ENRON’S SCANDAL 1
Contents
1.INTRODUCTION
2.THE ENRON’S SCANDAL
3.IMPACT ON STAKEHOLDERS
4.OUTCOME OF THE SITUATION
5.HOW FAIR WAS THE PUNISHMENT?
6.THE ROLE ETHICS WOULD HAVE PLAYED
7.CONCLUSION
8.REFERENCES
1.INTRODUCTION
According to Li (2010), Enron was formed in 1985 from merger of two companies; Houston Gas and InterNorth Inc. by Kenneth Lay.It grew to be among the highly innovative companies throughout 1990s. Its unique business strategy made it known. Initially, the company’sobjective was to sell electricity and gas but by 1990s it had ventured into other businesses such as pulp and paper companies and communications (Li, 2010). Its success was indicated by the rise in annual revenues; between 1995 and 2000 Enron recorded a revenue rise of $91 billion dollars. However in 2001 as Li (2010) notes accounting fraud was revealed in its financial reports. It was established that the company had indeed experienced a loss of more that $500 million dollars (Li, 2010) for the previous five years; contrary to its audit reports.The company fell bankruptlater in 2001. This essay examines the scandal, its effects and critically gives an ethical analysis of the situation.
2.THE ENRON’S SCANDAL
According to Giroux (2008) Enron scandal is the worst to have ever happened in the US business industry. As Li (2010) states Enron’s bankruptcy was a result of accounting fraud which was substantially institutionalized and creatively crafted within the management. As Giroux (2008) put it,the list of scandals within Enron is endless: the executive earned gigantic packages as form of incentives; the management focused on converting all the strategies into success to maintain their heavy compensations-through accounting manipulation;a greed financial officer with underground agreements to enrich himself; a collaborative law and auditing firms in Elkins and Arthur Andersen respectively; corrupt investment bankers- they structured all the financial deals in favor of Enron; deceptive financial analysts who would rate Enron high for attraction of investment, regardless of the reality of the economy; and a strong political system behind the company.
The introduction of US deregulation policy in gas exposed gas producers to trade risks and banks became reluctant to provide loans for gas production. In 1989, Enron formed the Bank of Gas in order to, as Giroux (2008) argue, stabilize the gas market. In this strategy, Enron would contract gas producers to supply gas at specified future prices, then they would loan them money which was paid through gas; rather than cash. Meanwhile, Enron would contract to supply gas to traders at a future set price. The result was a relative stability; Enron as the only profiting. Enron made huge gains in this strategy.
Mark-to-market technique of accounting introduced by Skilling (Giroux, 2008) revealed Enron successful in escaping losses which were associated with volatile prices of gas and inaccurate predictions. In this way, Enron valued long-term trading contracts at market value instead of the traditional historical cost. Mark-to-market is an accountingtechnique applied where developed markets for financial instruments exist and where there are obvious closing prices (Giroux, 2008).Essentially the profit is determined from the actual contracts. While it is clear that the market for gas was not obvious, Giroux (2008) notes that Enron went on to use it;Enron recorded big gains before even any gas sales were made.
Enron also used SPEs and structured financing to conceal their debts off the book and camouflage their existing debts. The officers manipulated the financial analysts to rate the company as ‘the strong buy’. With the SPEs and structured financing, Enron was successful to hide losses even when it ventured into other markets which were in reality recording losses. This attracted huge public investment.
Enron influential capability in the political classearned it loans of billion of dollars and other benefits for several international projects from the Federal government. In fact as Giroux (2008) notes,Lay, CEO, financed some powerful politicians and was involved in some key government appointments especially in the energy sector.
As a result of these fraudulent strategies the company was able to record high annual revenue rise until 2000 (when it recorded $100 billion dollars). However, in 2001 Enron reported big losses. This attracted scrutiny from SEC and rating agencies for bonds. The valuation by these bodies discovered problems with the corporation. Meanwhile due to publicity in the scandals of Enron, banks became unwilling to offer loans to Enron. As a result the company declared bankruptcy by the end of 2001.
