Term Paper on
Enron Scandal
By Marta Astorga
Marta Astorga
Business 1040
Term project
17 April 2014
The Enron Scandal
Background
Enron began business in 1986 as a small pipeline company out of Houston. At that time
Enron's goal was to create the first national gas pipeline. Unfortunately for Enron, the gas
industry was regulated by the government, meaning they were told how much to charge for
power, and profits were set a maximum. Kenneth Lay was one of the key spokesmen when it
came to deregulation of the energy market, much because of his personal connection to the Bush
family. In the early 1990's the United States congress approved a legislation that deregulated the
sale of natural gas. Not long before this Lay was one of the initiators that made it possible to sell
electricity on the free market. This major deregulation in the energy market gave Enron the
opportunity to sell their energy at higher prices, which equivalently lead to greater revenue. This
was the start of Enron's journey from an energy company to a trading company. The focus went
from energy markets to finding new ways of earning money. Large investments were made
around the world to expand its business and open for new markets. Enron was named America’s
most innovative company six years in a row by Fortune's Most Admired Companies survey. This
made the company attractive for top graduates out of the best universities across America, which
gave the company more competence and a big urge to strive forward (Doran, James, 2004).
In 1990, Jeffery Skilling joined Enron Corporation and in 1997, he was appointed as the
company's Chief Executive Officer. Skilling demanded to change Enron's accounting system
from a straightforward kind of accounting were Enron had listed actual revenue and costs of
supplying and selling gas to the mark-to-market accounting system. The mark-to-market method
requires estimations of future incomes when a long-term contract is signed. These estimations
were based on the future net value of the cash flow, costs related to the contract were often hard
to predict. This means that the estimated incomes from projects were included in Enron's
accounting even though the money was not yet received and if there were any changes such as
additional income or loss it would show up in subsequent periods. Investors were given
misleading information because of the deviation in the estimations. Enron was the first nonfinancial company to use the mark-to-market method. The U.S. Securities and Exchange
Commission gave Enron their approval to use the method on January 30, 1992. (McLean &
Elkin, 2004)
Enron was by 1992 the largest seller of natural gas in North America, their earnings
before interest and a tax was $122 million. To grow further, Enron followed a differentiation
strategy that were based on that the company owned and operated a variety of assets, pipelines,
broadband services, paper plants, water plants and electricity plants. Enron did not only make
money on its assets, it also traded actively with contracts of the products and services it provided,
making further revenue. This made Enron a favorite among investors and between 1990 and end
of 1998 Enron's stock price increased 311%. The increase didn't stop there, 1999 it increased
56% and 2000 it increased an additional 87%. The index for the market the same two years was
+20% and -10%. Enron's stock price was 83.13 dollars and its market value was just above 60
billion dollars the 31 December of 2000. (The fall of Enron, 2003)
In August, Jeffrey Skilling, CEO of Enron, announced his resignation, which was a huge
sign that turmoil was about at Enron, thereby launching an SEC investigation into the problems
of Enron. In October 2001, Enron was forced to disclose a third-quarter loss of 618 million
dollars. Through bad accounting practices, Enron somehow overstated the company's net worth
of about 1 billion dollars (Lindstrom, 2004). Enron entered into this mess when they started
taking losses as a result of bad business ventures. They hid the losses by moving Enron's assets
into these special purpose entities (SPE), and when they did so they reported the assets as sales to
external companies. These SPE's are supposed to be isolated from the parent company but in
Enron's case this was untrue and the SPE's depended on Enron management and stock capital.
When auditors forced Enron to bring these SPE's back into the company the sales from moving
the assets into the SPE's was lost and this explains the 1 billion dollar charge.
Arthur Andersen, LLP, should have noticed these problems internally and been
fixed sooner, but due to very complicated financial maneuvers they were never found. Andersen
did not move to ever investigate Enron, because they were so closely tied with Enron executives
and they were making a lot more money serving as a consulting firm to Enron then they were as
auditors. When Andersen finally found the problem with the accounting procedures they knew
an SEC investigation would take place, therefore they began shredding internal documents that
could be used against them in court. Andersen was correct, although the federal government
could not prove that the auditing procedures used by Andersen were illegal, they did charge
Andersen with obstructing justice for shredding internal documents. Enron in some cases just
didn't just hide the losses of the SPE's they created profits that the entities could not possibly
produce.
Unfortunately, Enron executives who were responsible for the shady accounting practices
were able to escape this debt by selling off most or all of their shares in the company before the
stock price fell greatly. The lower level employees who had invested in average of 62 percent of
their retirement funds in the Enron stock found that their retirement was worth absolutely
nothing when the stock plummeted from a high of 98 dollars to 1 dollar. Furthermore, those that
were 50 years of age and were eligible for selling their stock were not allowed. They also froze
employee's pension plans, but this freeze on the retirement plan was not effective among Enron
executives. Many people lost their jobs in the wake of the collapse and found out their retirement
was history. In late 2001 Enron declared bankruptcy under Chapter 11 of the United States
Bankruptcy Code (Anonymous, 2002).
