Question

Explain factors that led to the collapse of Enron according to the case study. (20 marks)

Answer 1

The story of Enron Corporation depicts a company that reached dramatic heights only to face a dizzying fall. The fated company's collapse affected thousands of employees and shook Wall Street to its core. At Enron's peak, its shares were worth $90.75; when the firm declared bankruptcy on December 2, 2001, they were trading at $0.26. To this day, many wonder how such a powerful business, at the time one of the largest companies in the United States, disintegrated almost overnight. Also difficult to fathom is how its leadership managed to fool regulators for so long with fake holdings and off-the-books accounting.

The Enron scandal drew attention to accounting and corporate fraud as its shareholders lost $74 billion in the four years leading up to its bankruptcy, and its employees lost billions in pension benefits. Increased regulation and oversight have been enacted to help prevent corporate scandals of Enron's magnitude

The deregulation of energy traders led to overconfidence in investments that Enron made because they thought they were in control. Arrogance caused them to risk more than they could afford, and when the market didn't end up how they thought, it caused the collapse.

Enron's collapse was caused by: (1) A corrupt leadership at the top, (2) Violation of laws that were not enforced by the company's CEO, Chair and members of its Board of Directors, and auditors (Arthur Andersen), (3) Lack of regulation Enron had one of the best ethics code in the industry.

The conviction of CEO Jeffrey skilling for fraud, conspiracy, and insider trading addressed: ethical failings at the individual level. Company leaders needed values-based ethical decision making, not more rules and laws.

KEY TAKEAWAYS

• Enron's leadership fooled regulators with fake holdings and off-the-books accounting practices.
• Enron used special purpose vehicles (SPVs), or special purposes entities (SPEs), to hide its mountains of debt and toxic assets from investors and creditors.
• The price of Enron's shares went from $90.75 at its peak to $0.26 at bankruptcy.
• The company paid its creditors more than $21.7 billion from 2004 to 2011.

Factors leading to collapse of Enron

1. Poor Corporate governance

• Board of directors permitted poor business decisions and unethical behavior of top managers to go unchecked
• Audit and compliance committee failed to assure correctness of financial statement  
• The board voted to suspend code of ethics allowing Fastow to go unethical.

2. Compensation and reward system

• Rank and yank system
• compensation was largely in form of stocks. This led to incentivizing employees to artificially inflate stock prices.

3. Corporate culture

• Aggressive competition to deliver to results.
• High risk taking was appreciated.
• Money symbolized success.

4. Inadequate ethics infrastructure

• Board occasionally voted to suspend code of ethics to allow for off the book partnerships.
• There were conflict of interest at many managerial positions within the company. The ethics committee did nothing to address those.