Enron Case
Hervé Stolowy
HEC School of Management, Paris
Department of Accounting and Management Control
78351 - Jouy-en-Josas – France
Telephone: +33 1 39 67 94 42
Fax: +33 1 39 67 70 86
E-mail: stolowy@hec.fr
Abstract
This case about the Enron Group offers an opportunity to explore many accounting and
reporting issues such as accounting information and communication, “quality” and
independence of external auditors as well as many aspects of corporate governance. In
addition it creates opportunities to discuss ethical issues in business, sociological aspects of
business culture and the interaction between business behavior and political circles.
This version: January 9, 2005
Acknowledgements: the author wishes to acknowledge the financial support from the HEC School of
Management, Paris (Financements de projets pédagogiques) and from the Research Alliance in Governance and
Forensic Accounting funded within the Initiative on the new economy program of the Social Sciences and
Humanities Research Council of Canada (SSHRC). He is also grateful to Michel Lebas, for his significant help
in the preparation of the English version of this case study and thanks Sophie Audousset for her research
assistance.
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1. Background information
1.1 Enron
Before its demise into bankruptcy in December 2001, Enron was a global supplier, broker and
market maker of energy and related services. Its share of the energy market in the United
States and Europe was about 25%. Enron was also developing its activities in any newly
deregulated markets such as South America, India and Japan). Although not integrated or
balanced, Enron was active at all phases of the energy supply chain: sales of energy
(electricity) and, to a lesser extent, sales of energy raw materials (natural gas and oil),
construction and management of oil and gas exploration infrastructures, energy production
facilities, transport and distribution networks as well as financial and risk management
services (helping customers manage expected and unexpected fluctuations in price, supply,
and demand of any energy or bandwidth capacity).
The year 2000 annual report list the following business segments (exploration and production
was discontinued in 2000):
Transport and distribution
Wholesale services (business to business brokerage and sales of energy and related
services, risk management services, plant construction and management, etc.)
Retail energy services (distribution of natural gas, electricity, water and other
commodities to industrial and commercial customers)
Broadband services and bandwidth intermediation (fiber optics network and brokerage)
Corporate (income from corporate-managed financial instruments and corporate
expenses) and others (distribution of water, waste water services, wind-generated power
and “green” electricity.)
Enron’s diversification within the broad energy field had been quite rapid in the previous ten
years. For the years 1996 to 1998, over 60% of the group’s income came from activities
developed only in the previous ten years. In 1998, Enron had diversified its portfolio of
activities beyond energy through the acquisition of fiber optics networks (for broadband
telecommunication and to support its development of Enron Online, its electronic market
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place) and the purchase of Azurix Corp. specialized in the distribution of water and wastewater management, mainly in South America).
1.2 Chronology of key events
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October 16, 2001: the results of the third quarter 2001 reflect an after tax impact of $544
millions of unexpected expenses. During the ensuing conference call with the financial
community, Chairman Kenneth Lay reveals that Enron also recorded during the third
quarter a reduction in capital of $1.2 Billion. These two accounting adjustments are linked
to, so far unconsolidated, “ad hoc entities”.
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October 22, 2001: the SEC (Securities and Exchange Commission) requests additional
information about transactions carried by Enron with certain entities.
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October 28, 2001: the Enron Executive Committee (EC) appoints a Special Committee,
headed by William Powers, with the mission to prepare a report to the EC.
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November 8, 2001: Enron files form 8-K that reveals additional information about the
previously announced expenses and off balance sheet transactions and indicates it will
restate its published income and financial statements for the years 1997 to 2001.
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November 19, 2001: Enron files form 10-Q with the SEC (quarterly report).
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November 28, 2001: rating agencies downgrade Enron’s debt to the “below investment”
grade.
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November 28, 2001: Enron announces notification by Dynegy of termination of merger
discussions (Announcement of a merger agreement had been made public on November 9,
2001).
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December 2, 2001: Enron and some of its key subsidiaries file voluntary petitions with the
U.S. Bankruptcy Court for the Southern District of New York for reorganization under
Chapter 11 of the US Bankruptcy law. As part of the reorganization process, Enron also
filed suit against Dynegy Inc. (NYSE: DYN) in the same court, alleging breach of
contract in connection with Dynegy’s wrongful termination of its proposed merger with
Enron and seeking damages of at least $10 billion.
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2. Questions
2.1 Elements of financial analysis
On the basis of the consolidated financial statements of Enron (Balance Sheet, Income
Statement, key figures and Statement of Cash Flow) and the Enron Annual Reports, evaluate
the following for the period 1997-2001:
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Evolution of the income statement and of its structure.
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Evolution of the balance sheet and of its structure.
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Analysis of the statements of cash flows and of their evolution.
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Calculation of the profitability and indebtedness ratios and analysis of their evolution.
The Annual Reports can be found either http://studies.hec.fr/web/stolowy - Enron subsection, (The login and
password are provided by e-mail to those registered in the course) or on the World Wide Web for example at
http://www.enron.com/corp/investors/annuals/ and http://www.enron.com/corp/investors/sec/ .
On the basis of your analysis, address the following two questions:
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How did the activity of Enron evolve over the years 1997-2001?
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What key indicators should have served as alarm signals?
2.2 Analysis of the impact of the restatements
On the basis of information in the 8-K form filed on November 8, 2001, evaluate the impact
of the restatements for the period 1997-June 2001. Comment specifically on the impact of
these restatements on net income, balance sheet totals and on the debt to equity ratio.
