Comparative corporate governance The Enron Debacle
Corporate Governance In A
Sudeshna Akanksha Panda
LL.M. IIYear III Semester
KIIT Law School
History of Enron
Does corporate ethics matter
Chronology of the fall
How and why did Enron happen
Who was responsible:
Regulators call for changes in accounting and auditing
What are the repercussions
Bush administration outlines reform plan
The Sarbanes-Oxley Act, 2002
How has Enron effected corporate governance practices
How do board members position themselves moving
Formed in July,1985.
The merger of Houston Natural Gas with
Omaha based Inter North resulted in the
formation of Enron.
The company initially dealt with producing
natural gas and pipeline operations for the
With deregulation of markets it branched
out into brokering, trading electricity and
other energy commodities.
It was one of the first energy companies to
start trading online.
Kenneth Lay was the first Chairman and the
Does corporate ethics Matter:
Enron’s corporate ethics best exemplified values of
risk taking, aggressive growth and entrepreneurial
But these values were not balanced by genuine
attention to corporate integrity and the creation of
customer - and not just shareholder - value. Because
the Enron corporate ethics was not well grounded,
A single scorecard - maximized price per share of
common stock - became its reason for being, and
even its positive values became liabilities.
Corporate officers at Enron seem at best to have
been neglectful of their responsibilities for oversight,
or, at worst, outright criminal and abusive in their
levels of greed and deception. It takes a special
person to blow the whistle in such an environment.
All of this was preventable, long ago, but Enron
failed to create a sustainably successful
that included values such as customer service,
maximizing customer loyalty and satisfaction, which
would have balanced the company’s overemphasis on
pure, short-term stock price.
But even more important, Enron’s corporate ethics
had evolved so that it only paid cosmetic attention to
that is and was the responsibility of the Board of
Directors and the executive officers of the company.
A well tended garden is never choked by
CHRONOLOGY OF THE FALL:
20th Feb,2001- A fortune story calls Enron a highly impenetrable co. that is
pilling up on debt.
On 14 Aug, 2001- Jeff Skilling resigned as chief executive, citing personal
reasons. Kenneth Lay became chief executive once again.
12 Oct, 2001- Arthur Anderson legal counsel instructs workers who audit
Enron’s books to destroy all but the most basic documents.
16 Oct, 2001- Enron reports a third quarter loss of $618 million.
24 Oct 2001- CFO Andrew Fastow who ran some of the controversial
SPE’s(Special Purpose Entity) is replaced.
8 Nov 2001- The company took the highly unusual move of restating its
profits for the past four years. It admitted accounting errors, inflating
income by $586 million since 1997. It effectively admitted that it had
inflated its profits by concealing debts in the complicated partnership
2Dec 2001- Enron filed for Chapter 11 bankruptcy protection and on the
same day hit Dynegy Corp. with a $10 billion breach-of-contract lawsuit.
12 Dec 2001- Anderson CEO Jo Berardino testifies that his firm
discovered possible illegal acts committed by Enron.
9 Jan 2002- U.S. Justice Department launches criminal investigation. Hence
within three months Enron had gone from being a company claiming assets
worth almost £62bn to bankruptcy. Its share price collapsed from about
$95 to below $1.
How and Why did Enron Happen?
• Twenty years of U.S. restructuring/reorganization limited
the viability of cost-based strategies.
• Need to “compete” with, and seek same inflated
valuations, as high-flying Internet & tech companies.
• Low interest rates throughout late 1990’s helped to
perpetuate an already overheating economy.
• Insufficient income/revenue growth created need for
ever more aggressive accounting/business practices.
• Creative Accounting: (SEP’s) Creation of partnerships
with shell companies, run by executives of Enron.
• High profits were made and it was easy to keep the
debts of the books.
• Board and Wall Street asleep at the wheel.
Kenneth Lay – former CEO and Chairman of Enron.
Andrew Fastow – former CFO of Enron. Fastow was indicted on 78
counts of securities fraud, money laundering, wire and mail fraud, as
well as conspiracy to inflate Enron’s profit.
Michael Kopper – former director in the global finance unit. Kopper
pleaded guilty to financial wrongdoing in August 2002.
Jeffrey Skilling – former CEO of Enron.
J. Clifford Baxter – formerVice Chairman of Enron.Accused of
securities fraud, Baxter died in an apparent suicide in January 2002.
