The Rise and Fall of Enron: A Tale of Corporate Greed and Corruption that Collapsed an Empire

Let’s take a minute and learn how this giant and the propitious company became part of the biggest corporate scandal in U.S. history. This emanated from financial malpractices, manipulating financial statements, window dressing, and finally causing the bankruptcy of Enron Corporation. 

This year marks exactly twenty-two years since the fall of the gigantic company and it's becoming a notable big name in the corporate world. The Enron scandal was from well-designed accounting scam. Hitherto Enron scandal is used as a case study for fraud and corruption. 

Founded in 1985, Enron Corporation was born from a merger of two companies that is Houston Natural Gas Corporation and Inter-North Inc., a Nebraska pipeline company. Kenneth Lay became the chairman and CEO of Enron. After the merger, Enron became the largest supplier of natural gas. At the start of 2001, Enron was ranked as the 7th largest publicly listed company in the United States and titled the ‘most innovative company’ by Fortune magazine. Nevertheless, Enron Corporation incurred substantial debt, U.S. congress passed new laws that deregulated the gas and electric utilities, and Enron lost the exclusive rights to operate its pipeline.

To pull through the catastrophe, Enron had to immediately design a new corporate strategy that will help generate profits and consistent cash flows. In 1990, Enron appointed Jeffrey K. Skilling as a new CEO to head the new segment-Enron Finance Corp, he worked previously as a consultant at McKinsey & Co. advising Enron. Under the management of the new CEO, Enron thrived and made a rebound by generating immense profits in a very short time. This was observed through the major achievement in market share. Jeffrey implemented the best strategy ‘the Gas Bank’ where Enron will act as an intermediary between natural gas suppliers and the customers, and shortly it dominated the market by selling shares at $ 90.75

Slowly, competition from other companies increased and Enron's profits dropped drastically, hence forcing Jeffrey Skilling to divert the strategy to other projects to produce more revenue and maintain the market share. Enron expanded its operation to various businesses including electricity, energy, power generation, metal, and broadband communication among other businesses. These projects failed to generate profits as expected. 

The corporation manipulated the transactions by which the enormous amount of debts conspired from the company’s financial statements as if that was not enough, Enron changed the corporate philosophy which was not favorable for the employees. The workers experienced a toxic working environment due to the implementation of the performance review. Enron Corporation became so toxic and strict to their employees considering the evaluation of performance was based on what the employees bring to the company. The employees with good scorecards were promoted while employees with substandard scorecards were dismissed immediately. Thousands and thousands of employees lost their jobs and all their pensions.

Enron requested to SEC to implement the Mark-to-Market (MTM) accounting approach and was successfully approved. The system is based on valuing assets by estimating the current market fair value instead of using actual cost i.e. the company’s statement of the financial position reported the assets in their current market fair value instead of book value. This allowed Enron to write unrealized future profits from trading into the current income statement, therefore giving the illusion of higher current earnings.

You may be contemplating how this mark-to-market strategy operated, right? This is how the Enron accounting system was applied, instead of the company reporting the actual profits, they reported the estimated profits. If the actual revenues reported are less than the estimated value, the company moved the asset to off-the-books and fail to disclose the losses. The Enron system allowed the writing off of all the futile transactions without affecting the financial statements.

The Chief Financial Officer (CFO) Andrew Fastow was a notorious grand innovator of the conspiracy in Enron. He designed the special purpose vehicle known as special purpose entities (SPE) with the main purpose of camouflaging the underperforming projects for their gain and hiding this devastating information from investors and creditors. 

The external auditor Arthur Andersen LLP, tear up thousands of Enron’s documents that reported losses. These documents apparently would have provided enough evidence for collusion between Arthur Andersen and executive management. The Auditing firm had all the powers and rights to disclose the malpractices in Enron, but because of greed, it did not. Hence leaving shareholders, creditors, employees, and other stakeholders to suffer under gluttonous executives. This audit firm ended and wound up its operation of auditing public companies on 31st August 2002.

How did the giant company collapse?

The former vice president of Enron Sherron Watkins (whistleblower) let the cat out of the bag by warning Enron corporations about malfeasance executed in the financial statements. She wrote a report to SEC highlighting the use of a complicated accounting vehicle by Enron to cover up the billions of dollars in losses.