2.3 Accounting issues
Irregularities have been shown to significantly taint the process of financial and accounting
reporting at Enron. Through your analysis of available information (particularly the 8-K filing
on November 8, 2001 and the Powers report dated February 1, 2002), prepare an analytical
presentation of the following accounting issues:
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Rhythms NetConnections
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Non consolidation of Chewco
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Non consolidation of Jedi
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Non consolidation of LJM
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Error on the recording of the capital increase of the four “Raptors” SPE (special Purpose
Entities).
In your presentations, the following key questions can (for example) be addressed:
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What is the nature of the problem?
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What was the intent of the management?
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How could the problem have been detected?
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How could the problem have been avoided?
2.4 Additional topics of analysis
2.4.1 Role of the auditors
Prepare a synthetic report on the role the external auditors played in the Enron debacle.
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What risks are associated with the lack of independence of the external auditors?
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What have been the consequences of Enron’s bankruptcy on its external auditors and on
the accounting profession in general?
2.4.2 Conflicts of interest
Analyze the impact of conflicts of interest on the managerial behavior and financial reporting
that led to Enron’s bankruptcy. Is any generalization possible?
2.4.3 Corporate Governance
Analyze the role played by the Executive Committee, the Board of Directors and the internal
control function on the demise of Enron.
Are these committees and function able to
effectively promote and protect the interests of shareholders?
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2.4.4 Role of regulatory agencies
What is the role of the SEC and of the FASB in the prevention and control of accounting
irregularities?
2.4.5 Other stakeholders
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To what extent can one state that the Enron bankruptcy is a political problem?
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What has been, if any, the role of financial analysts in the creation of the Enron debacle?
3. Documentation available on the HEC website
http://studies.hec.fr/web/stolowy - Enron section (login and password will be provided by the
case writer to students registered in the course).
3.1 Transparencies
Slides – part 1: case introduction (to be read before class)
3.2 Excel files
Financial statement analysis (text).xls: income statements, balance sheet, key figures and
statements of flows of cash for the period 1997 to 2001.
3.3 Annual reports and SEC filings
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Enron annual reports: 1998, 1999, 2000
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Quarterly reports (10-Q filings with the SEC): Q1, Q2, Q3 for 2001, and Q2 for 2000
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8-K filing dated November 8, 2001
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FY 2000 annual report of DYNEGY (potentially interested in the takeover of --or merger
with-- Enron).
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3.4 Powers report to the Special Committee, February 1, 2002): 218 pages
3.5 Goldman Sachs recommendation dated October 9, 2001
3.6 Letter from Sherron Watkins to Kenneth Lay
3.7 Other presentations (some of which are available by internet)
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“Enron: Business Culture and Economic Activity”», Kevin Farley (HEC MBA, January
2002), June 2002 (11 slides)
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« The Enron Fallout – Implications for Canada”, Financial Executives International
Canada, May 3, 2002 (15 slides)
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“Enron Briefing”, University of Toronto, March 19, 2002 (97 slides)
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“Through the SPE looking glass”, Deloitte & Touche, For The Record n°3, April/May
2002 (3 pages)
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“Corporate governance, management processes key elements in Enron failure”, CMA
Canada News release, April 18, 2002 (2 pages)
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“Enron: What Happened & The Implications”, KPMG, January 25, 2002 (10 slides).
3.8 Testimonies and speeches
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“Are current financial accounting standards protecting investors?”, Robert K. Herdman,
Chief Accountant, U.S. Securities and Exchange Commission, February 14, 2002 (6
pages)
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“Written testimony of the staff of the Joint Committee on Taxation on the report of
investigation of Enron corporation and related entities regarding federal tax and
compensation issues, and policy recommendations”, Joint Committee on Taxation,
February 13, 2003 (36 pages)
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“The reform of corporate reporting and auditing”, Baruch Lev, Professor at NYU’s Stern
School of Business, February 6, 2002 (11 pages)
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“Testimony concerning recent events relating to Enron Corporation”, Robert K. Herdman,
Chief Accountant, U.S. Securities and Exchange Commission, December 12, 2001 (14
pages)
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“Excerpts from speeches by the staff of the Office of the Chief Accountant through
December 6, 2001”, SEC, December 6, 2001 (31 pages).
3.9 Published Articles
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“Is Enron Overpriced? ”, Bethany McLean, Fortune, March 5, 2001
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“Enron’s Power Crisis”, Bethany McLean, Fortune, September 17, 2001.
3.10 Research Papers
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“Governance and intermediation problems in capital markets: evidence from the fall of
Enron”, P.M. Healy and K. Palepu, Harvard Research Paper, August 2002 (51 pages)
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“Enron and the dark side of shareholder value”, W.W. Bratton, George Washington
University Law School, May 2002 (79 pages)
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“Enron: Corporate failure, market success”, International Swaps and Derivatives
Association, April 17, 2002 (24 pages)
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“Winners and losers in multiple failures at Enron and some policy changes”, H.D. Vinod,
Fordham University NY, April 9, 2002 (11 pages)
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“The inevitability of Enron and the impossibility of "Auditor independence" under the
current audit system”, S. M. O'Connor, University of Pittsburg School of Law, March 1,
2002 (73 pages)
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“Sharing accounting’s burden: business lawyers in Enron's dark shadows”, L.A.
Cunningham, Boston College, April 2002 (70 pages)
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“Essay: Some thoughts on the Enron bankruptcy”, S.L. Schwartcz, Duke University
School of Law, 2002 (9 pages)
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“What Enron means for the management and control of the modern business corporation:
some initial reflections”, J.N. Gordon, Columbia Law School, 2002 (18 pages)
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“Financial engineering, corporate governance, and the collapse of Enron”, S.L. Gillan and
J.D. Martin, University of Delaware, 2002 (59 pages).
3.11 Related web sites
Links with dedicated or generic websites related to the Enron bankruptcy.
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