The collapse of Enron Company was as a result of failure in corporate governance. Corporate governance refers to a system that enables shareholders of a business organization to control the decisions of the organization, and its management. Rapoport et al (2009) explains that Enron was an energy company, based in Texas, one of the American States (p.21). Kenneth Lay formed the company in 1985, by merging InterNorth and Houston Natural gas.
The company hired Jeffery Skilling as one of its executives, and with the help of the company staff, and Arthur Anderson auditors, they took advantage of accounting loopholes, and inadequate financial reporting, to hide billions of debts arising from failed business deals. The chief financial officer misled the board of directors on the accounting principles, and this led to the loss of approximately 11 billion dollars, by shareholders. This was through the downward fall of its share prices, from $90 to as low as $1.
The United States Security and Exchange commission conducted an investigation concerning this scandal, and on 2nd of December 2001, the company filed for bankruptcy, in accordance to the United States Bankruptcy laws. Rapoport et al estimates loss of the company to stand at, 63.4 billion dollars, worth of assets (p.39). This was a big loss to shareholders, and investors because they received dismal returns from their investments, losing their capital, and pensions.
This paper examines the various theories of corporate governance, and applies their significance in explaining the collapse of Enron limited. This paper takes a position that the collapse of Enron was as a result of selfishness on the management, compromised financial reporting, and a highly compromised board of directors.
The development of the Enron compensation system was a contributor to its dysfunctional corporate culture. The aspects of executive compensation, and the efforts to reconcile the interests of the shareholders, and the management team, are an aspect of corporate governance. The corporate culture at Enron was of self-fulfilling, instead of taking care of the needs of the shareholders.
The management concentrated on short-term revenues, for purposes of increasing their bonus. The compensation program made employees to focus on high volume deals, at the expense of ensuring the profitability of the business, and the quality of the deal itself. Sterling (2002) observes that the purpose of this was to have a higher rating, therefore increasing the amount of their compensation (p.32).
Markham (2006) observes that the management team was extensively compensated in relation to the stock price, and to receive large bonuses, the accounting records were quickly recording to be up to date with the stock price (p.12). This practice compromised accountability, since it was based out of selfishness. The management team developed hypothetical expectation of growth in the stock prices, for purposes of misleading shareholders on its earnings, and profitability.
According to Leuz (2009), corporate culture among Enron employees was compensation centered, and it led to the accumulation of large debts due to exorbitant expenses by the employees and the company itself, and the high bonuses paid to employees (p.31). This aspect was a major contributor to the bankruptcy of Enron. Another corporate governance failure that led to the collapse of Enron are the conflict of interest between Enron company, and the Anderson auditing firm.
The firm, in a bid to retain the high value consultation fee paid by Enron failed to notify the board of directors of the high risk accounting policies that Enron was applying in its accounting records. Sterling (2002) observes that in 2000, the audit firm made an approximate value of 25 million dollars from Enron Company in the form of consultation fees (p.16).
In developing its accounting records, Enron Company hired highly experienced accountant to look at loopholes on the rules governing accounting standards, and thereafter develop a financial accounting system that would save the company’s revenue, as well as taking advantage of the weaknesses of GAAP, the general accounting rules that govern accounting principles in United States of America. Niskanen (2005) states that Anderson auditors identified these malpractices, but due to pressure from Enron, and the assumptions of wanting to hire a new group of auditors made the company to initiate measures of protecting it’s self interest in relation to its association with Enron Company (p.43).
Gledhill (2004) believes that the audit firm was responsible to highlight these issues to the Enron Audit and Compliance committee so that they can prevent the malpractice (p.36). This is despite the members of the audit firm knowing of the application of high risk accounting standards by the Enron management team. These accounting errors were as a result of the management’s poor decisions, Enron’s conflict of interest, and lack of compliance from the Enron Audit and Compliance committee. The issue of failure of corporate governance arises at the roles of the Enron Audit Committee.
The committee failed to ask the right questions, and aggressively investigate the accuracy of the audit reports from Anderson. It failed to look at the real financial situation of the company, but focused on the financial records, which was difficult to analyze. In view of this, committee failed to prevent the losses of the company, making it survive on dents, and eventually leading to its bankruptcy. Lack of proper financial reporting is another corporate governance failure that led Enron Company to insolvency. Shareholders of a company rely on financial reports, and records to make a decision on the profitability of the organization concerned.
However, if these reports are manipulated, and they do not reflect the true position of the company, shareholders are unable to make an accurate decision regarding the affairs of the company (. This is the case of Enron. Prebble (2010) states that the financial reports at Enron failed to highlight the various interests, the groups had with the company, and shareholders could not understand its complex financial records (p.39). This made the shareholders fail to address the pertinent issues with the concerned authority, for purposes of protecting the company against insolvency.
Lack of an independent board of directors was also a contributor to the insolvency of Enron Company. An independent board provides an objective judgment. The members of the board had financial ties with the organization, and this made them to lose focus on the objectives of the company. Gledhill (2004) gives an example of John Urquhart offered consultation services, and also drew huge financial allowances as the member of the board of directors (p.18). Another member, Frank Savage was the director of Alliance Capital Management, the biggest institutional investor at Enron. These financial attachments made the board of directors to lack objectivity in relation to the financial records of Enron. Had they acted with zeal, the board had the capability to identify the use of high risk accounting procedures.
There is a possibility that the members of the board felt obligated to the company because of the various business deals they had. This compromised their ability to ask questions, and demand answers on suspected financial recordings. This aspect is one of the reasons as to why Enron paid large amount of money as compensations to its employees. This is because the board also benefited from these financial benefits.
In conclusion, the collapse of Enron is a perfect example of how failure in corporate governance can result to the collapse of a company. This case provides some ethical teachings to the directors and employees of various companies. The ethical teachings in consideration are, production of high quality goods and services, financial transparency as a business strategy, to pay business executives as per the market demands, and implementation of government laws, and procedures in the governance of a company.
