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Enron’s Fall

Enron’s Fall. What are the systemic ,corporate , and individual issues raised by this case ?. Systemic Issues. Systemic issue look for causes outside the group that drive or direct groups or individuals to do something. The forces include :

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Enron’s Fall

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  1. Enron’s Fall What are the systemic ,corporate , and individual issues raised by this case ?

  2. Systemic Issues Systemic issue look for causes outside the group that drive or direct groups or individuals to do something. The forces include : • Laws and regulations that provide the framework in which people act ; • Economic and social institution that give meaning and direction to the public and ; • Culture that shapes the values and perceptions of people and groups.

  3. Systemic causes of the Enron’s fall : • The U.S. Securities and Exchange Commission allow Enron to use the “ mark to market” accounting method. • The legal and regulatory structure allow firms like Arthur Anderson to provide both consulting services and the audited report about the financial results of these consulting services.  It leads to conflict of interest.

  4. The legal structure and accounting rules allow Enron’s executives set up “ Special Purpose Entities” which enable Enron to hide its enormous debt. • The stock market was shooting upward in the booming 90’s. It seems like everyone was making lots of money. • This boom culture led Enron’s managers and executive to think that anything was fine if the money kept rolling in . • Most large companies like Enron are allowed to manage their own employee pension funds. Companies may use these funds to advantage the company even when they may disadvantage employees.

  5. Corporate Issues Corporate culture • Corporate culture refers to the prevailing implicit values, attitudes and ways of doing things in a company. • It often reflects the personality, philosophy and the ethnic-cultural background of the founder or the leader.

  6. 1. A very competitive working environment Corporate Culture in Enron Workers were evaluated base on their performance. Each year, the worst 10% would be fired, while the top performances would be rewarded lavishly.

  7. 2. A culture of deception (a) They used unjustifiable calculation method to entice investor to hold the company share. • In assessing the value of its assets (i.e. contracts), traders • were pressured to use • (i) an unrealistically low discount rate and • (ii) an overvalued future cash flows. • This method enabled the company to record a huge surge • in profit. • This created an illusion to investors. They were enticed to buy the company’s shares. Among them were the company’s workers, who invested their entire retirements and life savings into the shares.

  8. (b) They used a deceiving mechanism to cash in the share value so as to obtain a source of cheap capital from creditors. • The company was highly geared in debt. In 1987, two • years after its formation, 75% of its stock value was • debt. • Further expansion of the company required more debt- • raising. This would cause a deterioration in the credit • rating. As the risk of default increases, the creditors • (banks) would charge them a higher interest rate.

  9. To get around the problem, Andrew set up series of “Special Purpose Entities” which were invisible from Enron’s balance sheet. Enron shares were then transferred to these entities. They were then used as collaterals to obtain cheap capital. • The capital obtained was then channeled to the parent company in exchange for its debt, failing investment projects, and realizing the overvalued contracts.

  10. 3. A culture of greed and injustice • The relationships between (i) the top management and the shareholders and (ii) Lay and the shareholders also reveal the greed and injustice nature of the corporate culture. • The set up of the “Special Purpose Entities” enabled the company to cash in on the share value. However, a large part of the money obtained was not used to distribute fairly among the shareholders, but went to reward the top managers who engaged in the deceptive and illegal practices gave themselves high rewards.

  11. On knowing the accounting scandals of the company and the possibility of the collapse of the company, Lay publicly re-assured the future prospects of the company, but secretly he off-loaded his possession of the Enron share in the market. • In doing so, he took advantage of the privileged information that was no available to the general public, and hence was guilty of insider trading.

  12. Ethical problems with Enron’s culture The corporate culture of Enron is featured by its (1) Harshness (2) Dishonesty and (3) Greed The reward system re-assured this culture by rewarding these unethical conducts lavishly. We now turn our attention to explain why this business culture is unethical.

  13. 1. Harshness to the workers • Cons : • Workers tend to be incorporative and compete with each other. They are less willing to share resources and information. • No concern with the needs, values, desires and • well-being of the workers. • iii. In Enron, measured by the ability to cheat.

  14. 2. Dishonesty Pros : The set up of a deceiving mechanism enables the company to obtain a source of cheap capital from creditors. It satisfies the utilitarianism requirement at the corporate level, but not at the social level. • Cons : • Under the negative rights notion, people should have a • right to be freed from injury or fraud. (Failed) • Contractual rights require that everyone also had a right to be left free and fully informed when contract are made. (Failed) • Universalizability and Reversibility. (Failed) • 1st formation of Categorical Imperative.(Also Failed)

  15. 3. Greed • Pros : • It increases the benefits of the top executives. So it • satisfies the utilitarianism requirement in the short run, • but not the long run. • Cons : • Distributive justice requires benefits are distributed not according to the value of the contribution the individual makes to a society, task, group, or an exchange. (Failed) • The difference principle of John Rawls implies that business institutions should be as efficient in their use of resources as possible. (Failed)

  16. Individual Issues Virtues : Habits of dealing with one’s emotions, desires, and action in a manner that seeks the reasonable middle ground and avoids unreasonable extremes. Vices : Habits of going to the extreme of either excess of deficiency.

  17. Individual Issues Virtue Theory : An action is morally right if in carrying out the action the agent exercises , exhibits ,or develops a morally virtuous character, and it is morally wrong to the extent that by carrying out the action the agent exercises , exhibits , or develops a morally vicious character.

