Corporate governance report
- 1. Case Study on ENRON Corporation History of ENRON Corporation: Houston Natural Gas Corporation and Inter north Inc. merged in 1985 to form Enron Corporation. Since its conception, Enron has distinguished itself as an innovative, prominent leader in the natural gas market. Enron, headquartered in Houston, is the largest trader of natural gas and electricity in North America today. Enron also markets and trades other commodities, including water, paper, coal, chemicals, and fiber-optic bandwidth. Its telecommunications arm, Enron Broadband Services, is building a national fiber-optic network and creating a market to trade bandwidth capacity. The success of Enron’s aggressive strategies is demonstrated by the rise in its stock price from a split-adjusted $3.20 per share in 1985 to $80.63 per share on November 20, 2000. In this same period, revenues increased from $10.3 billion to $40.1 billion and net income improved from a loss of $54.7 million to $919.0 million. As a result of its ability to discover new business opportunities, transform traditional industries, and enter new ones, Fortune magazine named Enron “Most Innovative Company” for an unprecedented fifth consecutive year in 2000. Enron’s focus on innovation has been demonstrated throughout its history. As a newly formed company in the mid-1980, Enron pioneered the trading of natural gas when natural gas markets were deregulated. When Enron entered the electricity market in 1993, it revolutionized the industry by facilitating a market to trade electricity. Enron was also among the first energy companies to expand beyond traditional energy markets by entering the telecommunications industry. Enron has even entered the e-commerce sector by partnering with leading high-tech companies to form Enron Online, a business-to-business website that facilitates the trading of commodities. Page 1 of 6
- 2. Factors of Success: What is the story behind Enron’s success? Enron is not wedded to specific industry strategies. Rather, it has an overall strategy that calls for creating an environment and culture of creativity and idea generation. “Enron is a laboratory of innovation. Enron’s entrepreneurial approach calls for new insights, new ways of looking at problems and opportunities try something different change a goal, change a habit, change a mind. Enron has an exceptional ability to leverage its intellectual capital. Individuals are empowered to do what they think is best Enron’s philosophy is not to stand in the way of our employees. This environment spurs the innovation that enables Enron to revolutionize traditional energy markets and successfully enter new ones outside of the energy industry. “Enron’s primary competitive advantage is to identify opportunities and gain a first-mover advantage that we never surrender. Enron often introduces a product or concept before the competition even senses that a market exists”. Accounting practices: Enron created offshore entities units which may be used for planning and avoidance of taxes, increasing the profitability of a business. This provided ownership and management with full freedom of currency transfer and the anonymity that allowed the company to hide losses. created a dangerous spiral, in which each quarter, corporate officers would have to perform more and more financial deception to create the illusion of billions of dollars in profit while the company was actually losing money. This practice increased their stock price to new levels, at which point the executives began to work on insider information and trade millions of dollars’ worth of Enron stock. Chief Financial Officer Andrew Fastow directed the team which created the off-books companies, and manipulated the deals to provide himself, his family, and his friends with hundreds of millions of dollars in guaranteed revenue, at the expense of the corporation for which he worked and its stockholders. Page 2 of 6
- 3. Fraud Happened in ENRON: The Enron fraud case is extremely complex. Some say Enron's demise is rooted in the fact that in 1992, Jeff Skilling, then president of Enron's trading operations, convinced federal regulators to permit Enron to use an accounting method known as "mark to market." This was a technique that was previously only used by brokerage and trading companies. With mark to market accounting, the price or value of a security is recorded on a daily basis to calculate profits and losses. Using this method allowed Enron to count projected earnings from long-term energy contracts as current income. This was money that might not be collected for many years. The numbers were on the books so the stock prices remained high, but Enron wasn't paying high taxes. Enron had been buying any new venture that looked promising as a new profit center. Their acquisitions were growing exponentially. Enron had also been forming off balance sheet entities to move debt off of the balance sheet and transfer risk for their other business ventures. Because the executives believed Enron's long-term stock values would remain high, they looked for ways to use the company's stock to hedge its investments in these other entities. Business analysts began trying to unravel the source of Enron's money. The Raptors would collapse if Enron stock fell below a certain point, because they were ultimately backed only by Enron stock. The deals were so complex that no one could really determine what was legal and what wasn't. Eventually, the house of cards began falling. When Enron's stock began to decline, the Raptors began to decline as well. On August 14, 2001, Enron's CEO, Jeff Skilling, resigned due to "family issues." This shocked both the industry and Enron employees. The Enron scandal, revealed in October 2001, eventually led to the bankruptcy of the Enron Corporation, the dissolution of Arthur Andersen, which was one of the five largest audit and accountancy partnerships in the world. Enron undoubtedly is the biggest audit failure. It is ever the most famous company in the world, but it also is one of companies which fell down too fast. Meanwhile, it makes analysis the moral responsibility From Individuals’ Angle and Corporation’s Angle. Page 3 of 6