3.IMPACT ON STAKEHOLDERS
According to Li (2010) the stock price of Enron dropped in mid- 2000 from $90 to less than $1 at the end of 2001 per share. The shareholders lost nearly $74 (US billion dollars) of which more than $30 billion US dollars was attributed to financial fraud. On its closure, Enron fired 4500 employees without compensation of their dues (Giroux, 2008). Some major shareholders suffered financial losses such as Janus Fund who held 11 millionEnron shares by the month of October 2001. As Shelley, Janus spokesman, notes (cited in Strauss, 2006) most of these shares were sold on loss. This subsequently resulted into loss of 26.1% and Janus trailed by 14% or so points in S&P 500. Other shareholders who experienced huge losses include JAGIX who owned about 3.2 million Enron shares,JAMRX who owned 3.9 shares and Alliance capital who by mid- 2001 owned over $40 million shares (Strauss, 2006).
Patrick and Scherer (2003) stated that Enron’s scandal had moral impact on both the primary and secondary stakeholders. Enron’s top managementinvolvement in shareholder deception for short-term financial gains destroyed both their professional and social standing (Patrick & Scherer, 2003). Officials such as Lay and Skilling were indicted in 2004 and sentenced to jail after conviction (Giroux, 2008). Several others including Lea and Kopper still face charges of financial frauds. The government was also harmed. Since Enron was reputed to serve the public, the government had offered a charter which in reality benefited the wealthy elite of the corporationand stakeholders (Patrick & Scherer, 2003).
The scandal also caused harm to secondary stakeholders. Enron made other corporations to lose professional credibility to their clients. By agreeing to involve in questionable practices of accounting, as Toffler & 2003 notes, Arthur Anderson lost the credibility of his consulting firm (Cited in Patrick Scherer, 2003).Vinson and Elkins legal firm was another corporation whose reputation was tarnished by collaborating with Enron incondoning, against the legal mandate, frauds in employees and investors. Generally Enron’s scandal created global fear in American’s corporate investment (Patrick & Scherer, 2003).
4.OUTCOME OF THE SITUATION
The immediate outcome of the Enron’s scandal was the declaration of bankruptcy of the corporation and immense losses on shareholders (Li, 2010 & Patrick & Scherer, 2003). The scandal elicited public discussion on the ethical behavior in the financial management of public corporations. Cox et al (2009) argues that there is a need for emphasize on ethical studies in business training. This, as Cox et al (2009) notes,will increase the awareness of the student in ethical issues intheir future careers. Many studies have been done about the scandal in an attempt to understand extend of ‘financial immorality’ practiced by Lay and his accomplices.Many books have been written about Enron and the scandal: Power failure which attempted to study the cause of collapse of the corporation (Giroux, 2008), Smartest guys and others.
After the scandal was revealed, Justice Department indicted over 30 Enron executives with Fastow charged with 78 cases of defrauding Enron and was jailed for 10 years (Giroux, 2008).This scandal brought a comprehension to the Federal government that a lot was happening in financial management.According to Giroux (2008)there are lots of unethical practices in financial corporation management. These include, as Giroux (2008) notes, corrupt law firms, ruthless and greedy executives, accommodating auditors, easily manipulated financial analysts and political influence. In order to counter reoccurrence of such scandals in the market, Sarbanes Oxley Act was constructed; the Act requires the corporation to hireindependent CPAs as auditors (Scarpati, 2003).
According to Neuman (2005), the Enron scandal changed the public posturing of managers. In his study, Neuman (2005) established that theManagers are now aware that financial fraud can result into adverse impacts on their social standing, financial losses to the stakeholders and even can tarnish the entire capitalist giant image of the United States corporate.Managers, as Neuman (2005) asserts,have embraced theprovisions of the Sarbanes Oxley Act. As a result the demand of CPAs has increased in the recent past with most CPAs unwilling to accept those auditing positions offered by most corporations (Scarpati, 2003).
5.HOW FAIR WAS THE PUNISHMENT?
The punishment to serve in jail for Lay and the Enron’s scandal accomplices is outright fair in my opinion. Lay and other executives breached moral accountability of finance.It is the role of corporation managers to ensure positive outcomes and according to Patrick and Scherer (2003), managers and the top executives should be held accountable for any results of the corporation. As mandated by law the success of the company should be fairly and truthfully achieved(Patrick & Scherer, 2003 & Patrick & Quinn, 2001). Lay and accomplices defrauded investors by giving the wrong information of the financial status of the company. As Giroux (2008) notes,Lay and his financial officer pressurized financial analysts and auditors to give incorrect financial information. This created good public image about the corporation and therefore attracted many investors (Patrick & Quinn, 2000).This finally resulted into losses incurred by these investors in the post-fall of Enron. In my opinion, these executives acted against the moral behavior of any normal society and therefore ought to be closed behind the bars.
