Dissertation ( ENRON'S FAILURE)

A M I T Y G L O B A L B U S I N E S S S C H O O L , B H U B A N E S W A R Page 1
CHAPTER-1
INTRODUCTION
BACKGROUND OF THE STUDY:-
Once the seventh largest company in America, Enron was formed in 1985 when InterNorth
acquired Houston Natural Gas. The company branched into many non-energy-related fields
over the next several years, including such areas as Internet bandwidth, risk management, and
weather derivatives (a type of weather insurance for seasonal businesses). Although their core
business remained in the transmission and distribution of power their phenomenal growth
was occurring through their other interests. Fortune Magazine selected Enron as "America's
most innovative company" for six straight years from 1996 to 2001. Then came the
investigations into their complex network of off-shore partnerships and accounting practices
The saga of the ENRON Corporation has been unfolding in the media for well over a year. In
the span of only three years, ENRON has gone from public and professional acclaim of the
company and its senior executives to scorn, infamy and bankruptcy. Its public auditing firm,
Arthur Andersen, has basically been destroyed, as well as publicly disgraced. Tens of
thousands of employees and investors have been emotionally and financially affected. Major
financial services firms in banking, securities brokerage and insurance have been, and may
yet be, drawn into the legal battles regarding who is to blame for the ENRON failure.
Enron grew wealthy due largely to marketing, promoting power, and its high stock price.
Enron was named "America's Most Innovative Company" by Fortune for six consecutive
years, from 1996 to 2001. It was on the Fortune's "100 Best Companies to Work for in
America" list in 2000, and had offices that were stunning in their opulence. Enron was hailed
by many, including labor and the workforce, as an overall great company, praised for its large
long-term pensions, benefits for its workers and extremely effective management until its
exposure in corporate fraud. The first analyst to publicly disclose Enron's financial flaws was
Daniel Scotto, who in August 2001 issued a report entitled "All Stressed-up… And No Place
To Go", which encouraged investors to sell Enron stocks and bonds at any and all costs.

PROBLEM STATEMENT:-
The firm projected itself as a highly profitable, growing company - an image which quickly
turned out to be an elaborate mistruth. Enron's statements about profits were shown to be
untrue, with massive debts concealed so that they didn't show up in the company's accounts
Not only that, but the company was seen to have been extraordinarily active in political
lobbying - with large numbers of legislators close to the company in one way or another. This
fact had not been enough to save it, but raised questions about how appropriate such
closeness between a corporate and the political system actually is.
Enron provided millions of dollars to finance Mr Bush's 2000 election campaign. Mr Bush
was a personal friend of Mr Lay, but has been quick to distance himself from any
involvement with the firm.
The Enron fraud case is extremely complex. Some say Enron's demise is rooted in the fact
that in 1992, Jeff Skilling, then president of Enron's trading operations, convinced federal
regulators to permit Enron to use an accounting method known as "mark to market
ENRON had excessive compensation plan which resulted in major cash drains
Enron's nontransparent financial statements did not clearly depict its operations and finances
with shareholders and analysts
Its complex business model and unethical practices required that the company use accounting
limitations to misrepresent earnings and modify the balance sheet to portray a favorable
depiction of its performance
Investment banks and commercial banks, for not identifying the pitfalls for Enron associated
with complexity and large amounts of leverage.
The CFO initiated many of the transactions that can be criticized.

OBJECTIVE OF THE STUDY:
Everything in life holds some kinds of objectives to be fulfilled. This study is not an
exception to it. The following are a few straight forward goals which I have tried to fulfil in
the project:
1. To know the crises of Enron
2. To know the accounting irregularity followed by enron
3. To know the accounting violation made by Enron
4. To know the Enron‘s failur
OUTLINE OF THE STUDY:
The first chapter explains about the introduction to the research topic, problem statement,
objectives, and limitations of the study. The profile of the company is presented in the second
chapter. The reviews of different literatures are presented in the third chapter. The fourth
chapter explains the Research Methodology. The results and discussions of the study are
presented in the fifth chapter. The conclusions and suggestion of the study are presented the
sixth chapter
LIMITATIONS OF THE STUDY:-
1. Due to time restraints it was not possible to study in depth.
2. Many facts and data are such that they are not to be disclosed because of the confidential
nature of the same
3. Since the financial matters are sensitive in nature the same could not acquired easily

CHAPTER-2
COMPANY PROFILE
Enron traces its roots to the Northern Natural Gas Company, which was formed in 1932, in
Omaha, Nebraska It was reorganized in 1979 as the leading subsidiary of a holding company,
InterNorth which was a highly diversified energy and energy related products company.
Internorth was a leader in natural gas production, transmission and marketing as well as
natural gas liquids and an innovator in the plastics industry. It owned Peak Antifreeze and
developed EVAL resins for food packaging. In 1985, it bought the smaller and less
diversified Houston Natural Gas.
The separate company initially named itself "HNG/InterNorth Inc.", even though InterNorth
was the nominal survivor. It built a large and lavish headquarters complex with pink marble
in Omaha (dubbed locally as the "Pink Palace"), that was later sold to Physicians Mutual
However, the departure of ex-InterNorth and first CEO of Enron Corp Samuel Segnar six
months after the merger allowed former HNG CEO Kenneth Lay to become the next CEO of
the newly merged company. Lay soon moved the company's headquarters to Houston after
swearing to keep it in Omaha and began to thoroughly re-brand the business. Lay and his
secretary, Nancy McNeil, originally selected the name "Enteron" (possibly spelled in camel
case as "EnterOn"), but, when it was pointed out that the term approximated a Greek word
referring to the intestines, it was quickly shortened to "Enron". The final name was decided
upon only after business cards, stationery, and other items had been printed reading Enteron.
Enron's "crooked E" logo was designed in the mid-1990s by the late American graphic
designer Paul Rand. Rand's original design included one of the elements of the E in yellow
which disappeared when copied or faxed. This was quickly replaced by a green element.
Almost immediately after the move to Houston, Enron began selling off key assets such as
Northern Petrochemicals and took on silent partners in Enron Cogeneration, Northern Border
Pipeline and Tran western Pipeline and became a less diversified company. Early financial
analysts said Enron was swimming in debt and the sale of key operations would not solve the
problems.
Main Divisions of Work:
Online Marketplace Services: EnronOnline.com commodity trading system - the largest
web based ecommerce site in the world and dwarfs all other energy marketing web sites
combined.
This includes EnronCredit.com, ClickPaper.com (online pulp & paper information), online
energy risk management, Water2Water.com (online water marketplace), Waterdesk.com
(water industry workspace, brings water industry buyers and sellers together).
Enron Broadband Services: Internet Broadband - streaming media applications,
customizable bandwidth solutions.

Enron Transportation Services: The Gas Pipeline Group, which formally changed its
name in September 2000 to Enron Transportation Services.
Enron Energy Services: The retail arm of Enron, serving business users of energy in
commercial and industrial sectors.
Enron Wholesale Services: Project Development and Management - Enron delivers more
than two times the natural gas and power volumes as does its nearest energy marketing
competitor.
Wholesale Services includes: Azurix Global Water; energy infrastructure development,
engineering, procurement, and construction services; global exploration and production; and
wind power services.
Former management and corporate governance
Central Management
Kenneth Lay: Chairman, and Chief executive officer
Jeffrey Skilling: President, Chief operating officer, and CEO (February–August 2001)
Andrew Fastow: Chief financial officer
Rick Causey: Chief accounting officer
Rebecca Mark-Jusbasche: CEO of Enron International and Azurix
Lou Pai: CEO of Enron Energy Services
Forrest Hoglund: CEO of Enron Oil and Gas
Richard Gallagher: Head of Enron Wholesale Global International Group
Kenneth "Ken" Rice: CEO of Enron Wholesale and Enron Broadband Services
J. Clifford Baxter: CEO of Enron North America
Sherron Watkins: Head of Enron Global Finance
Jim Derrick: Enron General Counsel
Mark Koenig: Head of Enron Investor Relations
Joan Foley: Head of Enron Human Resources
Greg Whally: President and COO of Enron (August 2001– Bankruptcy)
Jeff McMahon: CFO of Enron (October 2001-Bankruptcy)

Board Of directors
Robert A. Belfer: Chairman, Belco Oil and Gas Corp
Norman P. Blake Jr.: Chairman, President and CEO, Comdisco, Inc.
Ronnie C. Chan: Chairman, Hang Lung Group
John H. Duncan: Former Chairman of The Executive Gulf and Western Industries Inc.
Wendy L. Gramm: Former Chairman of US Commodity Futures Trading Commission
Ken L. Harrison: Former Chairman and CEO of Portland General Electric
Robert K. Jaedicke: Professor Emeritus of Accounting at Stanford University
Charles A. LeMaistre: President Emeritus, University of Texas M.D. Anderson
Cancer Center
John Mendelsohn: President, University of Texas M.D. Anderson Cancer Center
Jerome J. Meyer: Chairman, Tektronix
Paulo V. Ferraz Pereira: Executive Vice President if Group Bozano
Frank Savage: Chairman: Alliance Capital Management
John A. Urquhart: Senior Advisor to the Chairman of Enron
John Wakeham: Former U.K. Secretary of state for Energy
Herbert S. Winokur Jr.: President of Winokur Holdings Inc.
Products
Enron traded in more than 30 different products, including the following:
Products traded on EnronOnline
o Petrochemicals
o Plastics
o Power
o Pulp and paper
o Steel
o Weather Risk Management
Oil and LNG transportation
Broadband
Principal investments
Risk management for commodities
Shipping / freight
Streaming media
Water and wastewater

Online marketplace services
EnronOnline (commodity trading platform)
ClickPaper (transaction platform for pulp, paper, and wood products)
EnronCredit (the first global online credit department to provide live credit prices and
enable business-to-business customers to hedge credit exposure instantly via the
Internet.)
ePowerOnline (customer interface for Enron Broadband Services)
Enron Direct (sales of fixed-price contracts for gas and electricity; Europe only)
EnergyDesk (energy-related derivatives trading; Europe only)
NewPowerCompany (online energy trading, joint venture with IBM and AOL)
Enron Weather (weather derivatives)
DealBench (online business services)
Water2Water (water storage, supply, and quality credits trading)
HotTap (customer interface for Enron's U.S. gas pipeline businesses)
Enromarkt (business to business pricing and information platform; Germany only)
Broadband services
Enron Intelligent Network (broadband content delivery)
Enron Media Services (risk management services for media content companies)
Customizable Bandwidth Solutions (bandwidth and fiber products trading)
Streaming Media Applications (live or on-demand Internet broadcasting applications)
Energy and commodities services
Enron Power (electricity wholesaling)
Enron Natural Gas (natural gas wholesaling)
Enron Clean Fuels (biofuel wholesaling)
Enron Pulp and Paper, Packaging, and Lumber (risk management derivatives for
forest products industry)
Enron Coal and Emissions (coal wholesaling and CO2 offsets trading)
Enron Plastics and Petrochemicals (price risk management for polymers, olefins,
methanol, aromatics, and natural gas liquids)
Enron Weather Risk Management (Weather Derivatives)
Enron Steel (financial swap contracts and spot pricing for the steel industry)
Enron Crude Oil and Oil Products (petroleum hedging)
Enron Wind Power Services (wind turbine manufacturing and wind farm operation)
MG Plc. (U.K. metals merchant)
Enron Energy Services (Selling services to industrial end users)
Enron International (operation of all overseas assets)

Capital and risk management services
Commercial and industrial outsourcing services
Commodity Management
Energy Asset Management
Energy Information Managementbb
Facility Management
Capital Management
Azurix Inc. (water utilities and infrastructure)
Project development and management services
Energy Infrastructure Development (developing, financing, and operation of power
plants and related projects)
Enron Global Exploration & Production Inc. (oil and natural gas field services)
Elektro Electricidade e Servicos SA (Brazilian electric utility)
Energy transportation and upstream services
Natural Gas Transportation
Northern Border Pipeline
Houston Pipeline
Transwestern Pipeline
Florida Gas Transmission
Northern Natural Gas Company
Natural Gas Storage
Compression Services
Gas Processing and Treatment
Engineering, Procurement, and Construction Services
EOTT Energy Inc. (oil transportation)
Enron manufactured gas valves, circuit breakers, thermostats, and electrical equipment in
Venezuela through INSELA SA, a 50–50 joint venture with General Electric. Enron owned
three paper and pulp products companies: Garden State Paper, a newsprint mill; as well as
Papiers Stadacona and St. Aurelie Timberlands. Enron held a controlling stake in the
Louisiana-based petroleum exploration and production company Mariner Energy.
Enron International
Enron International (EI) was Enron's wholesale asset development and asset management
business. Its primary focus was developing and building natural gas power plants outside
North America. Enron Engineering and Construction Company (EECC) was a wholly owned
subsidiary of Enron International, and built almost all of Enron International's power plants.

Unlike other business units of Enron, Enron International had a strong cash flow on
bankruptcy filing Enron International consisted of all of Enron's foreign power projects,
including ones in Europe.
Leadership
Rebecca Mark was the CEO of Enron International until she moved over to lead Enron's
newly acquired water business, Azurix, in 1997. Mark played a major role in the
development of the Dabhol project in India, Enron's largest international endeavour.
Projects
Enron International constructed power plants and pipelines across the globe. Some today are
still up and running, including the massive Teeside plant in England. Others, like a barge
mounted plant off Puerto Plata in the Dominican Republic, cost Enron money through law
suits and investment losses. Puerto Plata was a barge mounted power plant next to the hotel
Hotelero del Atlantico. When the plant was fired up, winds blew soot from the plant onto the
hotel guests' meals, blackening their food. The winds also blew garbage from nearby slums
into the plant's water-intake system. For some time the only solution was to hire men who
would row out and push the garbage away with their paddles. Through mid-2000 the
company collected a paltry $3.5 million from a $95 million investment. Enron also had other
investment projects in Europe, South America, Argentina, Brazil, Bolivia, Colombia,
Mexico, Jamaica, Venezuela, and across the Caribbean.
India
Around 1992 India came to the United States to find energy investors to help with India's
energy shortage problems. In December 1993, Enron inked a 20-year power-purchase
contract with the Maharashtra State Electricity Board. The contract allowed Enron to
construct a massive 2,015 megawatt power plant. Construction would be completed in two
phases, and Enron would form the Dabhol Power Company to help manage the plant. The
power project was the first step in a $20 billion scheme to help rebuild and stabilize India's
power grid. Enron, GE (who was selling turbines to the project), and Bechtel (who was
actually constructing the plant), each put up 10% equity.
In 1996, when India's Congress Party was no longer in power, the Indian government
assessed the project as being excessively expensive and refused to pay for the plant and
stopped construction. The Maharashtra State Electricity Board (MSEB), the local state run
utility, was required by contract to continue to pay Enron plant maintenance charges, even if
no power was purchased from the plant. The MSEB determined that it could not afford to
purchase the power (at Rs. 8 per unit kWh) charged by Enron. The plant operator was unable

to find alternate customers for Dabhol power due to the absence of an open free market in the
regulated structure of utilities in India. From 1996 until Enron's bankruptcy in 2001 the
company tried to revive the project and spark interest in India's need for the power plant
without success.
Overview of ENRON:
The following timeline for ENRON is presented to set the major milestones for the company:
July 1985- Houston Natural Gas merges with InterNorth to form ENRON, as an interstate
natural gas pipeline company. Kenneth Lay is CEO.
1989- ENRON starts trading natural gas commodities and commodity derivative financial
contracts.
1994- ENRON begins trading electricity as a commodity and related financial derivative
contracts. Jeffrey Skilling is executive in charge of this new business venture.
Nov. 1999- EnronOnline is launched as a web site for the global trading of energy
commodities and derivative contracts. Jeffrey Skilling leads this continued transformation
from a natural gas pipeline company to a global marketer and trader of oil, gas and electric
energy. Stock price trades at $45 per share.
2000- Stock price trades at high during year of $91 per share.
Feb. 2001- Jeffrey Skilling takes position as CEO, and Ken Lay remains as Chairman of the
Board. Stock price is trading at high range of $84 per share.
Aug. 2001- Jeffrey Skilling resigns as CEO, and Ken Lay returns to position as CEO and
Chairman. ENRON vice president, Sherron Watkins, writes anonymous letter to Ken Lay
about severe problems with partnerships known as LJM and Raptor, the accounting for those
partnerships, the role of the ENRON CFO in the partnerships, and the possible adverse effect
of these partnerships and their accounting if the information were ever revealed to the
investment markets.
Jan.-Aug. 2001- Lay and Skilling sell $41 million of ENRON stock. Other corporate insiders
sell $71 million of stock. Employees are restricted from selling stock from 401(k) retirement
accounts unless retiring or leaving employment.
Sep. 2001- Stock price trades around $28 per share, after 9/11 terrorist attacks.
Oct. 2001- ENRON reports a $618 million loss for the third quarter, and restates past
financial statements that results in $1.2 billion writedown of ENRON's stockholder equity.
Loss and writedowns result from Special Purpose Entities (partnerships) created under the

direction of Chief Financial Officer (CFO) Andrew Fastow. The Securities and Exchange
Commission (SEC), requests further explanation and information on the reported losses and
financial restatements. CFO Andrew Fastow is relieved of his position. ENRON's problems
largely related to "aggressive" accounting related to reporting of indebtedness on balance
sheet, reporting of profits from asset sales and reporting of earnings and cashflow from on-
going operations.
Nov. 2001- SEC upgrades inquiry into ENRON to a "formal investigation". ENRON states
that its profits over last five years have been "overstated" by $586 million. Public auditing
firm, Arthur Andersen, receives request from SEC for its records on the ENRON audits.
ENRON attempts to raise cash by delaying loan repayments and seeking new sources of short
term capital. Merger attempt with Dynegy Corp. is cancelled.
Dec. 2001- ENRON files for Chapter 11 bankruptcy protection. CEO of Arthur Andersen
tells Congress that ENRON might have violated securities laws.
Jan. 2002- Justice Department begins criminal investigation of ENRON's failure. Reports are
received about document destruction at ENRON and Arthur Andersen after SEC
investigation was announced. ENRON stock trades at prices between $0.20 and $0.50 per
share.
Feb.-Aug. 2002- Ongoing investigations by SEC, U.S. Justice Department, U.S. House of
Representatives, U.S. Senate, et al. Companies such as Merrill Lynch, Citicorp and J.P.
Morgan Chase are called to testify about their dealings with ENRON. Role of ENRON in the
California energy crisis is investigated. ENRON employees sustain massive losses in 401(k)
retirement accounts and employee layoffs continue. Federal government evaluates need for
new laws related to employee pension accounts, regulation and oversight of public auditing
firms, and corporate fraud and governance issues.

In 1984, Kenneth L. Lay became the Chief Executive Officer of Houston Natural Gas
Corporation, a pipeline operator. Soon after he took position, his firm merged with Internorth,
another pipeline company. Lay became the CEO of the merged firm, and the name of the firm
was changed to Enron. As deregulation of energy became more widespread (Lay influenced
the rate of change) the mission of Enron widened to include the trading of energy contracts.
Shortly after the merger with Internorth, Lay hired the consulting firm, McKinsey & Co., to
help develop a business strategy for Enron. One of the consultants assigned to the Enron
study was Jeffrey Skilling. Lay subsequently hired Skilling to develop new business activities
for Enron. Skilling successfully launched Enron‘s highly profitable business of trading
energy derivatives. Andrew Fastow was hired by Enron in 1990 from Continental Illinois
Bank in Chicago and was appointed Chief Financial Officer (CFO) of Enron in 1998. Fastow
was thought to complement Skilling‘s interests and abilities. