The Ability of Enron Corporation - Assignment Example

The Case Study of Enron Company By Student Name Course Code + name University Name City, name Date Abstract The report makes an in-depth analysis in the case of Enron Company that was a natural gas producer and trader prior to its collapse in 2000. For a clear understanding of the case, the researcher response to several essential questions related to the Company. To address the questions, the researcher uses a variety of references such as journals, websites, and books. The analysis reveals some lessons regarding the role of accounting professionals. In particular, the case study brings out the significance of ethical practices. Finally, the report gives a recommendation based on the lessons learned. In the case of auditors, the report recommends the establishment of an independent oversight body to regulate the performance of audit firms. Introduction Enron Corporation is a gas transmitting Company founded in 1985, under the chairmanship of Kenneth Lay. The Company came into existence when two major natural gas transporting Companies decided to merge. The two Companies included the Houston and Internorth Pipeline Companies (Thomas, 2002). After its formation, Enron became the largest transmitter of natural gas in North America. The firm had very well established markets network for natural gas. The Company also supplied electricity power in different parts of the United States. Further, the firm embraced innovation and was able come up with different trading products. The ability of Enron Corporation to diversify its products so as to meet the market demand played an important role in its rise. Following the firm’s innovative trend, it was recognized as the most innovative Company by the Fortune Magazine. The breakthrough of Enron Corporation began in 1984 when the Energy Regulatory body revised the restrictions on natural gas prices. The relaxation of pricing restrictions meant that Companies could purchase gas from anywhere. Initially, Companies in the gas business were not allowed to purchase gas from anywhere or anyone. The energy regulatory body had set very strict regulations regarding gas products (Thomas, 2002). Enron Corporation under the leadership of Ken Lay took advantage of this opportunity to sign out of some unnecessary expensive deals. Following the relaxation of pricing restrictions, Enron Company devised new strategies on how to market its gas products to its consumers. The firm knew that the only way to remain competitive in the market was through innovation. The firm focused its energy on how to reach a wider market. To achieve the goal of communicating to its target consumers about its natural gas products, the firm came up with Gas Bank strategy (Markham, 2015). The Gas Bank strategy created a link between the sellers and buyers of Natural gas. The approach was a success and saw Enron Company establish a platform with the consumers. The consumer base of the firm increased tremendously, owing to the introduction of the Gas Bank strategy. By 1991, the Company started viewing itself more as a trader of natural gas and less as a producer. The firm further broadened its operations to production and trading of other products such as electric power, water, paper, coal and fiber optics. Following the firm’s increased engagement in trading, some of its accounting policies changed. The Company introduced the use of mark-to-market policy of accounting. The policy involved realization of the expected returns upon signing of a contract. Also, the policy required all expenses to be recognized upon signing of a contract. Further, any unrealized gains/losses were to be recognized by occurring and not before (Markham, 2015). When Enron’s performance in the market started deteriorating, it manipulated accounting policies to remain relevant in the market. The firm did not want its stakeholders to realize that it was losing money and. Therefore, it used accounting practices to appear profitable. The following case study analyzes the status of Enron’s corporation before and after its fall. Responses to the Case Questions 1. While describing the context of Enron, illustrate why Enron was an admired company prior to 2000? Prior to 2000, Enron Corporation remained admirable in the eyes of the public. The tremendous growth and expansion of the firm was impressive. It took the Company less than a decade since its inception to become the largest producer and trader of natural gas. Despite the presence of other competitive businesses in the gas industry, Enron Company managed to remain relevant in the market (Anginer, 2010). The Company succeeded in increasing its customer base, through the implementation of appropriate consumer-based strategies. Through the strategies, the firm was able to inform consumers about its products, thus creating consumer loyalty. The Company also managed to remain admirable due to the effectiveness of its management. The management of the firm led by Ken Lay was able to take advantage of every opportunity in the market. The proactive nature of its management played a significant in the success of the firm. The ability of the Company to provide a variety of products in the market also made it admirable. The firm’s ability to offer diversified products saw it win the Fortune award for being the most innovative Company. It is interesting how the firm was able to provide so many products at the same time. The impressive performance of Enron further boosted its relevance in the market. The Company registered a remarkable rise in its stock prices from 56% in 1999 to 87% in 2000. The firm's image improved greatly following the rise in the stock prices,(Anginer, 2010). Existing and potential investors started viewing the firm in a different way. The Company’s financial performance was promising, and expectations were that the Company would continue performing even better in the future. 2. What led to the fall of Enron? Your discussion should revolve around the role of accounting professionals. The Company’s adoption of a complex business strategy contributed to its fall. The complex model involved dealing with a variety of products that included both physical and financial assets. For the complex business strategy to work, the Company was forced to manipulate various accounting practices, most of which were against the complex approach (Healy, 2003). The Company disregarded the use of accounting standards in the preparation of its financial statements. Different accounting professionals also failed in their role of ensuring that the firm’s strictly adhered to the set accounting standards. In particular, the external auditor, Arthur Andersen failed to report the fraudulent and unethical act of the Company. The external auditor knew that the Company was manipulating the accounting standards but still decided to keep quiet (Healy, 2003). For instance, when the firm adopted the use of mark-to-market accounting policy, the external auditor knew the practice was not appropriate but did not disclose this irregularity. As a result, the firm used the policy to overstate its revenues and to understate its liabilities. The Company’s management failure to detect the anomalies in the financial statements also contributed to its fall. In particular, the fund managers could not realize the accounting problems facing the firm. The fund managers depended on the accounting information given to decisions. However, they did notice that accounting information given was not correct. It, therefore, means that the fund’s managers made financial decisions based on wrong information. The fall of Enron Company is also attributed to Sell-Side Analysts’ failure to give a prior warning of the crisis (Healy, 2003). The assumption is that most of the analyst failed to report the incoming problem due their self-gain. The analysts’ financial interests prevented them from warning the Company about the possible crisis. The accounting professionals did not do much to save the Company if anything they contributed towards its fall. 3. Why were Enron’s internal and external checks and balances system fail to prevent its demise? Your discussion should revolve around the role of auditors and the accounting regulations The Company’s internal and external checks and balances system could not prevent it from collapsing since the systems were completely wrong. The available accounting regulations were limited and could not cope with the complex business model adopted by Enron. Further, the regulations were inflexible and. Therefore, it was difficult to adjust them to be able to address the demands of the new business system (Healy, 2003). The Company managed to come up with transactions that reflected its compliance with the accounting standards. However, the financial report did not reflect the actual financial risk undertaken by the Company. Further, the efforts by the accounting body (FASB) to make amendments to the existing rules faced opposition from various stakeholders. The existing accounting rules were limited and could not address the demands of the firm’s special purpose entities. There was, therefore, need for amendment of the rules so that they can cope with the complex operations of the Company. The Board, however, did not receive much support from the various concerned groups such as auditors, investors, and managers. There was also a lot of political interference in the process of amending the rules. Some of the board members did not show much interest in amending the rules and, this slowed down the whole process of the amendment (Healy, 2003). Also, the process of amending the rules requires approval by at least five out of the seven members of the board. It is, therefore, evident that the regulating body did not do much to prevent Enron Company from falling. The external auditors charged with the responsibility of scrutinizing the financial books of Enron and reporting any inconsistencies therein failed in their duty. The auditors were supposed to be independent and apply transparency in their reporting. However, in the case of Enron, the external auditors completely failed to report irregularities in the use of accounting standards. The auditors knew that the Company was manipulating the accounting rules to its favor but kept quiet (Healy, 2003). For instance, when Enron adopted the mark-to-market accounting practice, Andersen the auditor knew that it was wrong but did not say anything. The external auditors, therefore, failed