The management lacked truthfulness to both its employees (Patrick & Quinn 1997), shareholders and other stakeholders. Untruthfulness is unethical behavior which usually results into damage into the victimized party (Li, 2010 & Patrick & Scherer, 1999, 2000). Enron’s executivesuntruthfully involved other corporations such as Andersen audit firm into malpractices; this damaged the professional image of these corporation and lost credibility to their clients.These are legal damages which the executives such as Lay and Fastow ought to compensate their ‘complainants’. The charges by the Justice Department for several years in jail for some of these executive is a means to compensate the injured parties or/and corporations.
The political involvement by the Enron’s executives, in my opinion, is corruption. Corruption results into unfair competition and share of government incentives. I think these officials must have been using government agencies such as Department of energy to cover their ill practices and todupe the public. Corruption is the major breakdown of economies of the world and should be fought to its ultimate root. Therefore Lay’s conviction is fair to serve for the corruption charges to the government offices and officers.
6.THE ROLE ETHICS WOULD HAVE PLAYED
In my own opinion, the lack of truthfulness (Rest et al, 1999) in the management in the actual nature of the company was the major cause of Enron scandal. If the management was truthful, there could be no dubious accounting techniques such as mark- to- market which covered the corporate losses and huge debts. If there could be truthfulness, Enron’s officials would not be involved in the corrupt and fraudulent financial deals which led to collapse of business. If there could be truthfulness, the management would have hired transparent auditors; not the likes of Andersen, law firms and investment banks. If there could be truthfulness the management would have put in place an independent financial body to sensor the behavior of the financial managers against malpractices.
7.CONCLUSION
As Patrick and Scherer (2000 & 2003)concludemanagers can not ignore integrity and morality for stability of the corporation, Enron’s failure was as a result of moral ethics in the management.As Giroux (2008) states that the financial frauds in Enron resulted into its downfall. Therefore business ethics should be a subject of emphasize in both graduate and undergraduate business schools (Cox et al, 2009Patrick & Quinn, 2001). The Sarbanes Oxley Act of (Scarpati, 2003)2002 should therefore be unanimously embraced by the entire corporate world.
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9.REFERENCES
Cox, P., Barry, F.& Edwards, L. (2009). Enron: The Smartest Guys in the Room-Using the Enron Film to Examine Student Attitudes towards Business Ethics. Institute of Behavioral and Applied Management,260-290.
Giroux, G. (2008). What Went Wring? Accounting Fraud and Lessons from the Recen t Scandals. Social Research, 75 (4), 1206-1238
Li, Y. (2010). The Case Analysis of the Scandal of Enron. International Journal of Business Management, 5 (10), 37-41.
Patrick, J.A & Scherer, R. (2003). The Enron Scandal and the Neglect of Management Integrity Capacity. American Journal of Business, 18 (1)
Patrick, J.A, & Quinn, J. (1997). Management ethics: Integrity at work. Thousand Oaks, CA:Sage Publications.
Patrick, J.A. & Quinn, J. (2001). The challenge of leadership accountability for integrity capacity as a strategic asset. Journal of Business Ethics 34(3-4):331-343.
Patrick, J.A. and Quinn, J. (2000). The integrity capacity construct and moral progress in business. Journal of Business Ethics 23(1):3-18.
Patrick, J.A. and Scherer, R. (2000). Global leadership, capacity for judgment integrity, and acculturized organizational knowledge. Performance Improvement Quarterly 13(2):34.
Patrick, J.A., Quinn, J. (1999). Global leadership skills and reputational capital: Intangible resources for sustainable competitive advantage in the 21st century. Academy of Management Executive 13(1): 58.
Rest, D., Narvaez, M.J. Bebeau, and S.J. Thomas. (1999). Postconventional moral thinking: A neo-Kohlbergian approach. Mahwah, NJ: Lawrence Erlbaum Associates.
Scarpati, A. (2003). CPAs as Audit Committee. Business and Industry,
Strauss, L. (2006). The Enron Verdict: Always Diversity. Barron’s,86 (19), 35.