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Enron Corporation’s Failure and Recommendations Case Study

Introduction, recommendations.

Enron Corporation was a trading company in services, energy, and commodities. Before its downfall, Enron was one of the largest companies in the United States, and its share price was among the highest in the market. Financial statements showed that the company was doing relatively well. As a public traded company, it was considered a good investment, and many investors were buying its shares daily.

The employees were also among the best paid in the country, and many graduates wanted to join it. However, the company’s success was short-lived (Sterling, 2002). Trouble began when the company changed its organizational structure. The company employed many new people at managerial levels and gave them autonomy in making crucial decisions, which affected the company. With the change in organizational structure, the company reward system was changed such that high performing employees were given hefty bonuses and stock options. The new reward system was controlled by an internal authority, but this turned out to be a bad system.

The people who carried out the reviews and those who were reviewed worked on the same level, and they, therefore, started forming alliances. Employees were ‘looking out’ for each other, and the results of the reviews were skewed to the advantage of the employees. Everyone received a good review, and this created a culture of dishonesty that ultimately led to the company’s failure (Dharan & Rapoport, 2004).

On December 2, 2001, the company filed for bankruptcy, and this led to one of the most cited corporate litigation processes. The case revealed the accounting fraud employed by the company and demonstrated how organizational structures in a company could be a major cause of downfall. This paper will look at company management, processes, and individual responsibility that led to Enron’s failure. It will further recommend the various things the company would have done to avert the downfall.

Analysis of the company management, processes, and individual responsibility in causing the downfall

The company’s earlier organizational structure was based on constructivism. This organizational structure encouraged the employees to work hard and achieve more. The adoption of a new system, however, gave too much authority and power to the new managers. The new managers were in no way related to the company and, therefore, they used the new powers bestowed on them to enrich themselves (Dharan & Rapoport, 2004).

They were unaware of the company’s values and norms, and this made them abuse many of the powers they had been given. The new managers did not give sound guidance to the employees, and this caused the company to run into losses. Because the new organizational structure rewarded top performers, many young managers employed dubious methods to get the bonuses. This led to a culture of individualism and perfectionism in the company, which resulted in its downfall (Sterling, 2002). According to Kirk Hanson during an interview with Nakayama:

There are many causes of the Enron collapse. Among them are the conflicts of interest between the two roles played by Arthur Andersen, an auditor and a consultant of Enron. The lack of attention shown by members of the Enron board of directors to the off-books financial entities with which Enron did business; and the lack of truthfulness by management about the health of the company and its business operations contributed to the company’s failure.

In some ways, the culture of Enron was the primary cause of the collapse. The senior executives believed Enron had to be the best at everything it did and that they had to protect their reputations and their compensation as the most successful executives in the U.S. When some of their business and trading ventures began to perform poorly, they tried to cover up their own failures (Nakayama, 2002).

Another thing that made the company fail was that the financial statements of the company did not reflect its operations and financial position to its owners. The unethical practices in the company required it to change and misrepresent its earnings to show that the company was doing relatively well. According to Bethany and Peter, “The Enron scandal grew out of a steady accumulation of habits, values, and actions that began years before and finally spiraled out of control” (Elkind & Bethany, 2003). The company changed figures of income, cash flow, inflated the value of the assets, and dramatically reduced the liabilities in the books (Sterling, 2002).

The company’s executives adopted market-to-market accounting and tried their best to hide the company’s debts. These would help the company to report profits on investments even though they would later turn out to be a source of losses. Because of the large discrepancies that were aimed at matching up the profits and cash flow, investors and creditors were given misleading and, at times, false reports. One example of a deal that Enron reported as profitable when actually it was resulting in losses is 2000, a twenty-year contract with Blockbuster Video. The agreement would have seen the company introduce on-demand entertainment in various cities in America.

After rolling out several pilot projects, the company announced an estimated profit revenue of close to $100 million from the agreement. Many financial analysts were up at arms, asking the viability of the project and the demand for the services. When the agreement failed, Blockbuster terminated the contract, but Enron continued to recognize the expected profits from the venture in its books. This did not keep up with the agreement hence resulted in a loss (Fox, 2003).

The company had also created several offshore entities that were used to plan and avoid taxes as well as raise the company’s profits. These entities gave the management and owners of the company freedom to move currency, and its anonymity allowed the company to hide its massive losses. The practice of using these entities helped the company’s stock prices to rise, and the management of the company was accused of insider trading. The Chief Financial Officer of the company, Andrew Fastow, helped create these shell companies and used them to enrich himself and his friends. By the time the Enron scandal was unearthed, it is claimed that he had siphoned hundreds of millions from the corporations he had worked for and their investors (Sterling, 2002).

The dubious practices at the company management level ultimately led to its downfall and rendered the company bankrupt. The downfall was not only a result of the improper accounting standards and alleged corruption but also stemmed from the organizational structure that was adopted. The organizational structure that was adopted by the company can be described as very competitive and individualistic to a point where there was no teamwork in the company (Fox, 2003).

It can also be described as one that promoted perfectionism and encouraged power-seeking among the employees. This kind of culture in the company made the employees to be scared of their superiors and made them become ‘yes men.’ They agreed to the decisions made by their superiors and rarely made contributions or pointed out mistakes in the company (Fox, 2003).

Various things should have been done differently at Enron. The organizational structure that was adopted by the company should have been replaced after it was noticed that it was changing the values and norms of the company. The employees should have been encouraged to work as a team, and the goals set should have been realistic and achievable. The review of employees should have been done by an external firm instead of the internal authority created. This would have made the reviews honest, and the culture of individualism and “looking out for each other” would not have sufficed.

The new members of the management should not have been given autonomy and authority to carry out transactions on behalf of the company without senior management supervision. The senior management should always be the one to guide young managers and help them adapt to the company.

The management should have been more honest about the financial situation of the company. There should have been mechanisms in the company’s management that require it to report and make available the balance sheet report to shareholders. To avert issues like those that faced Enron, companies should thoroughly keep checks on their top management. This is because if they are left to run the company without proper supervision, they might connive and cause a company to fail just like Enron.

Dharan, B. G., & Rapoport, N. B. (2004). Enron: corporate fiascos and their implications . New York: Foundation Press.

Elkind, P., & Bethany, M. (2003). The smartest guys in the room: the amazing rise and scandalous fall of Enron . New York: Portfolio.

Fox, L. (2003). Enron: the rise and fall . New York: Wiley & Sons.

Nakayama, A. (2002). Lessons from the Enron Scandal . Santa Clara University. Web.

Sterling, T. F. (2002). The Enron scandal . New York: Nova Science Publishers.

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IvyPanda. (2024, February 26). Enron Corporation's Failure and Recommendations. https://ivypanda.com/essays/enron-corporations-failure-and-recommendations/

"Enron Corporation's Failure and Recommendations." IvyPanda , 26 Feb. 2024, ivypanda.com/essays/enron-corporations-failure-and-recommendations/.

IvyPanda . (2024) 'Enron Corporation's Failure and Recommendations'. 26 February.

IvyPanda . 2024. "Enron Corporation's Failure and Recommendations." February 26, 2024. https://ivypanda.com/essays/enron-corporations-failure-and-recommendations/.

1. IvyPanda . "Enron Corporation's Failure and Recommendations." February 26, 2024. https://ivypanda.com/essays/enron-corporations-failure-and-recommendations/.

Bibliography

IvyPanda . "Enron Corporation's Failure and Recommendations." February 26, 2024. https://ivypanda.com/essays/enron-corporations-failure-and-recommendations/.

