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A Paper on the Causes
of Corporate Failure
A Case Study of Enron
Scandal Case
SUBMITTED BY:
IFEANYI KALU UKA

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INTRODUCTION
COPRRATE GOVERNANCE: According to Report on the Observance of Standard and
Codes The Wo ld Ba k, 200 :2 Co po ate go e a e efe s to the st u tu es
and processes for the direction and control of companies. Corporate governance
concerns the relationships among the management, Board of Directors, controlling
shareholders, minority shareholders and other stakeholders. The European Central
Bank has almost the same perspective in describing the corporate governance
he e it e tio ed that o po ate go e a e is the P o edu es and processes
according to which an organization is directed and controlled. The corporate
governance structure specifies the distribution of rights and responsibilities among
the different participants in the organization; such as the board, managers,
shareholders and other stakeholders, and lays down the rules and procedures for
decision- aki g Eu opea Ce t al Ba k, 200 .
CORPORATE FAILURE: Corporate failure refers to companies’ operations following
its inability to make profit or bring in enough revenue to cover its expenses. This
can occur as a result of poor management skills, inability to compete or even
insufficient marketing. Corporate failure is of very important interest to economic,
financial and corporate managers. Corporate failure could be seen in terms of the
inability of a corporate organization to conform itself with its strategic path of
growth and development to attain its economic and financial objectives as well as
legal obligations. This paper has considered the factors that can cause corporate
failure and its attendant inability to attain these objectives. Corporate
organizations have been advised to establish research and development
departments to continuously monitor their performance and to introduce effective
ways by which they could satisfy their consumers and service their operating
environments to effectively continue as going concerns.

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Causes and Effect of Corporate Governance Failure
Corporate failure could be caused by number of factors, such as;
1) Managerial inefficiency and ineffectiveness
2) Socio-cultural factors.
3) Economic instability.
4) Public policy.
Looking at these factors that leads to corporate governance failure, we will be using
the Enron case as a case study to effectively identify these problems which are
elated to a o ga izatio ’s failu e.
Enron Scandal Case Overview
Enron Corp is a company that reached dramatic heights, only to face a dizzying collapse.
The story ends with the bankruptcy of one of America's largest corporations. Enron's
collapse affected the lives of thousands of employees and shook Wall Street to its core.
At Enron's peak, its shares were worth $90.75, but after the company declared
bankruptcy on December 2, 2001, they plummeted to $0.67 by January 2002. To this day,
many wonder how such a powerful business disintegrated almost overnight and how it
managed to fool the regulators with fake, off-the-books corporations for so long.
History and Scandal of Enron Corporation
Enron was created in 1986 by Ken Lay to capitalize on the opportunity he saw
arising out of the deregulation of the natural gas industry in the USA. What started
as a pipelines company was transformed by the vision of a McKinsey consultant,
Jeff Skilling, who had the idea of applying models used in the financial services
industry to the deregulated gas industry. He persuaded Enron to set up a Gas Bank
through which buyers and sellers of natural gas could transact with each other
using an intermediary (Enron) whose contractual arrangements would provide

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both parties with reliability and predictability regarding pricing and delivery. Enron
duly recruited him to run this business and he rapidly built up a major gas trading
operation through the early nineties. During this time Enron was extending its
pipeline operations into a wider power supply business, initially in the USA and then
on an international scale, completing a large plant at Teesside in the UK and
contracting to build a huge plant near Mumbai in India. In due course it had deals
all-round the globe, from South America to China. The hard driving expansion of
E o ’s po e usi ess o ld ide eated a global reputation for Enron. “killi g’s
vision was to transform Enron into a giant, asset-light operation, trading power
generally and his next target was trading electricity. Lay was lobbying Washington
hard to deregulate electricity supply and in anticipation he and Skilling took Enron
into California, buying a power plant on the west coast. E o ’s atio al eputatio
rested on the rapid expansion of its domestic business and its steadily growing
revenue and earnings from trading. So on the back of his track record, Skilling was
appointed Chief Operating Officer by Ken Lay and he then embarked upon
transforming the whole of Enron to reflect his vision. San Francisco, California. The
US West Coast was an early target for its aggressive and misguided expansion.
Observing the dotcom boom, Skilling decided Enron could create a business based
on a broadband network which could supply and trade bandwidth and he set out
to build this at a great pace. However, the experiment in deregulation in California
did ’t work well and in due course was reversed with recriminations all round.
Moreover, the international business expansion as ’t u de pi ed ade uate
administration and many of the contracts later turned bad. So Enron then took the
decision to build on its international presence by becoming a global leader in the
water industry and bought a big water company in the UK, following it up with a
big deal in Argentina. At this poi t, a ou d 2000, E o ’s eputatio as still idi g