Enron split up and was sold in several divisions to the highest bidders (Lindstrom, 2004).
Enron's core business, the energy trading company, has been negotiating in a complex deal with
UBS Warburg. The bank has not paid for the trading unit, but will share some of the profits with
Enron. Centrica, part of the former British Gas, has bought Enron's European retail arm for 96.4
million pounds. Dynegy, a smaller rival, has won a key pipeline in the United States after merger
talks fell through. The pipeline was then resold to Warren Buffet. The power project in India's
Maharashtra state, the biggest foreign investment project in India, is still for sale (GUTMAN,
2002).
As a result of the Enron scandal, many other large corporations were forced to restate their
financial reporting. Many telecommunications companies felt the wake of the Enron scandal
when their restated balance sheets showed much less revenue. Stock prices of some of the largest
companies fell at an average of one third while technology stocks dropped 70 percent. 700
companies were found to be using creative accounting and bookkeeping techniques and were
forced to restate earnings for the past 5 years. Two very large companies, WorldCom Inc. and
Global Crossing, went bankrupt as a result of the Enron scandal (Lindstrom, 2004).
More along the aftershock of the Enron Scandal would cause reformation of most corporate
behavior. Congress passed the Public Company Accounting Reform and Investor Act which
created an entirely new law which gave much more power to the government to oversee
accounting procedures in corporations. The law created a Public Accounting Oversight Board
which was allowed to set new accounting principles to investigate companies and certified public
accountants that adherently did not conform to the new standards, and fine them for violations of
these standards. And because Enron's accounting firm was able to audit and consult Enron,
which was entirely too casual, now auditing and consulting must be separated. The bill also
caused stiffer punishment for chief financial officers, strict disclosure laws, and any information
that could be potentially hazardous to an investor's share price had to be disclosed much sooner.
As a result, many accounting firms have "tightened their belt" in hope that they will not end up
like Arthur Anderson, LLP (Bryce, R. (2002).
The Enron Scandal is one that should have never taken place. Political administrations and
profit earning corporations cannot be so closely tied as they are now, the people should run the
country, not the corporations. Also, thanks to new legislation, auditors of accounting firms will
no longer have casual relationships with the audited corporation and therefore "creative
accounting" can no longer take place.
Works Cited
Lindstrom, Diane. "Enron Scandal." Microsoft Encarta Online Encyclopedia (2004): 29 pars. 9
Dec 2004 .
Anonymous. "BBC News | In Depth | Enron." BBC News (Feb 2002): December 9, 2004.
Gutman, Huck. "Enron Scandal: The Long, Winding Trail." Common Dreams News Center (Feb
2002): 24 pars. 9 Dec 2004
Dorans, James (2004-05-14) Enron Staff win $85m, The Times, 2012-12-01
Enron scandal, http://en.wikipedia.org/wiki/Enron_scandal 2012-12-01
McLean & Elkin, P. (2004). “The smartest guys in the room” New York. Fortune
Bryce, R. (2002) Pipe Dreams: Greed, Ego, and the death of Enron. Oxford: Public Affairs.
Healy, Paul M. Krishna G. Palepu. (2003), “The Fall of Enron” Journal of Economic
Perspectives
Poster sites
http://www.biography.com/people/
http://img.docstoccdn.com/thumb/orig/68380012.png
http://time.com/time/printout/0,8816,197668,00.html
http://baltimorepostexaminer.com/wp-content/uploads/2012/12/Eron-management-team
Marta Astorga
Reflections
Business 1040
I have learned many things by doing this research. One of the things I have learned is
doing a research is really time consuming, but it helps you get a better understanding of what
research you are doing. Another thing I learned from doing this research is history that happened
in our Country, which I had no Idea happened. The last thing I learned was there are always
consequences for your actions; Enron Scandal is a great example.
From doing this research I was able to understand what led to the Scandal. In class I just
got the message that Enron cooperates where doing bad things, but with doing this research I got
great deals of what bad or unethical practices they were doing. I also got to learn the meaning of
deregulation and market-to- market, which I found interesting. I didn’t know that free market
have the will to charge high interest and high prices if wished that is something new I learned.
I didn’t have Idea that this happen in our country. I am the type of person who likes
history and for some reason this is the first time I have heard of Enron or the scandal. New laws
were placed due to the bad practices done by the Company. Doing this research has helped me
get a better understanding of why some laws at work are placed. To be honest I like it that way
so that the owners of the company don’t take advantage and let the company fall for bad
practices. Many employees unaware of the situation suffered greatly even up to being jobless.
I am a strong believer in consequences for your actions; Enron is a great example of what
happens when unethical practices are being done with in cooperation. Many people served time
in jail, many people lost their jobs, and new laws needed to be put to prevent situations like this
to happen again. I really enjoyed doing this project. I t made me get a better understanding on
history of Enron Scandal.