring 2003), [online]. Available from
<http://www.nexis.com>; accessed 8 September 2003.
2
“Enron Affair: What Are the Implications?” BBC News, (19 March 2002), [online]. Available from
<http://news.bbc.co.uk>; accessed 2 October 2003.
3
Ibid.
4
“Enron’s Who’s Who”, BBC News, [online]. Available from <http://news.bbc.co.uk>; accessed
27 September 2003.
5
Nightly Business Report, Community Television Foundation of South Florida, Inc., Transcript
#012000cb.118, (20 January 2003), [online]. Available from <http://www.nexis.com>; accessed
30 September 2003.
6
Ibid.
7
“Enron’s Who’s Who”, BBC News, [online]. Available from <http://news.bbc.co.uk>; accessed
27 September2003.
8
Ibid.
9
A. Reinstein and T. R. Weirich, CPA Journal, Volume 72, no. 12, (1 December), [online].
Available from <http://www.nexis.com>, accessed 8 September 2003.
10
J.A. Petrick and R. F. Scherer, “The Enron Scandal and the Neglect of Management Integrity Capacity,
Mid-American Journal of Business, Volume 18, no. 1, (Spring 2003), [online]. Available from
<http://www.nexis.com>, accessed 8 September 2003.
11
“Auditor Saw Enron Papers Shredded”, BBC News, (14 May 2002), [online]. Available from
< http://news.bbc.co.uk>, accessed 28 September 2003.
12
S.P. Robbins, Organizational Behavior (New Jersey: Prentice Hall, 2003), 539.
13
Ibid.
14
Ibid.
15
Ibid.
16
A. Reinstein and T. R. Weirich, CPA Journal, Volume 72, no. 12, (1 December 2002), [online].
Available from <http://www.nexis.com>, accessed September 8, 2003.
17
B. George, “Why it’s Hard to Do What’s Right, Fortune, (September 29, 2003),[online]. Available from
<http:// www.nexis.com>, accessed 23 September 2003.
18
“Andersen’s fall from Grace”, BBC News, (17 June 2002),[online]. Available from
<http://news.bbc.co.uk>, accessed 27 September 2003.
19
S.P. Robbins, Organizational Behavior (New Jersey: Prentice Hall, 2003), 539.
20
A. Reinstein and T. R. Weirich, CPA Journal, Volume 72, no. 12, (1 December 2002), [online].
Available from <http://www.nexis.com>, accessed 8 September 2003.
21
J.A. Petrick and R. F. Scherer, “The Enron Scandal and the Neglect of Management Integrity Capacity”,
Mid-American Journal of Business, Volume 18, no. 1, (Spring 2003), [online]. Available from
<http://www.nexis.com>, accessed 8 September 2003.
22
S.P. Robbins, Organizational Behavior (New Jersey: Prentice Hall, 2003), 539.
23
Ibid.
24
“Auditor Saw Enron Papers Shredded”, BBC News, (14 May 2002), [online]. Available from
< http://news.bbc.co.uk>; accessed 28 September 2003.
25
S.P. Robbins, Organizational Behavior (New Jersey: Prentice Hall, 2003), 538.
26
Kristen Hays, “Trial Wasn’t Fair, Andersen Says in Appeal”, Kansas City Star, 10 October 2003.
27
“What Now for Andersen?” BBC News, (16 June 2002), [online]. Available from
<http://news.bbc.co.uk>; accessed 27 September 2003.
28
“Heat Grows on Rating Agencies”, BBC News, (1 February 2002), [online]. Available from
<http://news.bbc.co.uk>; accessed 27 September 2003.
29
Ibid.
30
“Enron Scandal”, MSN Learning & Research, Encarta, [online]. Available from
<http://encarta.msn.com>. Accessed 10 October 2003.
31
“Enron: Crime, Punishment, and Reform”, BBC News, (21 August 2002) [online]. Available from
< http://news.bbc.co.uk>, accessed 2 October 2003.
1
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Managerial Accounting
October 13, 2003
32
A. Reinstein and T. R. Weirich, CPA Journal, Volume 72, no. 12, (1 December 2002), [online].
Available from <http://www.nexis.com>, accessed 8 September 2003.
33
Ibid.
34
“Enron Scandal at a Glance”, BBC News, (22 August 2002), [online]. Available from
<http://news.bbc.co.uk>; accessed 27 September 2003.
35
“Enron Scandal”, MSN Learning & Research, Encarta, [online]. Available from
<http://encarta.msn.com>. Accessed 10 October 2003.
36
“Enron Scandal at a Glance”, BBC News, (22 August 2002), [online]. Available from
<http://news.bbc.co.uk>; accessed 27 September 2003.
37
Ibid.
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