to prevent the firm from collapsing, despite knowing the unethical conduct of the firm. 4. Describe in general terms the breaches of accounting and ethical conduct that occurred within Enron. The law requires Companies to conduct themselves in an ethical manner and to uphold integrity. Businesses are also expected to adhere to set standards of accounting in preparation and reporting of their financial statements (Demski, 2003). However, Enron Company failed to conduct itself ethically. In particular, the management of Enron violated the required code of conduct by giving misleading information to the public. Transparency is an important ethical aspect for any given firm. However, Enron Company lacked transparency and withheld important information from its stakeholders. For example, the management knew that the Company was losing money but did not disclose this vital information in the financial reports. Instead, it portrayed a picture that the it was still making profits. Financial information is very significant especially to investors since they use the information to make investment decisions. Therefore, when Enron gave wrong financial information, it meant that it was misleading its investors into making risky financial decisions. The Company also violated the accounting standards by adopting a complex business model that limited the applicability of accounting standards. The report reveals that the Company was overstating its revenues and understating its liabilities. Overstating profits meant that the firm would continue appearing like it’s doing well, and this would boost the confidence of its investors (Demski, 2003). Accounting standards require businesses to disclose their actual profits/losses during the reporting period. However, Enron Company did not disclose the correct financial information; instead it made the public think that it was making profits whereas it was not. Other accounting professionals who were working for the firm also failed to behave ethically. For example, the external auditor failed to disclose the illegalities that were taking place within the organization. Despite, the Sell-Side analysts being aware of the pending crisis, they failed to give warning. 5. How did the top leadership/ Board of Directors at Enron undermine the foundational values of the Enron Code of Ethics? Enron Company just like any other organization had set several foundational values that were to guide its operations. Among its core ethical values included communication, integrity, excellence, and respect. However, the leadership of Enron did not live up to its commitment to abide by the set code of ethics. As the Company grew, its leadership forgot about the aspect of communication (Petrick, 2003). Communication of information to the relevant stakeholders was very important for the continuous success of the business. However, the firm’s leadership ignored their ethical responsibility of communicating to its stakeholders. For instance, the firm withheld important financial information from its investors, and instead gave them wrong information. Failure to disclose important information to its stakeholders also implied the lack of respect for the stakeholders. A company originally founded on respect towards all its stockholders was acting against its foundational value of respect. The firm was also founded on the aspect of excellence, but the Company overstepped its mandate in fulfilling this essential foundational value. The management of the firm was willing to go to whichever extent to ensure its success. Though the Company excelled in its ventures, it violated its core values such as integrity. The success of the firm resulted from its engagement in corrupt contracts, and this was against its integrity values. The organization that had initially committed itself to being truthful and transparent was now anything but transparent (Petrick, 2003). The report reveals how the Company’s leadership communicated misleading financial information to the public. For instance, the financial statements of the firm did not reflect its actual financial status. The financial reports showed overstated profits. The reports also reflected an understated value of the debt. 6. How did Enron’s corporate culture promote unethical decisions and actions? Enron Company has received criticisms over its arrogance nature of its corporate culture. There were growing concerns about the risky financial decisions taken by the firm. The Company’s culture was that it could explore any line of business no matter how risky it was. The concerns of the firm were only its profits and nothing else (Sims, 2003). As a result of this arrogant corporate culture, the Company ventured into various trading activities and ended up risking the investors’ funds. For the Company to sustain its daring corporate culture, it had to disregard some of its essential ethical values such as integrity and respect. The arrogant corporate culture of the firm contributed significantly towards the Company making wrong decisions. Further, the corporate culture undermined the core ethical values of the business in various ways. The firm’s decision to decentralize the operations of its units ensured that only a handful of people knew about the