Arthur Anderson – the accounting firm that was responsible for
auditing Enron.Arthur Anderson was found guilty of obstruction of
justice for shredding documents related to the Enron scandal.
Role of Andersen: Arthur Andersen – one of the world's five leading
accounting firms - was the auditor to Enron. When the scandal broke.
Andersen’s chief auditor for Enron, David Duncan, ordered the
shredding of thousands of documents that might prove compromising.
Andersen has dismissed Duncan and Andersen’s chief executive at the
time of the Enron collapse, Jo Berardino, resigned at the end of
March 2002 Besides obstruction of justice,Andersen also faces
charges that it improperly approved of Enron's off-balance-sheet
partnerships, called "special purpose entities", which the company
used illicitly to hide losses from investors.
Responsibility of the Board:
A fundamental role in the achievement of good corporate governance is
attributed to actors in the board of directors and independent external
Key functions of the board of directors, which were particularly
relevant in the case of Enron, include:
selection and remuneration of executives,
being alert to potential conflicts of interest adversely
affecting the firm, and ensuring the integrity of the company’s systems of
accounting and financial reporting.
Prerequisites for satisfactory performance.
Include access to accurate and timely information.
The role of the board in the area of conflicts of interest:
clearly includes the monitoring needed to avoid self-dealing by management.
The primary finding of a report to a committee of the United States Senate
on the role of the Enron board in its collapse is damning:
The Enron Board of Directors failed to safeguard:
numerous indications of questionable practices by Enron management over
chose to ignore them to the detriment of Enron shareholders, employees and
In 2001 this consisted of 15 members, many of
them with 15 or more years of experience on
the Board of Enron and its predecessor
companies, and many of them also members of
the boards of other companies.
Of the five committees of the Enron board the
key Audit and Compliance Committee (the
primary liaison body with the external auditors)
had six members, of whom two had formal
accounting training and professional experience
and only one limited familiarity with complex
The Compensation Committee had five
members, three with at least 15 years of
experience with Enron.
Auditing Firm’s Responsibility:
Regarding auditing good corporate governance requires high-
quality standards for preparation and disclosure, and independence
for the external auditor.
Enron’s external auditor was Arthur Andersen, which also provided
the firm with extensive internal auditing and consulting services.
In the period leading up to Enron’s insolvency is indicated by the
fact that in 2000 consultancy fees(at $27 million) accounted for
more than 50% of the approximately $52 million earned by
Andersen for work on Enron.
The history of relations between Enron and Arthur Andersen
suggests that they were frequently characterized by tensions due
to the latter’s misgivings concerning several features of Enron’s
Both the Powers Committee and bodies of the United States
Senate which have investigated Enron’s collapse have taken the
view that lack of independence linked to its multiple consultancy
roles was a crucial factor in Andersen’s failure to fulfill its
obligations as Enron’s external auditor.
Andersen did not fulfill its professional
responsibilities in connection with its audits
of Enron’s financial statements.
Or its obligation to bring to the attention of
Enron’s Board (or the Audit and Compliance
Committee) concerns about Enron’s internal
contracts over the related party transactions.
Who Was Responsible (beyond
• Andersen signed off on Enron's books and helped structure its
– They accepted consultancy fees, while acting as an "external auditor”. Most
of the so-called Big Five accounting firm have similar conflicts.
• Enron's board received detailed briefings as early as four years ago
the partnerships whose losses triggered company's bankruptcy.
– Minutes, covering 4 board meetings and 3 meetings of the board's finance
committee, suggest board members approved aggressive accounting actions,
including moving debt off company books.
• Enron’s law firm,Vinson & Elkins, investigated alleged
– They asked few real questions, failed to talk to key witnesses and blessed
Enron's controversial partnerships.V&E issued their report one day before
Enron restated its financials because of those partnerships
• While certainly extreme and clearly over the line, it
appears unlikely the Enron cover-up began as a
widespread conspiracy to commit fraud.
• Rather it seems mostly a case of a business strategy not
delivering expected results (quickly enough) and a short
term solution getting totally out of hand.
• A widening circle of basically good people appear to have
gotten swept up in the pressure to behave in a manner
mandated by the “frenzy of greed” that characterized U.S.
business practices at the time.
Was Enron Unique?