The Enron scandal was exposed in November 2021, which lead to the bankruptcy of the big corporation in the United States and Wall Street favorite. This was brought up by the analyst who was examining the financial statements of the company. Enron Corporation declared a $ 618 billion loss and a reduction in owners’ equity of $ 1.2 billion. On November 2001, Enron revealed inflating income by $ 586 billion. Due to this, the stock price dropped from ninety dollars to twenty-six cents. The shareholders of Enron lost shares worth $ 74 billion which led to bankruptcy. It was delisted from New York Securities Exchange.

After realizing the unethical behavior, the Securities and Exchange Commission started its investigation into all the transactions. It also leads to the implementation of the Enron Task Force which comprised analysts, multi-agency, SEC, and prosecutors. All the executives involved in this unethical behavior faced criminal charges for conspiracy, insider trading, fraud, and obstruction of justice.

The Main Causes of the Enron Scandal 

1. Enron utilized special purpose vehicles (entities) to conceal its debts from creditors and investors
2. Mark-to-Market accounting played a substantial part in the downfall of Enron. Enron reported projected earnings from transactions to show imaginary profits to the public.
3. Imprecise financial reporting practices- Enron’s transactions didn’t follow the GAAP standards and accounting standards.
4. The pre-eminent collapse of Enron is a result of poor corporate governance. The executive management was very greedy and selfish. The executive managers are hired to maximize the shareholders' wealth and other stakeholders, but Enron’s executive plus management external auditor (Andersen) wanted to satisfy their interests. 

Lesson Learnt from Enron Scandal

• The danger of hiding material information in financial statements and using an accounting system that hides losses to deceive investors and creditors. 
• The importance of safeguarding shareholder value. The executive directors should act in the best interest of shareholders to maximize shareholders' wealth. Enron used a complex business model, hence making it easier for the executive director to carry out a conspiracy without being noticed. This put their shareholder in a position they can’t explain the company’s strategies. Is it because Enron was a renowned giant on Wall Street thus making the stockholders reluctant to obtain insight into the new company’s strategies? The fact remains that shareholders should understand their investment and also any new strategy created by the company. 
• Compliance with financial standards is essential – the U.S. created Sarbanes-Oxley Act (SOX Act) to rebuild the public trust, corporate governance, and financial statement compliance practices in companies as a result of the Enron Scandal.

Why Enron Scandal Relevant in today’s Business World

There is a lot to be learned from the Enron Scandal that applies to the modern corporate world. The seismic waves caused by the Enron scandal that swept through capital markets were epicenter, shuddering investors’ confidence completely and modifying the regulatory and corporate environment prospect. The fall of the giant company in the U.S. was a wake-up call to all investors and other stakeholders. 

• The scandal leads to stringent new regulations in financial systems and compliance measures in accounting standards that companies should observe when preparing financial statements i.e. GAAP and IFRS. This includes disclosure and transparency of financial statements after an audit. Any audit firm that colludes with management should be revoked from operating instanter.
• The company board of directors should have some independent/non-executive directors who will monitor the activities of the company. The independent director doesn’t have any material relationship with the company. The main interest is the unique and best interest of the company and not self-interest. 
• Review of the board is crucial- Evaluation of the board as a group as well as individuals in the company is very important. Investigation of what directors are doing in the company will help to solve the problem sooner and save the company.
• Another important item is the implementation of a code of corporate governance with checks and balances. The company image is illuminated through good corporate governance. A company that has good governance is perceived as an ethical company and attracts existing and prospective investors.
• Value of Audit trail-if there was transparency in the reporting financial statement of Enron Corporation, the shareholders and creditors would have realized the fraud committed by the executive management earlier before landing the company in financial distress. An audit trail ensures accountability and strong internal controls in a company. Fraudulent activities through tracking all the transactions and detecting the unprofessional act committed.
• Healthy corporate culture- the company should think about employee welfare, i.e. job security. Enron focused on achieving financial goals and their interest and create unrealistic goals for the employees that led to the firing of many employees and rendering them jobless. The same employees worked so hard to put Enron in the limelight for its excellent performance. The company should ensure they take part in corporate social responsibility. Stakeholders play a critical role in contributing to the performance of the company.

By learning from the past blunders made by Enron Corporation, there is still room for improvement in the business world in the future.

These are Mr. Jellison words ‘no one is too big to fail’ 

‘The smartest Guy in the Room’ is a clear imaginary film about the downfall of Enron