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Twenty Years Later: The Lasting Lessons of Enron

Michael Peregrine  is partner at McDermott Will & Emery LLP, and  Charles Elson  is professor of corporate governance at the University of Delaware Alfred Lerner College of Business and Economics.

This spring marks the 20th anniversary of the beginning of the dramatic and cataclysmic demise of Enron Corp. A scandal of exceptional scope and impact, it was (at the time) the largest bankruptcy in American history. The alleged business practices of its executives led to numerous individual criminal convictions. It was also a principal impetus for the enactment of the Sarbanes-Oxley Act and the evolution of the concept of corporate responsibility. As such, it is one of the most consequential corporate governance developments in history.

Yet a new generation of corporate leaders has assumed their positions since then; for others, their recollection of the colossal scandal may have faded with the years. And a general awareness of corporate responsibility principles is no substitute for familiarity with the governance failings that reenergized, in a lasting manner, the focus on effective and responsible governance. A basic appreciation of the Enron debacle and its governance implications is essential to director engagement.

Enron was formed as a natural gas pipeline company and ultimately transformed itself, through diversification, into a trading enterprise engaged in various forms of highly complex transactions. Among these were a series of unconventional and complicated related-party transactions (remember the strangely named Raptor, Jedi and Chewco ventures) in which members of Enron’s financial leadership held lucrative financial interests. Notably, the management team was experienced, and both its board and its audit committee were composed of a diverse group of seasoned, skilled, and prominent individuals.

The company’s rapid financial growth crested in March 2001, with media reports questioning how it could maintain its high stock value (trading at 55 times its earnings). Famous among these was the Fortune article by Bethany McLean, and its identification of potential financial reporting problems at Enron. [1] In a dizzying series of events over the next few months, the company’s stock price collapsed, its CEO resigned, a bailout merger failed, its credit was downgraded, the SEC began an investigation of its dealings with related parties, and it ultimately declared bankruptcy. Multiple regulatory investigations followed, several criminal convictions were obtained and Sarbanes-Oxley was ultimately enacted to curb the perceived abuses arising from Enron and several similar accounting scandals. [2]

There remain multiple important, stand-alone governance lessons from Enron controversy of which all directors would benefit:

1. The Smartest Guys in the Room . The type of aggressive executive conduct that contributed heavily to the fall of Enron was not unique to the company, the industry or the times. In the absence of an embedded culture of corporate ethics and compliance, there is always the potential for some executives to pursue “edge of the envelope” business practices, especially when those practices produce meaningful near term financial or other operational results. That attitude, combined with weak board oversight practices, can be a disastrous combination for a company.

Even though commerce has made great progress since then on internal controls, corporate responsibility ultimately depends upon the integrity of management, and the skill and persistence of board oversight. [3]

2. The Critical Importance of Board Oversight . As the company began to implode, Enron’s board commissioned a special committee to investigate the implicated transactions, directed by William C. Powers Jr., then dean of the University of Texas School of Law. The Powers Report, as it came to be known, outlined in staggering detail a litany of board oversight failures that contributed to the company’s collapse. [4]

These included inadequate and poorly implemented internal controls; the failure to exercise sufficient vigilance; an additional failure to respond adequately when issues arose that required a prompt and serious response; cursory review of critical matters by the audit and compliance committee; the failure to insist on a proper information flow; and an inability to fully appreciate the significance of some of the information with which the board was provided. [5]

3. Spotting Red Flags . Amongst the most damaging of the governance breakdowns was the failure to question the legitimacy of the related-party transactions for which so many internal controls were required. These deficiencies served to bring a once significant company and its officers to their collective knees and offer many lasting governance lessons. As the Powers Report concluded with brutal clarity, a major portion of the company’s business plan—related-party transactions—was flawed. [6]

These transactions were replete with risky conflicts of interest involving management. There was a significant “forest for the trees” concern—an inability to recognize that conflicts of such magnitude that required so many board-approved internal controls and procedures should never have been authorized in the first place. All this, despite the fact that the individual Enron directors were people of accomplishment and capability who had been recognized by the media as a well-functioning board. [7]

Yet, they lacked the actual necessary independence to recognize the red flags waving before them. Their varied relationships with company leadership made them all-too-comfortable with what they were being told about the company. [8] This connection made it difficult for them to recognize the dangers associated with the warning signals that the conflicted transactions projected. Indeed it was the revelation of these conflicts that attracted media attention and ultimately “brought the house down”. [9]

4. It Can Still Happen . The 2020 scandal encompassing the German financial services company Wirecard offers one of the latest high profile (international) examples of how alleged aggressive business practices, lax internal and auditor oversight, accounting irregularities and limited regulatory supervision can combine into a spectacular corporate collapse that prompted numerous government fraud investigations. It is for no small reason that the Wirecard scandal is referred to as the “German Enron”. [10]

5. A Significant Legacy . Yet the Enron controversy remains fundamentally relevant as the spark behind the corporate responsibility environment that has reshaped attitudes about corporate governance for the last 20 years. It’s where it all began—the seismic recalibration of corporate direction from the executive suite back to the boardroom, where it belongs. It birthed the fiduciary guidelines, principles, and “best practices” that serve as the corridors of modern corporate governance, developed in direct response to the types of conduct so criticized in the Powers Report. [11]

And that’s important for today’s board members to know. [12] Because over the years, the message may have lost its sizzle. The once-key oversight themes incorporated within “plain old” corporate responsibility seem to be yielding the boardroom field to the more politically popular themes of corporate social responsibility. And, while still important, corporate compliance seems to have had its “fifteen years of fame” in the minds of some executives; the organizational initiative has turned elsewhere.

But the pendulum may be swinging back. There is a renewed recognition that compliance programs can atrophy from lack of support. The new regulatory administration in Washington may return to an emphasis on organizational accountability. As Delaware decisions suggest, shareholders may be growing increasingly intolerant of costly corporate compliance and accounting lapses. And there’s a renewed emphasis on the role of the whistleblower, and the board’s role in assuring the support and protection of that role.

So it may be useful on this auspicious anniversary to engage the board on the Enron experience, in a couple of different ways. First, include an overview as part of formal director “onboarding” efforts. Second, have a board level conversation about expectations of oversight, and spotting operational and ethical warning signs. And third, reconsider the Enron board’s critical and self-admitted failures, in the context of today’s boardroom culture. [13]

Such a conversation would be a powerful demonstration of a board’s good-faith commitment to effective governance, corporate responsibility and leadership ethics.

1 Bethany McLean, “Is Enron Overpriced?” Fortune, March 5. 2001. https://archive.fortune.com/magazines/fortune/fortune_archive/2001/03/05/297833/index.htm. (go back)

2 See , Michael W. Peregrine, Corporate BoardMember , Second Quarter 2016 (henceforth “Corporate BoardMember”). (go back)

3 See , e.g., Elson and Gyves, In Re Caremark : Good Intentions, Unintended Consequences, 39 Wake Forest Law Review, 691 (2004). (go back)

4 Report of the Special Investigation Committee of the Board of Directors of Enron Corporation, February 1, 2002. http://i.cnn.net/cnn/2002/LAW/02/02/enron.report/powers.report.pdf. (go back)

5 See , Michael W. Peregrine, “The Corporate Governance Legacy of the Powers Report” Corporate Counsel , January 23, 2012 Monday. (go back)

6 See , Michael W. Peregrine, “Enron Still Matters, 15 Years After Its Collapse”, The New York Times , December 1, 2016. (go back)

7 F.N. 5, supra . (go back)

8 See , Elson and Gyves, “The Enron Failure and Corporate Governance Reform”, 38 Wake Forest Law Review 855 (2003) and Elson, “Enron and the Necessity of the Objective Proximate Monitor”, 89 Cornell Law Review 496 (2004). (go back)

9 John Emshwiller and Rebecca Smith, “Enron Posts Surprise 3rd-Quarter Loss After Investment, Asset Write-Downs”, The Wall Street Journal , October 17, 2001. https://www.wsj.com/articles/SB1003237924744857040. (go back)

10 Dylan Tokar and Paul J. Davies, “Wirecard Red Flags Should Have Prompted Earlier Response, Former Executive Says” The Wall Street Journal , February 8, 2021. https://www.wsj.com/articles/wirecard-red-flags-should-have-prompted-earlier-response-former-execu tive-says-11612780200. (go back)

11 Corporate BoardMember , supra . (go back)

12 See Peregrine, “Why Enron Remains Relevant”, Harvard Law School Forum on Corporate Governance, December 2, 2016. (go back)

13 Corporate BoardMember , supra. (go back)

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The Fall of Enron

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What Happened at Enron?