• Paul Krugman notes “(U.S.) corporate profits grew
rapidly between 1992 and 1997, but then stalled; after-tax
profits in the third quarter of 2000 were barely higher
than they were three years earlier."
• However,“the operating profits of the S&P 500-- ...
(large) companies reporting to investors -- grew 46% --
over those three years”.
• Paul Krugman believes the main reason was that “…
companies made increasingly aggressive use of accounting
gimmicks to create the illusion of profit growth.”
• “Corporate leaders were desperate to keep their stock
prices rising, ... anything short of 20% profit growth was
considered a failure.”
• “Why were they desperate? In a word: options.”
Source: Paul Krugman, NewYorkTimes, Pg.A21, May 21, 2002
Regulators Call for Changes in
Accounting and Auditing Standards
• In an SEC Public Statement on Accounting, Chairman Harvey L. Pitt stated:
– Today, disclosures are made not to inform, but to avoid liability.
– Financial disclosures are dense, impenetrable. We have called for plain
English financial statements.
– Corporate governance.. and role of Audit Comm. are.. in need of review.
– We need more prompt action by the FASB, the nation's accounting standard
– There is a need for reform of the regulation of our accounting profession. We
cannot afford a system ... that facilitates failure rather than success.
– Accounting firms have important public responsibilities...The Commission
cannot, and... will not, tolerate this pattern of growing restatements, audit
failures, corporate failures and investor losses. Somehow, we must put a stop
to a vicious cycle that has been in evidence for far too many years
What are the Repercussions?
• Desire to Assign Blame for WhatTranspired
• Decreasing Investor Confidence
• Retreat to Simplicity & Easy-to-Understand Models
• Increased Call for CorporateTransparency
• Review of Bank/Analyst Audit/Consult Relationships
• Return to Fiscal Conservatism and Practices
• Call for Increased Regulation and Scrutiny
• Political Fallout and Maneuvering on all Levels
How Has Enron Effected Corporate
• Need for disclosure has increased dramatically.
• Investment banks reevaluate basic business model.
• Accountants need to walk a much finer line.
• Boards under more pressure than ever before
– Audit function in particular under intense scrutiny.
• Changes in options and compensation treatment.
• Active regulators and law enforcement.
• Many proposed changes under discussion.
Bush Administration Outlines
• President Bush outlined plan to hold executives more accountable through
independent audit system and better access to financial information.
• CEO’s required to attest to the accuracy of financial disclosures.
– To punish accounting abuse, top executives would be forced to forfeit
other compensation. In extreme cases, they could be barred from serving as
directors for other public corporations.
• Accounting firms would be subject to unprecedented oversight.
• The president would require top executives to disclose when they buy or sell
company stock within two days. Currently, executives can wait a year or more
without disclosing personal transactions.
• But Bush balks at a proposal by Paul O'Neill to prohibit executives from using
insurance coverage to pay legal costs arising from misconduct.
• Plan stops short of blocking auditors from consulting work for audit clients.
• White House officials said most of Bush's proposals could be carried out by
the SEC within its existing authority.
The Sarbanes-Oxley Act, 2002:
Provisions of the Act affecting directors and senior
executives include a requirement for certification of
reports filed with the SEC, prohibition of insider
lending to a firm’s executives.
Directors, penalties for accounting restatements
Bans on trading by executives and directors in the
firm’s stock during certain blackout periods for
A requirement for independence for members of
The requirement that the SEC review a firm’s
periodic financial reports at least once every three
The obligation on directors, officers and others
owning 10 per cent or more of the firm’s securities to
report changes in their ownership within a specified,
New requirements for disclosure concerning subjects
such as off-balance-sheet transactions, internal
The existence or absence of a code of ethics for a
firm’s senior financial officers.
Timely disclosure of material changes in firms financial
condition (so-called real time disclosure).
Auditor independence is to be strengthened by
limiting the scope of non-audit and consulting services
for audit clients, and by requiring that a firm’s audit
committee pre-approve non-audit services provided
by the firm’s auditor.
The Act also establishes a Public Company Accounting Oversight
Board (PCAOB) with wide ranging authority to ensure
compliance.The PCAOB will be responsible for setting standards
for auditing, this role constituting a radical strengthening of public
control over auditors and accountants.
Other provisions of Sarbanes-Oxley include:
rules to strengthen the independence of research analysts,
lengthening the statute of limitations for litigation involving the
violation of certain securities,
laws, the establishment of new securities-related offences
increases in certain criminal penalties,
and new protections for employee “whistleblowers”
include insider loans (since many legal regimes permit loans to
executives and directors),
the rules to be followed by audit committees,
the code of ethics for senior financial officers, and the oversight of
some more detailed rules for auditors.
Steps Taken ByVarious Corporate
• El Paso: Took off balance-sheet partnerships and put
them on balance sheet to improve transparency.
• IBM: Expanding information on intellectual-property
income and impact on of company's pension plan.
•Tyco: Weekly conference calls on accounting issues.
• World com & Quest: More disclosure and Q&A
• GE: Providing detail on how company's individual
including GE Capital--churn out their earnings.
Business Ethics Magazine Outlines Four
• Ensure auditors really audit by making them fully independent.
• Bar law-breaking companies from government contracts.
• Create a broad duty of loyalty in law to the public good.
–Today a corporate duty of loyalty is due only to shareholders, not to ...
stakeholders, and Enron behaved accordingly... Such piracy against the public
good would be outlawed under a state Code for Corporate Citizenship,
proposed by Robert Hinkley, formerly a partner with Skadden,Arps. His
change to the law of directors’ duties would leave the current duty to
shareholders in place, but amend it to say shareholder gain may not be
pursued at the expense of the community, the employees, or the
• Find truly knowledgeable directors: Employees.
– If SherronWatkins had been on the Enron board, the whole scandal might
have been averted.
How Do Board Members Position
Themselves Moving Forward:
. • Financial literacy and an “inquiring mind” is more important than ever --
particularly on the Audit Committee.
• Board Membership requires more responsibility than ever before and
should not be seen as a retirement hobby.
• Directors need to be actively involved in understanding a companies
business -- its operation, finances & management.
• Directors cannot simply rely upon the word of management, auditors,
and outside professionals
• Directors must be independent and able to represent the interests of
shareholders as they relate to other stakeholders.
• Directors must seek to balance short term performance pressures with
the need to sustain and expand value over the long term.
“Sustainability and not Profits Alone
Key to Good Corporate
• World Council for Corporate Governance (WCFCG) recently
organized the 2nd Intl. Conference on Corporate Governance in
Mumbai which was attended by 416 business leaders and policy
makers from 20 countries.
• The Conference felt that most corporate collapses are the
outcome of a short sighted focus on immediate returns for the few
rather than sustainable growth of the corporation. Sustainability
has to be the ultimate end game of the business.
• WCFCG is, therefore, launching a worldwide movement to
change the corporate ethics from short termism to sustainability
through good corporate governance practices.
As Enhanced Corporate Governance Assumes
an Increasingly Prominent and Important Role:
“In an age where capital flows worldwide … as quickly as information, a
company that does not promote a culture of strong independent oversight
risks its very stability and future health.” Kumar Mangalam Comm. on Corp.
Gov., (India) 10/99
• “Continued emphasis will be placed on corporate reform. Without
restructuring the corporate giants … economic reforms cannot be
completed. The times have changed.” President Kim Dae-Jung (Korea)
• “The economic turmoil had, within less than a year, taught corporate
Malaysia that corporate governance or rather the lack thereof, can exact a
heavy toll from the markets.” High Level Finance Committee on Corp.
• “We must brace ourselves for the fact ... in the new environment in which
we must operate, the bar or standard of performance has been raised ... This
we can ascribe partly to the (Asian) crisis, and partly to the forces of
globalization.” Jaime Augusto Zobel de Ayala, President Ayala Corporation
Source: Building Stronger Boards and Companies in Asia, Asian Corporate Governance Association,
… Not only in the U.S., But all Over the World
Money in the new economy can be made in the same ways
you make money in the old economy - by providing goods or
services that have real value.
Financial cleverness is no substitute for a good corporate
The arrogance of corporate executives who claim they are
the best and the brightest, "the most innovative," and who
present themselves as superstars should be a "red flag" for
investors, directors and the public.
Executives who are paid too much can think they are above
the rules and can be tempted to cut ethical corners to retain
their wealth and perquisites.
Government regulations and rules need to be updated for
the new economy, not relaxed and eliminated.