operations of the business (Sims, 2003). Further, the Company implemented financial controls that were insufficient. The Company’s board of directors was compliant with the unethical operations of the firm. The firm also ensured that it employed incompetent accounting professionals such as accountants and auditors so that it can manipulate them. The corporate culture also contributed to the Company taking unethical approach regarding appraising its employees. The firm adopted the peer-evaluation method where employees were to examine the performance of each other and to give recommendations. The approach resulted in firing of the lowest ranking employee. The compensation program also encouraged the executives to take unethical actions (Sims, 2003). The managers were to be rewarded based on their performance. The compensation based on performance resulted in managers inflating the profits to appear as if they were performing well. The managers, therefore, manipulated the accounting standards while preparing financial reports so as to reflect high profits. 7. Using the information provided in the case readings, describe the FOUR lessons you have learned as an accounting professional from Enron case. Following the case of Enron Company, we can draw several lessons that will help us better improve our accounting profession. First, regarding auditors, it is very important to have an independent oversight body with a mandate of overseeing the operations of the various audit firms (Vinten, 2002). An oversight body would ensure that auditors do not give in to the management pressure of ignoring essential disclosures. The case of Enron shows a lack of oversight over auditor’s performance. The second lesson is that accounting professionals need incentives to perform better as opposed to threats. Instead of engaging in fraudulent activities, the accounting professionals should negotiate with their employers for better remunerations. The third lesson is that accounting professionals should put the interests of the Company first before their interests. The case of Enron reveals a scenario where various professionals seek only to satisfy their interest. For example, the external auditor failed to disclose the illegalities taking place in the firm for his interest. The Sell-Side analysts also failed to give warning to the Company about a potential financial crisis. The Company’s leadership also took unethical actions to satisfy their financial interests. Finally, there is the need for accounting professionals to uphold a high code of conduct. The case of Enron shows a situation where professionals completely failed to comply with the required ethical standards. Every profession is guided by certain ethical rules (Vinten, 2002). The professionals should ensure that they comply with their respective ethical standard. 8. Using the lessons learned from the Enron case; describe the effects of unethical business practices on society & community. Unethical business practices have devastating effects on the society at large. In the case of Enron, the Company misled the society by giving wrong financial information. The firm portrayed itself as profitable and thus won the trust of the people. The society ended up making investment decisions based on the firm’s financial information. As it later turned out, the was manipulating its transactions to reflect positive returns. The investors and the society lost a lot of money when the Company collapsed. The loss to the society resulted from unethical decisions and actions taken by Enron Company (Vinten, 2002). Conclusion The above analysis reveals the case of Enron, a Company that started so well. Within less than a decade, Enron Company had become the largest supplier of natural gas. The firm, however, collapsed due to the arrogant nature of the firm’s corporate culture, it ended up collapsing. The report also reveals the unethical behavior of the Company. In particular, the Company gave misleading financial information to its stakeholders. The case of Enron depicts a team of professionals who have no regard for ethical rules, provided that they satisfy their self-interest. Following the Enron’s case, it’s important for regulating bodies to conduct amendments to the existing accounting standards. Bibliography Vinten, G., 2002,“The corporate governance lessons of Enron,” Corporate Governance: The international journal of business in society, 2(4), 4-9. Thomas, C. W., 2002, “The rise and fall of Enron,” JOURNAL OF ACCOUNTANCY-NEW YORK-, 193(4), 41-52. Markham, J. W., 2015, “A financial history of modern US corporate scandals: From Enron to reform,”Routledge. Sims, R. R., andBrinkmann, J., 2003, “Enron ethics (or: culture matters more than codes),” Journal of Business ethics, 45(3), 243-256. Petrick, J. A., and Scherer, R. F., 2003, “The Enron scandal and the neglect of management integrity capacity,”American Journal of Business, 18(1), 37-50. Healy, P. M., and Palepu, K. G., 2003, “The fall of Enron,” Journal of Economic Perspectives, 3-26. Demski, J. S., 2003, “Corporate conflicts of interest,” Journal of Economic Perspectives, 51-72. Anginer, D., and Statman, M., 2010, “Stocks of admired and spurned companies,” The Journal of Portfolio Management, 36(3), 71-77. Read More