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On December 2, 2001, Enron Corporation filed for bankruptcy protection under Chapter 11. One of the most highly publicized business debacles in history-its settlements, criminal charges, civil…

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On December 2, 2001, Enron Corporation filed for bankruptcy protection under Chapter 11. One of the most highly publicized business debacles in history-its settlements, criminal charges, civil charges, and workouts will continue for years. But outside of the courts and sensational press, what really happened? What caused the collapse of what at one time was the sixth largest company in the United States? The case explores the Enron story-in an attempt to not only answer the question of what happened, but what may be learned from this failure.

Learning Objectives

The case is used to:

allow a reader a more approachable information base to understand the rise and fall of Enron.

focus on how a company chooses or experiences the evolution of a corporate culture which has certain pillars (such as recruiting, compensation, performance evaluation, etc.) and leads to inevitable outcomes.

demonstrate the basics of business and financial growth, including the rate of growth which a firm can sustain through internal and external financing.

explore the personality characteristics of Enron leadership.

Jul 26, 2004

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Enron and World Finance

A Case Study in Ethics

• Paul H. Dembinski (Professor) 0 ,
• Carole Lager (PhD in Political Science) 1 ,
• Andrew Cornford (Research Fellow) 2 ,
• Jean-Michel Bonvin (PhD in Sociology, Professor) 3

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Financial markets center, switzerland.

University Paris IV-Sorbonne, Switzerland Department of Sociology, University of Geneva, Switzerland

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Table of contents (16 chapters)

Front matter, overview of the book.

Andrew Cornford

Enron: Origins, Character and Failure

Enron and internationally agreed principles for corporate governance and the financial sector, a revisionist view of enron and the sudden death of ‘may’.

• Frank Partnoy

Who Is Who in the World of Financial ‘Swaps’ and Special Purpose Entities

• François-Marie Monnet

Ethics in Thought and Action

An ethical diagnosis of the enron affair.

• Etienne Perrot

Anonymity: Is a Norm as Good as a Name?

• Edward Dommen

Spaces for Business Ethics

• Domingo Sugranyes Bickel

Corporate Governance and Auditing

The demise of andersen: a consequence of corporate governance failure in the context of major changes in the accounting profession and the audit market.

• Catherine Sauviat

Enron et al. and Implications for the Auditing Profession

• Anthony Travis

Enron Revisited: What Is a Board Member to Do?

• Beth Krasna

How to Restore Trust in Financial Markets?

• Hans J. Blommestein

Corporate Culture and Ethics

Enron: the collapse of corporate culture.

• John Dobson

Ethics, Courage and Discipline: The Lessons of Enron

• Robert C. Kennedy

Developing Leadership and Responsibility: No Alternative for Business Schools

• Henri-Claude de Bettignies

Ethics for a Post-Enron America

• John R. Boatright

'The essays in this book greatly enhance our understanding of the causes of one of the most important events in financial history. The authors examine in notable depth the ethical and governance dimensions of the Enron saga, while providing a fascinating commentary on the nature of modern finance capitalism.' - John Plender, Financial Times and author of Going off the Rail - Global Capital and the Crisis of Legitimacy

'Enron and World Finance addresses the most important issue of our time...This brilliant collection of essays with its remarkably insightful introduction and conclusion require us to consider what might be called the tyranny of economics...Enron is important not only in itself but also as a warning signal of the predictable destructive consequences of the failure of language.' - Robert A. G. Monks, Lens Governance Advisors, USA

'Enron offers an 'ideal' example of using or perhaps misusing financial innovations within modern corporations. The book Enron and World Finance provides a very insightful overview of this memorable case where the ethical dimension of an organization is nonexistent. As professors of Finance, we welcome such a book that illustrates the pitfalls of financial creativity when it ignores or abuses the boundaries of an honest corporate culture and of its management.' - Marc Chesney and Rajna Gibson, Professors of Finance, Swiss Banking Institute, University of Zürich, Switzerland

'The book provides, at once, afresh understanding of the place of ethical thought in financial markets, and a focus on leadership and responsibility for the implementation of ethical duties. I commend this fascinating book to a wide readership in financial and academic institutions.' - Professor Dr. Hans Tietmeyer, Bundesbankprasident i.R., Germany

Paul H. Dembinski

Carole Lager

University Paris IV-Sorbonne, Switzerland

Jean-Michel Bonvin

Department of Sociology, University of Geneva, Switzerland

Book Title : Enron and World Finance

Book Subtitle : A Case Study in Ethics

Editors : Paul H. Dembinski, Carole Lager, Andrew Cornford, Jean-Michel Bonvin

DOI : https://doi.org/10.1057/9780230518865

Publisher : Palgrave Macmillan London

eBook Packages : Palgrave Economics & Finance Collection , Economics and Finance (R0)

Copyright Information : Palgrave Macmillan, a division of Macmillan Publishers Limited 2006

Hardcover ISBN : 978-1-4039-4763-5 Published: 16 December 2005

eBook ISBN : 978-0-230-51886-5 Published: 16 December 2005

Edition Number : 1

Number of Pages : XVI, 257

Topics : Accounting/Auditing , Business Strategy/Leadership , Business Ethics , Finance, general

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• What Really Went Wrong with Enron?
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What Really Went Wrong with Enron? A Culture of Evil?

The Markkula Center for Applied Ethics convened a panel of four Santa Clara University business ethicists to discuss the Enron scandal.

On March 5, 2002, the Markkula Center for Applied Ethics convened a panel of four Santa Clara University business ethicists to discuss the Enron scandal. Panelists included Kirk O. Hanson, executive director of the Ethics Center and University Professor of Organizations and Society; Manuel Velasquez, Dirksen Professor of Business Ethics, Department of Management; Dennis Moberg, Wilkinson Professor of Management and Ethics, and Martin Calkins, S.J., assistant professor of management. Edited excerpts from their conversation appear below:

Manuel Velasquez: What went wrong at Enron? In ethics, explanations tend to fall into three categories: personal, organizational, and systemic. Personal explanations look for the causes of evil in the character of the individuals who were involved. Did this happen, for example, because the people involved were vicious? Were they greedy? Were they stupid? Were they callous? Were they intemperate? Were they lacking in compassion?

Organizational explanations look for causes in group influences. They take seriously the ways that we influence each other when we do things as a group. These influences include the shared beliefs that groups develop about who is important, what is permissible, and how things are done here in this group. These include also the shared values that we call a group culture, the rules or policies groups develop to govern their interactions with each other and the rest of the world.

