Enron Case Analysis
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CASE ANALYSIS: ENRON
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Enron, which used to be the 7th largest and most admired companies in the United States collapsed due to the executives unethical decisions and driven by greed. Greed for profit came in all forms of shapes and sizes. Basic business ethics did not even exist in the minds of these leaders. Business ethics which is an “early warning system” was completely ignored, driven by selfish greed. This practical application of “early warning system” which would have given the leaders to reflect on their decision could have possibly changed the outcome. In the case of Enron, “they knew of an authorized high risk accounting policies in the face of warnings from Andersen; they allowed excessive remuneration; they did not follow their own code of ethics by allowing Fastow to transact with the company” (Donaldson, & Werhane, 2008, p. 316).
Kenneth Lay merged InterNorth and Houston Natural Gas found the new entity, Enron in 1985. He became the chairman and later took on the role as the CEO. Richard Kinder, the chief operating officer and Kenneth Lay set up new ventures and acquisitions that were financed by debt. The company started off with a good amount of debt because “Enron had to buy off a potential hostile bidder, a hangover from the merger, which cost the company some $350 million” (Donaldson, & Werhane, 2008, p. 295). This put the company at 75% in debt of its market capitalization. Regardless of the increasing amount of debt, Lay and the executives attempted further expansion.
In 1989, Lay hired a Harvard MBA, Jeffrey Skilling to be in charge of Enron Finance. Skilling was a very intellectual and a motivated individual striving to meet the “Wall Street expectations.” He created the “mark-to-market” accounting and pressured the executives to constantly find new ways to hide debt. Due to selfish greed, Skilling continued to practice
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unethical decisions, focusing on “profit.” According to the movie, The Smartest Guys in the Room, directed by Alex Gibney, Bethany McLean, the writer of the documentary states that Skilling said that money was the only thing that motivated people. Because he was strong believer in this, he used money to motivate his employees to work hard whether the way was ethical or unethical. Skilling created a system called PRC also known as “Performance Review Committee.” This was a system to grade people between 1 and 5. He expected roughly 10% of the people to be graded 5s. If not a superior, they will most likely be fired. This system pressured the employees to find new ways in performing to be the greatest regardless of the ways. To raise the companys revenue and to hide the debt, Enron pursued diversification strategy. “The drive to maintain reported earnings growth, and thus the share price, led to the extensive use of aggressive accounting policies to accelerate earnings. The Special Purpose Entities [also known as SPE], Enron used to move assets and liabilities off the balance sheet” (Donaldson, & Werhane, 2008, p. 294) were formed and used to protect the company from facing potential problems. Skilling was very eager to hide all the problems and at the same time, maximize the profit.
Andrew Fastow, was the Chief Financial Officer who was one of the key figures behind the complex web of “off balance sheet” special purpose entities used to conceal their massive losses. These entities were controlled by Enron. According to the movie, Sharon Watkins states that Andrew Fastow gambled on Enrons stock, hoping it will never fall. Fastow created many SPEs to hide the companys debt. In the movie, there was a scene when the companys stock was going down the drain, Lay gathered all the employees and persuaded them that the company was in very good shape. Lay stated, “There are speculations about Andy. I am the board and am
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also sure that Andy has operated the most ethical and appropriated manner possible.” Immediately after this speech, Andy was fired after the board discovered that he made $45 billion through LJM partnerships. Andrew Fastow was driven by greed that motivated him to conduct such acts.
Milton Friedman, an American economist was the twentieth centurys most prominent advocate of free markets. According to Friedman, he describes a corporation as an artificial person and in this sense may have artificial responsibilities, but business as a whole cannot be said to have responsibilities, even in this vague sense” (YouTube). Friedman believes that individuals who are to be responsible are the businessmen, meaning individual proprietors or corporate executives. “In a free-enterprise, private-property system, a corporate executive is an employee of the owners of the business” (YouTube). The corporate executive is directly responsible to his employers and the responsibility is to make as much money as possible. Friedman strongly believed that “there is one and only one social responsibility of business-to use its resources and engage in activities designed to increase its profits so long as it stays within the rules of the game, which is to say, engages in open and free competition without deception or fraud” (Donaldson, & Werhane, p. 39). Milton believes in the method of producing a product to make profit. He generally puts the business focus on “money.” Anything that can generate revenue for the business and maximizing the profit is considered an “ethical responsibility,” according to Friedmans neoclassical theory of ethics.
The executives of Enron went beyond the boundaries and crossed every existing line to maximize their profit. Whether it may be committing a fraud or cooking the books, they did
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everything in their power to “make the company look good” to attract shareholders. They pressured their employees to use every method possible in finding ways