- 4. ENRON: Discovering Fraud On August 15, Sherron Watkins, an Enron VP, wrote an anonymous letter to Ken Lay that suggested Skilling had left because of accounting improprieties and other illegal actions. She questioned Enron's accounting methods and specifically cited the Raptor transactions. Later that same month, Chung Wu, a UBS PaineWebber broker in Houston, sent an e-mail to 73 investment clients saying Enron was in trouble and advising them to consider selling their shares. Sherron Watkins then met with Ken Lay in person, adding more details to her charges. She noted that the SPEs had been controlled by Enron's CFO, Fastow, and that he and other Enron employees had made their money and left only Enron at risk for the support of the Raptors. The Raptor deals were written such that Enron was required to support them with its own stock. When Enron's stock fell below a certain point, the Raptors' losses would begin to appear on Enron's financial statements. On October 16, Enron announced a third quarter loss of $618 million. During 2001, Enron's stock fell from $86 to 30 cents. On October 22, the SEC began an investigation into Enron's accounting procedures and partnerships. In November, Enron officials admitted to overstating company earnings by $57 million since 1997. Enron, or "the crooked E," filed for bankruptcy in December of 2001. Page 4 of 6
- 5. Share Prices before and after Fraud happens: Final Destination of Frauds: Enron's CFO, Andrew Fastow, was behind the complex network of partnerships and many other questionable practices. He was charged with 78 counts of fraud, conspiracy, and money laundering. Fastow accepted a plea agreement in January 2004. After pleading guilty to two counts of conspiracy, he was given a 10-year prison sentence and ordered to pay $23.8 million in exchange for testifying against other Enron executives. Jeff Skilling and Ken Lay were both indicted in 2004 for their roles in the fraud. On May 25, 2006, a jury in a Houston, Texas federal court found both Skilling and Lay guilty. Jeff Skilling was convicted of 19 counts of conspiracy, fraud, and insider trading and making false statements. Ken Lay was convicted of six counts of conspiracy and fraud. In a separate trial, Lay was also found guilty on four counts of bank fraud. Kenneth Lay died of a heart attack on July 5, 2006, and a federal judge ruled that his conviction was void because he died before he had a chance to appeal. On October 23, 2006, Skilling was sentenced to 24 years in prison. Page 5 of 6
- 6. Conclusion: (1) There should be a healthy corporate culture in a company. In Enron’s case, its corporate culture played an important role of its collapse. The senior executives believed Enron had to be the best at everything it did and the shareholders of the board, who were not involved in this scandal, were over optimistic about Enron’s operating conditions. When there existed failures and losses in their company performance, what they did was covering up their losses in order to protect their reputations instead of trying to do something to make it correct. (2) A more complete system is needed for owners of a company to supervise the executives and operators and then get the idea of the company’s operating situation. There is no doubt that more governance from the board may keep Enron from falling to bankruptcy. The boards of directors should pay closer attention on the behavior of management and the way of making money. In addition, Enron’s fall also had strikingly bad influence on the whole U.S. economy. Maybe the government also should make better regulations or rules in the economy. (3) “Mark to market” is a plan that Jeffrey Skilling and Andrew Fastow proposed to pump the stock price, cover the loss and attract more investment. But it is impossible to gain in a long-term operation in this way, and so it is clearly immoral and illegal. However, it was reported that the then US Security and Exchange Commission allowed them to use “mark to market” accounting method. Thus, an accounting system which can disclose more financial information should be created as soon as possible. (4) Maybe business ethics is the most thesis point people doing business should focus on. As a loyal agent of the employer, the manager has a duty to serve the employer in whatever ways will advance the employer's self-interest. In this case, they violated the principle to be loyal to the agency of their ENRON. Especially for accountants, keeping a financial statement disclosed with true profits and losses information is the basic responsibility that they should follow. *****XX***** Page 6 of 6