Finally, systemic explanations look for causes outside the group, for example in the environmental forces that drive or direct groups or individuals to do one thing rather than another. These include the laws and the regulations that provide the framework in which people act, the economic and social institutions that give meaning and direction to our lives, and the culture that shapes the values and perceptions of people and groups.

I am going to concentrate on the third kind of explanation for what went wrong with Enron-the systemic explanations….

I think that one of the obvious systemic causes of the Enron scandal is our legal and regulatory structure. First, current laws and SEC regulations allow firms like Arthur Andersen to provide consulting services to a company and then turn around and provide the audited report about the financial results of these consulting activities. This is an obvious conflict of interest that is built into our legal structure.

Second, a private company like Enron currently hires and pays its own auditors. This again is a conflict of interest built into our legal system because the auditor has an incentive not to issue an unfavorable report on the company that is paying him or her.

Third, most large companies like Enron are allowed to manage their own employee pension funds. Again, this is a conflict of interest built into our legal system because the company has an incentive to use these funds in ways that advantage the company even when they may disadvantage employees.

And fourth, most companies like Enron have codes of ethics that prohibit managers and executives from being involved in another business entity that does business with their own company. But these codes of ethics are voluntary and can be set aside by the board of directors. Our legal structure today largely allows managers to enter these arrangements, which constitute a conflict of interest. The managers and executives, of course, have a fiduciary duty to act in the best interest of the company and its shareholders, But the law leaves considerable discretion to managers and executives to exercise their own business judgment about what is in the best interests of the company.

A lot of the Enron story developed during the booming '90s. The stock market was shooting upward. Start-ups were rolling in venture capital, established businesses were expanding, consumers were spending, and it seemed like everyone was making lots of money. I would suggest that during periods like these, our moral standards tend to get corrupted. The ease with which we see money being made leads us to cut corners, to take shortcuts, to become focused on getting our own share of the pie no matter what because everybody else is getting theirs. This general boom culture, I believe, was part of what affected Enron and led its managers and executives to think that anything was okay so long as the money kept rolling in. Dennis Moberg: Manny talked about the importance of looking at this case from a lot of different vantagepoints. I'd like to concentrate primarily on the character of the individuals in question: Kenneth Lay, Jeffrey Skilling, and Andrew Fastow. Character ethics focuses on the ethics of the person rather than the ethics of the action in question. It distinguishes between individuals who might be called good or virtuous and individuals who might be called bad-at the extreme, evil people or people who are vice-ridden or vicious….

The best list of vices is the classic seven deadly sins: pride, anger, sloth, avarice, gluttony, lust, and envy. Do we see any of these elements of character displayed among the executives at Enron?

• Pride: Jeffery Skilling once said, "I've never not been successful at business or work...ever!"
• Anger: When interviewed by a Fortune reporter, Skilling said, "The people who ask questions don't understand the company." When this reporter persisted a bit, Skilling called her unethical for even raising the question and abruptly hung up the phone. Later, he called another reporter an "expletive deleted."
• Sloth: One of the most critical board meetings at Enron in 1991-where they were giving approval to set aside their ethics statements on behalf of these shenanigans with partnerships-that meeting lasted one hour. That's barely enough time to get a Coke.
• Avarice: Fastow, the CFO, sold $36 million of his Enron investments before the company tanked. Lay had a whole bunch of sweetheart deals with family members. I'm sure tempted to call that greed….

Add to this…a tendency toward cronyism. Managers at Enron's divisions grew arrogant, thinking themselves invincible. We see this insular tendency of the company to seal itself off from forces on the outside. They had something called a rank-and-yank performance appraisal system, which eliminated anyone who fell behind-a real Darwinist system that took care of anyone who might potentially disagree. All of the internal whistleblowers were rebuffed, humiliated, or treated in an intimidating way by the various players. And finally, one of my favorites-their 1999 annual report in which all of the members of the board of directors are listed by their nicknames, again suggesting that tendency towards cronyism….

In terms of fixing the system from a character viewpoint…, we need reforms that discourage cronyism-this insular tendency in too many American corporations to seal themselves off from the realities beyond themselves. Jeffrey Skilling, Andrew Fastow, and Kenneth Lay all live in the same gated community in Houston, which I think is a great metaphor for what happened at Enron.

Martin Calkins, S.J.: Corporate governance relies on the state of mind and personal relationships of managers, not a list of empty procedures or principles. In the Enron case, the rules were in place, but were willfully and skillfully ignored.

In the Enron case, we see the result of a growing and pervasive winking at the letter of the law. This winking didn't come out of nowhere. It built up in our society during the 1990s and culminated in 1995 in the Private Securities Litigation Reform Act—a law that eased some of the restrictions put in place after the Great Depression to prevent the sort of behavior we see with Enron. Both the behavior and the rules and laws to prevent it have been around for years. The laws were simply circumvented in the Enron case.

On the issue of character, I agree with Dennis that the Enron debacle seems to be character-based. Unlike Dennis, however, I would be less inclined to judge the character of the Enron people harshly. The Enron people may very well be the good people they present themselves to be. Perhaps it was the corporate culture in which they operated that led to the problem we have today. It may be that we have here an example of the so-called "separation thesis": an incident where individuals, for reasons tied to corporate culture and societal expectations, adopted as their own an ethic associated with their role as manager that was distinct (separate) from their individual ethics. In other words, these may be good people who acted wrongly because they thought their managerial roles demanded they act in a certain unethical manner.

Finally, I would like to make some suggestions and recommendations for reform.

First, I think this issue shows the need for better financial disclosure mechanisms. Perhaps we should institute programs to replace today's peer review process involving the American Institute of Certified Public Accountants. At a minimum, the case seems to show that the Financial Accounting Standards Board, which has responsibility for rule making in this area, needs to establish regulations and standards that are more forthright and understandable to ordinary people such as you and me.

Second, the case illustrates a need for more responsible public servants, not more laws. The 1995 Private Securities Litigation Reform Act relaxed the restrictions that would have checked the behaviors that led to the Enron scandal. Yet government officials now call for more laws. This seems to be a ploy to direct public attention away from what politicians have already done to the law.

For example, Ohio Democratic Representative Dennis "The Menace" Kucinich, former mayor of the city of Cleveland who was almost single-handedly responsible for that city's bankruptcy in 1978-79, is drafting legislation that would create a new independent organization to audit publicly traded companies. Do we really need more legislation and another government office? What about the laws and people to enforce them that are already in place? A proposal such as Kucinich's seems to me to be a smokescreen to protect politicians. In my view, we need to hold these politicians responsible for what they have done, just as we have held the business people to accountability.

Third, the case illustrates a need to amend but not ban all non-audit work. There has been a call lately to eliminate all non-audit services by auditing companies. However, many of these essential non-audit services are so closely linked to the audited information that it does not make sense to ban the auditor from providing these services. Tax advice is one example. The auditor has a familiarity with corporate financial records such that it makes sense for him or her to give certain tax advice.

In addition, there has been a proposal to require firms to change auditors regularly. This seems sensible at first, but it may increase the inefficiencies and risks associated with reporting and thereby reduce financial reporting quality.

In short, I think we ought to go slowly in instituting restrictions on the services auditors can provide. It may be that we should allow them to perform certain services with limitations - such as having a staggered rotation of partners and staff on an audit to assure better financial reporting.

In the end, while the Enron case illustrates a number of flaws in the system of reporting, before we establish new laws and reporting procedures, we ought to look at what, in specific, is wrong with what we are doing now and nuance our responses. Otherwise, we may be creating more harm than good.

Kirk O. Hanson: The collapse of Enron is probably one of the most significant events in the history of American business. Within six months, the company went from one of the most respected in the United States to bankruptcy-an unparalleled failure. What went wrong?

Number one: Enron executives really did believe this is a winner-take-all society-that there was a culture behind them saying, "You're worth nothing if you're not a centi-millionaire."…

One of my friends, a former executive at Enron who resigned in 2000, described what the recruiting process was like…. They recruited just at the major business schools. They wined and dined the prospects. They promised them huge bonuses and fed those young egos as much as they would take.

Once people were hired, it was an up-or-out culture. Those who survived began to think they were gods. And Jeffrey Skilling used to pit them against each other. He knew that as long as he could keep them scared of one another and competing, he would have control. When you create an environment in which, if you want to be among the best and the brightest, you've got to play the game the way the boss has set it up, that's not a culture where people are going to challenge top management.

In addition, the auditors had an incentive not to challenge Enron. Think about your role if you're the manager of the Arthur Andersen audit. Let's say you're the partner in Houston who manages the Enron account. What do you get paid for? You get paid for keeping that client. What do you get fired for? You get fired if you lose that client. The incentives all run in the direction of doing whatever this company demands of you. And if you've got a very aggressive management, like Enron had under Skilling and Andrew Fastow, then it becomes all the harder. You have to give in more and more.

The CEO of one of the big five accounting firms once told me, "My biggest ethical problem is that I incent people to keep clients at all costs. I know that creates ethical pressures on my people. I've got to find a partner who lost an account for the right reason-because it was ethically the right thing to do-and give them the biggest bonus next year."

I saw him a year later, and I said, "How'd it go?"

He said, "Well, I'm still looking for that partner." So you understand the kind of pressures on these auditors. And the pressures are made all the worse if it's not just auditing business but another $10 million in consulting services at stake at the same time. That's why we at least want to get rid of that conflict of interest.

Ten years from now, we'll look back on the Enron debacle and think of it as a morality play on the rights and privileges of the rich vs. the regular employees. One of the most outlandish aspects of the scandal is that the people at the top seem to have gotten their money out, leaving their fortunes intact. In fact, their claim that they were running one of the great risk-seeking enterprises of the new economy was rather hollow. They were running a risk-free company for themselves while the risk was assumed by the people at the lower levels in the organization.

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Enron Revisited

Riann winget.

Scholar argues that regulatory action should reflect underlying causes of corporate fraud.

This one name alone conjures up images of fraudsters in back rooms drawing up illegal schemes for profit.

But what if one of the biggest frauds in history was not as serious or harmful as some critics claim ? And what if the regulatory response to Enron—which President Bush lauded as one of the most “sweeping” reforms of American business practices “since Franklin Roosevelt”—was little more than an overreaction that could stifle innovation?

In a recent article , Steven L. Schwarcz of the Duke University School of Law argues that the regulatory response to the Enron scandal—specifically, the passing of the Sarbanes-Oxley Act (SOX)— responded to the “posterchild of corporate fraud” dramatically but, ultimately, ineffectively.

Schwarcz argues that SOX ultimately failed to regulate corporate fraud. He asserts that executives at corporations across the nation could behave similarly to the executives at Enron, yet not necessarily commit fraud under SOX as it stands today.

Schwarcz points out that although SOX was drafted specifically to address the fraud committed in the Enron case, it failed to address the cognitive biases that can influence decision-making and lead to fraud. Nor does SOX demonstrate how corporations should handle the kind of complicated disclosures that misled Enron investors, contends Schwarcz.

He discusses the shortcomings of SOX by first detailing the Enron scandal itself and why it might not have been as serious an event as public outcry suggested following its wake. Enron’s executives transformed the company, founded in 1985, from a “stodgy natural gas pipeline company” into a sophisticated trader of energy contracts and other complex financial instruments, according to Schwarcz. The company’s success continued throughout the 1990s, when Enron was named as “the most innovative company in corporate America” for six years in a row.

The 2000 economic downturn , however, negatively impacted the underlying value of many of Enron’s assets. To continue its financial trading business, Enron executives needed to protect the company’s investment grade status, or they would risk huge financial losses that could lead to default, Schwarcz explains . A company in this position would typically sell underlying assets to offset any losses, but a series of lock-up agreements prevented Enron executives from selling these assets in time.

With limited choices to save the company, Enron’s executives “found a creative alternative,” Schwarcz claims . Upon approval from external auditors, Enron executives shifted accounting methods so that projected gains were reported on Enron’s current balance sheets, while losses were moved to books of Enron subsidiaries or third-party special purpose entities. The shift in accounting methodology and the off-balance-sheet transaction disclosures are two parts of the fraudulent conduct that landed some Enron executives in jail.

Schwarcz argues that the accounting change demonstrated a judgment failure of “optimism bias,” rather than intentional fraud. He contends that Enron collapsed because its executives did not consider the possibility that a drop in asset value might also coincide with a drop in Enron’s stock price altogether.

In addition, Schwarcz argues that the executives’ decisions did not render them fraudsters outright, but rather that these decisions showed how cognitive bias—an unconscious tendency to select certain information that often results in flawed reasoning—can corrupt decision making. Just as the Enron executives had their own cognitive biases, Schwarcz suggests that other cognitive biases led both regulators and the general public to attribute Enron’s failure to active wrongdoing when looking back on the incident.

Yet on the issue of combating cognitive bias, SOX remains silent, Schwarcz notes . Although Schwarcz does not directly offer reforms to SOX that would consider cognitive biases, he points to other scholarship, which proposes solutions for corporations to check their biases, manage potential risks in their operations, and disclose specific information on such risks.

Schwarcz asserts that, although Enron executives disclosed the off-balance-sheet transactions to investors, the transactions were so complicated that Enron’s efforts to disclose them misled investors anyway. The disclosures were either oversimplified or written in complex terms such that Enron’s investors could not fully appreciate the financial risk involved.

And although SOX imposed more stringent disclosure requirements, Schwarcz notes that SOX did not address overly complex disclosures. This issue exemplifies the real shortcoming of SOX as a response to Enron, Schwarcz contends .

To combat the still-ongoing issue of complex, potentially misleading disclosures, Schwarcz details several paths to reform, including amending SOX and creating new regulation.

One possible solution Schwarcz endorses is standardizing off-balance-sheet transactions. Some critics of the approach might claim that too much standardization could hinder financial innovation, but Schwarcz asserts that carefully curated standardization could mitigate this harm and promote innovation.

Schwarcz, in part, defends Enron’s executives, noting that corporate managers must often take risks to save their businesses. As he notes , some risks will not pay off and businesses do fail. But Schwarcz cautions against attributing all business failure to malfeasance or fraud. Instead, he encourages regulators and public commentors to resist overreacting and inhibiting innovation.

Schwarcz concludes by emphasizing that financial innovation supports competition in a global economy and should be promoted, “even at the risk of another Enron.”

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Enron Scandal: Risk Management, Corporate Governance, and Ethical Shortcomings

('..the dominance of the 'shareholder value' norm in Anglo-American corporate governance….is almost entirely missing from the public policy discourse surrounding Sarbanes-Oxley and Higgs. Is it possible that policy makers are learning the wrong lesson from Enron?'

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Alexandre Di Miceli da Silveira

The year 2011 has marked a decade since the Enron collapse, considered the most emblematic corporate scandal worldwide. Despite its importance, few studies provide an integrated analysis of the underlying failures that allowed Enron’s debacle, going beyond the traditional view that reduces the case to a mere "accounting fraud". Few studies also evaluate the main lessons from the Enron scandal in perspective, by comparing its common causes with corporate scandals that emerged during the global financial crisis in 2007-2008. These are the gaps I aim to fill. I conclude that Enron’s accounting manipulations, rather than being the cause of the problems, were the consequence of managerial failures and wishful blindness by its stakeholders. I also show that some lessons from Enron have not been fully internalized by companies worldwide, since most of its underlying causes are similar to those of several corporate scandals that emerged a couple of years later.

SSRN Electronic Journal

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Kuldeep Singh

Corporate governance is one of the most important legislative domains of a business organization which has an impact on its profitability, growth and even sustainability of business. As business circumstances are vary the investors are differ with respect to incentives, risk-attitude, and different incentive strategies, the outcome of this process emerge as a kind of corporate governance practices. In order to protect investors from financial irregularities, misleading and fraudulent activities carried out by the firm the U.S Securities and Exchange Commission passed the act called Sarbanes-Oxley Act (SOX), whereas in India the Clause 49 of SEBI, is many times termed as Indian version of SOX but it has also been criticized for not being holistic in nature. Many of the corporate governance regulations are scattered in various clauses of Indian Companies act too. In this paper we aim to compare SOX and Indian regulations on corporate governance. We discuss the similarities, differences, areas of SOX superiority and suggest various improvements which if incorporated in Indian laws may lead to achievement of comprehensive regulation on corporate governance.

Yael S Simon

Tassawar Zahoor

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Laynii Moree Nieto

This paper explores the shift from the Cadbury Report (1992) norms and rules to the current UK Corporate Governance Code (2014) focusing upon the reasoning, the influences and the implications thereof. The Cadbury Report (1992) has provided us with the legacy of definition of the corporate governance as the " system by which companies are directed and controlled " , voluntary adoption of the governance best practices and the " comply or explain " principle. The adoption of good governance practices is especially significant for the relationship between managers and shareholders in achieving high standards of corporate behaviour. Issues relating to managerial accountability, transparency, and regulation have been complex and still require further evaluation. The publication of the Cadbury Report (1992) has proven to be an influential in the development of a number of corporate governance codes worldwide. The greatest achievement of the Cadbury Report (1992) is the voluntary adoption of the corporate governance recommendations and use of the comply or explain principle. We believe that the flexibility provided by the adoption of the voluntary code of best practice is the strength of corporate governance in the UK, yet the constantly evolving UK corporate governance code may be an indication of a deeper problem. An important part of the corporate governance is the prioritisation of the shareholder value, and although this is still the case, the UK Corporate Governance Code 2014 has veered for behavioural change. and requiring further confirmation by directors on several matters such as risk management, internal control, and going concern suggesting greater accountability, with further changes to disclosure and confirmation by the directors. This reaffirms that the corporate governance is changing, and is expected to change in the future.

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What Was Enron?

Understanding enron, the enron scandal.

• Mark-to-Market Accounting

What Happened to Enron

• The Role of Enron's CEO

The Legacy of Enron

The bottom line.

• Company Profiles
• Energy Sector

What Was Enron? What Happened and Who Was Responsible

Adam Hayes, Ph.D., CFA, is a financial writer with 15+ years Wall Street experience as a derivatives trader. Besides his extensive derivative trading expertise, Adam is an expert in economics and behavioral finance. Adam received his master's in economics from The New School for Social Research and his Ph.D. from the University of Wisconsin-Madison in sociology. He is a CFA charterholder as well as holding FINRA Series 7, 55 & 63 licenses. He currently researches and teaches economic sociology and the social studies of finance at the Hebrew University in Jerusalem.

Investopedia / Daniel Fishel

Enron was an energy-trading and utility company based in Houston, Texas, that perpetrated one of the biggest accounting frauds in history. Enron's executives employed accounting practices that falsely inflated the company's revenues and, for a time, made it the seventh-largest corporation in the United States. Once the fraud came to light, the company quickly unraveled, filing for Chapter 11 bankruptcy in December 2001.

Key Takeaways

• Enron was an energy company that began to trade extensively in energy derivatives markets.
• The company hid massive trading losses, ultimately leading to one of the largest accounting scandals and bankruptcy in recent history.
• Enron executives used fraudulent accounting practices to inflate the company's revenues and hide debt in its subsidiaries.
• The SEC, credit rating agencies, and investment banks were also accused of negligence—and, in some cases, outright deception—that enabled the fraud.
• As a result of Enron, Congress passed the Sarbanes-Oxley Act to hold corporate executives more accountable for their company's financial statements.

Enron was an energy company formed in 1986 following a merger between Houston Natural Gas Company and Omaha-based InterNorth Incorporated. After the merger, Kenneth Lay, who had been the  chief executive officer  (CEO) of Houston Natural Gas, became Enron's CEO and chair.

Lay quickly rebranded Enron into an energy trader and supplier. Deregulation of the energy markets allowed companies to place bets on future prices. In 1990, Lay created the Enron Finance Corporation and appointed Jeffrey Skilling, whose work as a McKinsey & Company consultant had impressed Lay, to head the new corporation. Skilling was then one of the youngest partners at McKinsey.

Enron provided a variety of energy and utility services around the world. Its company divided operations in several major departments, including:

• Enron Online : In late 1999, Enron built its web-based system to enhance customer functionality and market reach.
• Wholesale Services : Enron offered various energy delivery solutions, with its most robust industry being natural gas. In North America, Enron claimed to deliver almost double the amount of electricity compared to its second tier of competition.
• Energy Services : Enron's retail unit provided energy around the world, including in Europe, where it expanded retail operations in 2001.
• Broadband Services : Enron provided logistical service solutions between content providers and last-mile energy distributors.
• Transportation Services : Enron developed an innovative, efficient pipeline operation to network capabilities and operate pooling points to connect to third parties.

However, by leveraging special purpose vehicles, special purpose entities, mark-to-market accounting, and financial reporting loopholes, Enron became one of the most successful companies in the world. Upon discovery of the fraud, the company subsequently collapsed. Enron shares traded as high as $90.75 before the fraud was discovered but plummeted to around $0.26 in the sell-off after it was revealed.

The former Wall Street darling quickly became a symbol of modern corporate crime. Enron was one of the first big-name accounting scandals, but uncovered frauds at other companies such as WorldCom and Tyco International soon followed.

Before coming to light, Enron was internally fabricating financial records and falsifying the success of its company. Though the entity did achieve operational success during the 1990s, the company's misdeeds were finally exposed in 2001.

Pre-Scandal

Leading up to the turn of the millennium, Enron's business appeared to be thriving. The company became the largest natural gas provider in North America in 1992, and the company launched EnronOnline, its trading website allowing for better contract management just months before 2000. The company also rapidly expanded into international markets, led by the 1998 merger with Wessex Water.

Enron's stock price mostly followed the S&P 500 for most of the 1990's. However, expectations for the company began to soar. In 1999, the company's stock increased 56%. In 2000, it increased an additional 87%. Both returns widely beat broad market returns, and the company soon traded at a 70x price-earnings ratio.

Early Signs of Trouble

In February 2001, Kenneth Lay stepped down as Chief Executive Officer and was replaced by Jeffrey Skilling. A little more than six months later, Skilling stepped down as CEO in August 2001, with Lay taking over the role again.

Around this time, Enron Broadband reported massive losses. Lay revealed in the company's Q2 2001 earnings report that "...in contrast to our extremely strong energy results, this was a difficult quarter in our broadband businesses." In this quarter, the Broadband Services department reported a financial loss of $102 million.

Also, around this time, Lay sold 93,000 shares of Enron stock for roughly $2 million while telling employees via e-mail to continue buying the stock and predicting significantly higher stock prices. In total, Lay was eventually found to have sold over 350,000 Enron shares for total proceeds greater than $20 million.