  18. Kenneth LayFounder, Chairman and CEO of Enron

  19. Kenneth Lay Dishonestand Lacked Integrity : • Under his leadership, the company managed to conceal its massive debts through questionable accounting. • Lay and his attorneys decided nothing was amiss although the special purpose entities might have to be dismantled eventually if Enron’s stock continued to slide. • Publicly , Lay announced to employees ad investors that the future growth of the company has never been more certain and urged them to invest in Enron stock. • Lay and other executives began to quietly sell much of their Enron stock.

  20. Jeffrey SkillingPresident and Chief Operating Officer . Served as CEO from Feb. – Aug.2001

  21. Jeffrey Skilling Hypocritical ,Irresponsible and Dishonest : • He insists that his abrupt resignation was motivated by "personal reasons" and not Enron's impending doom. • He left without a pay-off, saying he wanted to spend more time with his children and do more charity work. But he is reported to have sold millions of dollars' worth of company stock after his departure. • Testifying before Congress, he vehemently denied any knowledge of the complex web of financial arrangements that became Enron's downfall.

  22. Andrew FastowChief Financial Officer

  23. Andrew Fastow • Lacked Integrity and Dishonest : • He was allegedly responsible for creating a web of off-balance sheet partnership with external companies that allowed him to hide Enron’s very large losses. • He was also found by an internal Enron investigation to have secretly made $30m from managing one of the partnerships. • He is said to have refused to answer questions at a December meeting with Securities and Exchange Commission officials. • He tried to fire Sherron Watkins and to seize her computer when he learned of her attempt to alert superiors of impending trouble.

  24. Sherron WatkinsCorporate Development Executive

  25. Sherron Watkins Honest, Responsible ,Courageous and Integrity : • In August 2001 she wrote a letter to Kenneth Lay warning of accounting irregularities that could pose a threat to the company could “implode in a wave of financial scandals ”. • On February 2002, she came before a congressional committee and publicly revealed everything she knew about the company’s accounting practices. In her testimony, she cast sacked chief financial officer as the villain of the piece but claimed that chairman Kenneth Lay was duped.

  26. Table of Summary

  27. 5 criteria to evaluate whether Enron has done wrong : 1) Utilitarian perspective 2) Rule-utilitarian’s view 3) Rights : as the moral standard 4) From the perspective of ethics of virtue 5) From the perspective of corporate social responsibility

  28. Utilitarian : • To bring about the greatest net benefit and the minimum cost to the greatest number. • A. What Enron has done : • Enron engaged in heavy borrowing in expanding business in the 1980s in around 1800 different commodities like natural gas, coal and paper pulp etc. • Benefit : • Facilitated the transaction of vital commodities, paying the • foundation to GDP growth, company growth, rise in asset • value, increase in share price.

  29. There is nothing wrongwith borrowing and being in debtin business world. Economic growth hinges on growth in nominal in contrast to real resources. For example : A $1 can lead to business of $100, 100 times of real resources. The problem is : The percentage of debt (out of asset) : Enron’s debt is 75% of its stock market value. Can the debt be manageable ?

  30. B) Enron engaged itself in commodity transaction : It stabilizedthe commodity price against the background of the US government’s deregulating the energy prices. Stabilizing the commodity prices is beneficial. There is nothing wrong with commodity trading and achieving price stability.

  31. C) Enron inflated the market value of the contracts : Market value = The excess of such market value (discounted net present value of contracts) over the buying price = profit ??????? Enron : Away from the conventional accounting treatment of profit Benefit : Rise in asset value of Enron : rise in share price : beneficial to shareholders.

  32. D) Enroncovered up the debtunder the separate accounting financial statements of the “Special Purpose Entities” : Benefit: Growth of business : growth of asset value : rise in Enron’s share price : rise to shareholders’ income. So long as the share price does not fall, the growth ofbusiness can be tremendous,but such cover-up sows the seed of hidden disaster as the asset value of business depends primarily on the investors’ **confidence & integrity of CEO & executives.

  33. E) Inflating the market value of Enron : deceiving investors, shareholders & the US government : That is why, after Enron’s collapse, President Bush signed into law the Sarbanes-Oxley Act addressing corporate accountability.

  34. 2) Rule-utilitarian’s perspective : Decides what is right not in terms of the utility of the action itself, but in terms of the rule under which the action falls. What Enron has done : A. Engaged in unhealthy heavy borrowing and the dishonest practice of the CEOs :unacceptable. B. Deliberately inflating the future cash flow : deceiving the business partners. C. By collaborating with the accounting firm, Arthur Anderson, in providing false financial statements to shareholders, investors, the public & the US government, Enron is immoral.

  35. 3) Rights : as the moral standard : Rights : Enron’s shareholders are entitled to have the dividends and capital gain. Their income dissipated as a result of the collaboration between Enron and Arthur Anderson, the cover up of debt and the lack of integrity of the CEOs.

  36. 4) From the perspective of ethics of virtue : Ethics of virtue : Ethics is not just concerned with actions, but also the development & assessment of character. Enron : When the interest of CEOs & the business conflict with limited resources facing Enron, the executives acted immorally.

  37. 5) Corporate Social Responsibility : • Assumptions : • The Enron share price did not fall. • Enron’s accounting practices were allowed by the generally accepted accounting rules. Enron should have taken up the social responsibility of providing a fair healthy business environment, benefiting shareholders, investors, government, pensioners, economic growth & USA as a whole.

  38. Conclusion “The tale of Enron is a story of human weakness, of hubris and greed and rampant self-delusion : of ambition run amok ; of a grand experiment in the deregulated world ; of a business model that didn’t work ; and of smart people who believed their next gamble would cover their last disaster--and who couldn’t admit they were wrong. ” Quoted from Bethany McLean and Peter Elkind : The Smartest Guys In The Room :The Amazing Rise And Scandalous Fall of Enron (2004)

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