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high and Lay and Skilling were looked up to as visionary thinkers and top business
leaders. However, as we see elsewhere in this case study, the rapid expansion had
u ell ahead of E o ’s a ilit to fu d it, a d to address the problem, it had
secretly created a complex web of off-balance sheet financing vehicles. These,
unwisely, were ulti atel se u ed, a d he e depe de t, o E o ’s apidl rising
share price. Also, its hard driving culture was underpinned by incentive schemes
which promised, and delivered, huge rewards in compensation packages to
outstanding performers. The result was that, to achieve results, aggressive
accounting policies were introduced from an early stage. In particular, the use of
mark to market valuation on contracts produced artificially large earnings,
disguising for some years underlying poor profitability in major parts of the
business. This, of course, meant that Enron was not generating adequate cash flow,
while spending extravagantly on expansion, and eventually it blew up suddenly and
dramatically. Colleagues of this author who met Lay and had dealings with Enron
confirm that there was skepticism in the a ket a out E o ’s p ofita ilit a d its
cash position. “uspi io s g e that E o ’s ea i gs had ee a ipulated and in
late summer 2001 it emerged that its Chief Finance Officer had privately made
hi self i h at E o ’s e pe se through the off-balance sheet vehicles. About this
time the dotcom boom ended suddenly and for Enron, this coincided with the
international power business going radically wrong, the broadband business having
to be shut down, the water business collapsing and the electricity services business
getti g i to se ious t ou le i Califo ia. E o ’s sha e p i e started to slide and
Skilling, appointed Chief Executive Officer in January 2001, resigned in August.
E o ’s share price then rapidly declined, triggering repayment clauses in the
fi a i g ehi les hi h E o ould ’t ha dle. Its credit rating went to junk status,
which caused the share price to collapse and triggered further crystallizing of debt

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obligations. Banks refused further finance, suppliers refused to supply and
customers stopped buying. At the beginning of December 2001, Enron filed for the
biggest bankruptcy the USA had yet seen. This, in turn, took down one of the largest
accounting firms in the world, Arthur Andersen, which was deemed to have so
compromised its professional standards in its dealings with its client Enron that it
as i a a s o pli it i E o ’s criminal behaviour. The second half of this
Enron case study assesses business ethics and the impact on corporate governance,
as measured against our Five Golden Rules.
Ethical Assessment
Enron didn’t start out as an unethical business. As we have seen in this case study,
what introduced the virus was the pursuit of personal wealth via very rapid growth.
This led to the introduction of quite extreme incentive schemes to attract and
motivate very bright and driven people, which, in turn, led to an unhealthy focus
on short term earnings. The next step was, naturally, to look at how earnings could
be massaged to achieve the aggressive revenue and earnings targets. Since the
massaged figures for growth in earnings still left a shortfall in cash, Enron quickly
maxed out on its borrowing abilities. But issuing more equity would have hurt the
share price, on which most of the incentives were based. So schemes had to be
created to produce funding secretly and this funding had to be hidden. In this way,
an amoral and unethical culture developed in Enron in which customers, suppliers
and even colleagues were misled and exploited to achieve targets. And the top
management, who were rewarding themselves with these same incentive
schemes, boasted that a pure, market- driven ethos was propelling Enron to
greatness and deluded themselves that this equated to ethical behaviour. Lay even
lectured the California authorities, whom Enron was cheating, that Enron was a

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model of business ethics. Finally, the respected Arthur Andersen allowed greed for
fees to over-rule the strong business ethics tradition of its founder and caused it to
succumb to bending and suspending its professional standards, with fatal results.
Impact on Corporate Governance
The five Rules of Good Corporate Governance start with the need for an ethical
culture. Having established that, Enron’s culture became progressively more
deficient in this regard. Let’s consider briefly the impact of this failure in business
ethics on the other Rules. Clear goal shared by all key stakeholders Lay and,
particularly Skilling, engendered in all the staff of Enron the goal of driving up the
share price to the virtual exclusion of all else. The goal of achieving a long term
satisfaction from a stable customer base took a distant second place to signing up
deals. In California, the customers were deliberately exploited by the traders to the
maximum extent their ingenuity could achieve. Even internally, the Chief Finance
Officer’s funding scheme was designed to make him rich at his employer’s expense.
Transparency and accountability
From the early stages, Enron’s focus on earnings and share price growth and the
related financial incentives led to a necessary lack of transparency as the figures
were fiddled. One could argue that Enron felt very much accountable to their
shareholders for delivering consistent above average growth in Enron’s market
capitalization. However, this growth was achieved by subterfuge and deception.
Certainly the dealings in California were as far from transparent as it was possible
to be. The flaws in Enron should have been spotted from early on, and indeed were
periodically commented on by various observers from the early nineties onward. If

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independent ethical and corporate governance surveys had been conducted by
independent parties, they would have highlighted the growing problems. To
illustrate, consider the hypothetical survey summarized in the following chart. The
scores out of ten (high is good) result from a set of questions which aim at deriving
an independent, unbiased view from the interviewees, based on observations of
corporate behavior. What we have called the sniff test represents the personal
view of the interviewee and would take into account their gut feels about the
corporation and its management and owners. The highlighted scores would point
the observer to clear problem areas. Click to enlarge the image. One would
conclude from this survey in June 2000 that: neither customers, suppliers,
financiers nor local communities rated Enron’s morality in terms of business ethics
customers and local communities thought they were breaking regulations
customers and suppliers thought they were probably bending their own rules
customers, shareholders, suppliers, financiers and local communities thought they
were not truly honest. It is clear with the benefit of hindsight that what started out
as an imaginative and ground-breaking idea, which transformed the natural gas
supply industry, rapidly evolved into a megalomaniac vision of creating a world-
leading company. Intellectual self-confidence mutated into contempt for
traditional business models and created an environment in which top management
became divorced from reality. The obsessive focus on driving the share price
obscured the lack of basic controls and benchmarks and the progressive dishonesty
in generating revenue and earnings figures in order to deceive the stock market led
to the management deceiving themselves about the true situation. Right up to
nearly the end, Enron complied with all its regulatory requirements. The failings in
these regulations led directly to Sarbanes-Oxley. But all the extra reporting in

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SarBox didn’t prevent the global financial meltdown in 2008 as the banks gamed
the regulatory system. Now we have Dodd- Frank. What we actually need is
independent Corporate Governance surveys.
CONCLUSION
A lot of factors, internal and external, to the firm could be responsible for corporate
failure. Corporate failure exerts negative impact on both local and international
economic environments. The incidence of corporate failure in Nigeria is not well
researched into except as it concerns the banking industry. However, the country
has experienced a high incidence of micro, small and medium business failure
which has exerted disastrous negative impact on the local environment. However,
researches concerning this category of business have not been widely published.
An effective way of averting corporate failure is to consider the relative influence
of management, board of directors, employees, external auditors, regulatory
bodies, government etc. on the operating performance of a firm and see how they
can contribute positively to maintain a firm as a going concern. Corporate bodies
that are quoted on the Nigerian stock exchange are effectively supervise by both
the Securities and Exchange Commission (SEC) and the Nigerian Stock Exchange
(NSE) to avert and minimize corporate failure. It is recommended that Supervisory
Agencies (SAs) should be established in each state of Nigeria to effectively
supervise the operations of the micro, small and medium enterprises to adequately
comply with the provisions of the Companies and Allied Matters Act (CAMA) 2004,
as amended. This is to ensure that the operations of these companies are not at
variance with the provisions of the Act.

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