During this time, Sherron Watkins had expressed concerns regarding Enron's accounting practices. A Vice President for Enron, she wrote an anonymous letter to Lay expressing her concerns. Watkins and Lay eventually met to discuss the matters, in which Watkins delivered a six-page report detailing her concerns. The concerns were presented to an outside law firm in addition to Enron's accounting firm; both agreed there were no issues to be found.

By October 2001, Enron had reported a third quarter loss of $618 million. Enron announced it would need to restate its financial statements from 1997 to 2000 to correct accounting violations.

Enron's $63.4 billion bankruptcy was the biggest on record at the time.

On Nov. 28, 2001, credit rating agencies reduced Enron's credit rating to junk status, effectively solidifying the company's path to bankruptcy. On the same day, Dynegy, a fellow energy company Enron was attempting to merge with, decided to nix all future conversations and opted against any merger agreement. By the end of the day, Enron's stock price had dropped to $0.61.

Enron Europe was the first domino, filing for bankruptcy after close of business on Nov. 30. The rest of Enron followed suit on Dec. 2. Early the following year, Enron dismissed Arthur Andersen as its auditor , citing that the auditor had yielded advice to shred evidence and destroy documents.

In 2006, the company sold its last business, Prisma Energy. The next year, the company changed its name to Enron Creditors Recovery Corporation with the intention of repaying any remaining creditors and open liabilities as part of the bankruptcy process.

Post Bankruptcy/Criminal Charges

After emerging from bankruptcy in 2004, the new board of directors sued 11 financial institutions involved in helping conceal the fraudulent business practices of Enron executives. Enron collected nearly $7.2 billion from these financial institutions as part of legal settlements. The banks included the Royal Bank of Scotland, Deutsche Bank, and Citigroup.

Kenneth Lay pleaded not guilty to eleven criminal charges. He was convicted of six counts of securities and wire fraud and was subject to a maximum of 45 years in prison. However, Lay died on July 5, 2006, before sentencing was to occur.

Jeff Skilling was convicted on 19 of the 28 counts of securities fraud he was charged with, in addition to other charges of insider trading. He was sentenced to 24 years and four months in prison, though the U.S. Department of Justice reached a deal with Skilling in 2013. The deal resulted in 10 years being cut off of his sentence.

Andy Fastow and his wife, Lea, pleaded guilty to charges against them, including money laundering, insider trading, fraud, and conspiracy. Fastow was sentenced to 10 years without parole to testify against other Enron executives. Fastow has since been released from prison.

Causes of the Enron Scandal

Enron went to great lengths to enhance its financial statements, hide its fraudulent activity, and report complex organizational structures to both confuse investors and conceal facts. The causes of the Enron scandal include but are not limited to the factors below.

Special Purpose Vehicles

Enron devised a complex organizational structure leveraging special purpose vehicles (or special purpose entities). These entities would "transact" with Enron, allowing Enron to borrow money without disclosing the funds as debt on their balance sheet.

SPVs provide a legitimate strategy that allows companies to temporarily shield a primary company by having a sponsoring company possess assets. Then, the sponsor company can theoretically secure cheaper debt than the primary company (assuming the primary company may have credit issues). There are also legal protection and taxation benefits to this structure.

The primary issue with Enron was the lack of transparency surrounding the use of SPVs. The company would transfer its own stock to the SPV in exchange for cash or a note receivable. The SPV would then use the stock to hedge an asset against Enron's balance sheet. Once the company's stock started losing its value, it no longer provided sufficient collateral that could be exploited by being carried by an SPV.

Inaccurate Financial Reporting Practices

Enron inaccurately depicted many contracts or relationships with customers. By collaborating with external parties such as its auditing firm, it was able to record transactions incorrectly, not only in accordance with GAAP but also not in accord with agreed-upon contracts.

For example, Enron recorded one-time sales as recurring revenue. In addition, the company would intentionally maintain an expired deal or contract through a specific period to avoid recording a write-off during a given period.

Poorly Constructed Compensation Agreements

Many of Enron's financial incentive agreements with employees were driven by short-term sales and quantities of deals closed (without consideration for the long-term validity of the deal). In addition, many incentives did not factor in the actual cash flow from the sale. Employees also received compensation tied to the success of the company's stock price, while upper management often received large bonuses tied to success in financial markets.

Part of this issue was the rapid rise of Enron's equity success. On Dec. 31, 1999, the stock closed at $44.38. Just three months later, it closed on March 31, 2000 at $74.88. With the stock hitting $90 by the end of 2000, the massive profits some employees received only fueled further interest in obtaining equity positions in the company.

Lack of Independent Oversight

Many external parties learned about Enron's fraudulent practices, but their financial involvement with the company likely caused them not to intervene. Enron's accounting firm, Arthur Andersen, received many jobs and financial compensation in return for their services.

Investment bankers collected fees from Enron's financial deals. Buy-side analysts were often compensated to promote specific ratings in exchange for stronger relationships between Enron and those institutions.

Unrealistic Market Expectations

Both Enron Energy Services and Enron Broadband were poised to be successful due to the emergence of the internet and heightened retail demand. However, Enron's over-optimism resulted in the company over-promising online services and timelines that were simply unrealistic.

Poor Corporate Governance

The ultimate downfall of Enron was the result of overall poor corporate leadership and corporate governance . Former Vice President of Corporate Development Sherron Watkins is noted for speaking out about various financial treatments as they were occurring. However, top management and executives intentionally disregarded and ignored concerns. This tone from the top set the precedent across accounting, finance, sales, and operations.

In the early 1990s, Enron was the largest seller of natural gas in North America. Ten years later, the company no longer existed due to its accounting scandal.

The Role of Mark-to-Market Accounting

One additional cause of the Enron collapse was mark-to-market accounting. Mark-to-market accounting is a method of evaluating a long-term contract using fair market value. At any point, the long-term contract or asset could fluctuate in value; in this case, the reporting company would simply "mark" its financial records up or down to reflect the prevailing market value .

There are two conceptual issues with mark-to-market accounting, both of which Enron took advantage of. First, mark-to-market accounting relies very heavily on management estimation. Consider long-term, complex contracts requiring the international distribution of several forms of energy. Because these contracts were not standardized, it was easy for Enron to artificially inflate the value of the contract because it was difficult to determine the market value appropriately.

Second, mark-to-market accounting requires companies to periodically evaluate the value and likelihood that revenue will be collected. Should companies fail to continually evaluate the value of the contract, it may easily overstate the expected revenue to be collected.

For Enron, mark-to-market accounting allowed the firm to recognize its multi-year contracts upfront and report 100% of income in the year the agreement was signed, not when the service would be provided or cash collected. This form of accounting allowed Enron to report unrealized gains that inflated its income statement, allowing the company to appear much more profitable than it was.

The Enron bankruptcy, at $63.4 billion in assets, was the largest on record at the time. The company's collapse shook the financial markets and nearly crippled the energy industry. While high-level executives at the company concocted the fraudulent accounting schemes, financial and legal experts maintained that they would never have gotten away with it without outside assistance. The Securities and Exchange Commission (SEC), credit rating agencies, and investment banks were all accused of having a role in enabling Enron's fraud.

Initially, much of the finger-pointing was directed at the SEC, which the U.S. Senate found complicit for its systemic and catastrophic failure of oversight. The Senate's investigation determined that had the SEC reviewed any of Enron's post-1997 annual reports, it would have seen the red flags and possibly prevented the enormous losses suffered by employees and investors.

The credit rating agencies were found to be equally complicit in their failure to conduct proper due diligence before issuing an investment-grade rating on Enron's bonds just before its bankruptcy filing. Meanwhile, the investment banks—through manipulation or outright deception—had helped Enron receive positive reports from stock analysts, which promoted its shares and brought billions of dollars of investment into the company. It was a quid pro quo in which Enron paid the investment banks millions of dollars for their services in return for their backing.

Enron reported total company revenue of:

• $13.2 billion in 1996
• $20.3 billion in 1997
• $31.2 billion in 1998
• $40.1 billion in 1999
• $100.8 billion in 2000

The Role of Enron's CEO

By the time Enron started to collapse, Jeffrey Skilling was the firm's CEO. One of Skilling's key contributions to the scandal was to transition Enron's accounting from a traditional historical cost accounting method to mark-to-market accounting, for which the company received official SEC approval in 1992.

Skilling advised the firm's accountants to transfer debt off Enron's balance sheet to create an artificial distance between the debt and the company that incurred it. Enron continued to use these accounting tricks to keep its debt hidden by transferring it to its  subsidiaries  on paper. Despite this, the company continued to recognize  revenue  earned by these subsidiaries. As such, the general public and, most importantly, shareholders were led to believe that Enron was doing better than it actually was despite the severe violation of GAAP rules.

Skilling abruptly quit in August 2001 after less than a year as chief executive—four months before the Enron scandal unraveled. According to reports, his resignation stunned Wall Street analysts and raised suspicions despite his assurances that his departure had "nothing to do with Enron."

Skilling and Kenneth Lay were tried and found guilty of fraud and conspiracy in 2006. Other executives plead guilty. Lay died shortly after his conviction, and Skilling served twelve years, by far the longest sentence of any of the Enron defendants.

In the wake of the Enron scandal, the term " Enronomics " came to describe creative and often fraudulent accounting techniques that involve a parent company making artificial, paper-only transactions with its subsidiaries to hide losses the parent company has suffered through other business activities.

Parent company Enron had hidden its debt by transferring it (on paper) to wholly-owned subsidiaries —many of which were named after Star Wars characters—but it still recognized revenue from the subsidiaries, giving the impression that Enron was performing much better than it was.

Another term inspired by Enron's demise was "Enroned," slang for having been negatively affected by senior management's inappropriate actions or decisions. Being "Enroned" can happen to any stakeholder, such as employees, shareholders, or suppliers. For example, if someone lost their job because their employer was shut down due to illegal activities they had nothing to do with, they have been "Enroned."

As a result of Enron, lawmakers put several new protective measures in place. One was the Sarbanes-Oxley Act of 2002, which enhances corporate transparency and criminalizes financial manipulation. The Financial Accounting Standards Board (FASB) rules were also strengthened to curtail the use of questionable accounting practices, and corporate boards were required to take on more responsibility as management watchdogs.

What Did Enron Do That Was So Unethical?

Enron used special purpose entities to hide debt and mark-to-market accounting to overstate revenue. In addition, it ignored internal advisement against these practices, knowing that its publicly disclosed financial position was incorrect.

How Big was Enron?

With shares trading for around $90/each, Enron was once worth about $70 billion. Leading up to its bankruptcy, the company employed over 20,000 employees. The company also reported over $100 billion of company-wide net revenue (though this figure has since been determined to be incorrect).

Who Was Responsible for the Collapse of Enron?

Several key executive team members are often noted as being responsible for the fall of Enron. The executives include Kenneth Lay (founder and former Chief Executive Officer), Jeffrey Skilling (former Chief Executive officer replacing Lay), and Andrew Fastow (former Chief Financial Officer).

Does Enron Exist Today?

As a result of its financial scandal, Enron ended its bankruptcy in 2004. The name of the entity officially changed to Enron Creditors Recovery Corp., and the company's assets were liquidated and reorganized as part of the bankruptcy plan. Its last business, Prisma Energy, was sold in 2006.

At the time, Enron's collapse was the biggest  corporate bankruptcy  ever to hit the financial world (since then, the failures of WorldCom, Lehman Brothers, and Washington Mutual have surpassed it). The Enron scandal drew attention to accounting and corporate fraud. Its shareholders lost tens of billions of dollars in the years leading up to its bankruptcy, and its employees lost billions more in pension benefits. Increased regulation and oversight have been enacted to help prevent corporate scandals of Enron's magnitude.

U.S. Joint Committee on Taxation. " Report of Investigation of Enron Corporation and Related Entities Regarding Federal Tax and Compensation Issues, and Policy Recommendations, Volume 1: Report ," Page 56.

U.S. Joint Committee on Taxation. " Report of Investigation of Enron Corporation and Related Entities Regarding Federal Tax and Compensation Issues, and Policy Recommendations, Volume 1: Report ," Pages 59-63.

University of Chicago. " Enron Annual Report 2000 ."

U.S. Joint Committee on Taxation. " Report of Investigation of Enron Corporation and Related Entities Regarding Federal Tax and Compensation Issues, and Policy Recommendations, Volume 1: Report ," Pages 77 and 84.

Wall Street Journal. " Enron Announces Acquisition of Wessex Water for $2.2 Billion ."

University of Missouri, Kansas City. " Enron Historical Stock Price ."

The New York Times. " Enron Chairman Kenneth Lay Resigns, Company Says ."

University of Chicago. " Enron Reports Second Quarter Earnings ."

U.S. Securities and Exchange Commission. " SEC Charges Kenneth L. Lay, Enron's Former Chairman and Chief Executive Officer, with Fraud and Insider Trading ."

U.S. Securities and Exchange Commission. " Form 10-Q, 9/30/2001, Enron Corp. "

U.S. Joint Committee on Taxation. " Report of Investigation of Enron Corporation and Related Entities Regarding Federal Tax and Compensation Issues, and Policy Recommendations, Volume 1: Report ," Page 85.

GovInfo. " Enron and the Credit Rating Agencies ."

United States Bankruptcy Court. " Enron Corp. Bankruptcy Information ."

Blackstone. " Enron Announces Proposed Sale of Prisma Energy International Inc. "

GovInfo. " Enron Creditors Recovery Corp ."

JournalNow. " Judge OKs Billions to Enron Shareholders ."

United States Department of Justice. "Federal Jury Convicts Former Enron Chief Executives Ken Lay, Jeff Skilling on Fraud, Conspiracy and Related Charges ."

Federal Bureau of Investigation. " Former Enron Chief Financial Officer Andrew Fastow Pleads Guilty to Commit Securities and Wire Fraud, Agrees to Cooperate with Enron Investigation ."

U.S. Joint Committee on Taxation. " Report of Investigation of Enron Corporation and Related Entities Regarding Federal Tax and Compensation Issues, and Policy Recommendations, Volume 1: Report ," Page 62.

University of North Carolina. " Enron Whistleblower Shares Lessons on Corporate Integrity ."

U.S. Joint Committee on Taxation. " Report of Investigation of Enron Corporation and Related Entities Regarding Federal Tax and Compensation Issues, and Policy Recommendations, Volume 1: Report ," Pages 5-6 and 79.

George Benston. " The Quality of Corporate Financial Statements and Their Auditors Before and After Enron ."

U.S. Joint Committee on Taxation. " Report of Investigation of Enron Corporation and Related Entities Regarding Federal Tax and Compensation Issues, and Policy Recommendations, Volume 1: Report ," Pages 2, 44, and 70-75.

The New York Times. " Jeffrey Skilling, Former Enron Chief, Released After 12 Years in Prison ."

U.S. Joint Committee on Taxation. " Report of Investigation of Enron Corporation and Related Entities Regarding Federal Tax and Compensation Issues, and Policy Recommendations, Volume 1: Report ," Page 72.

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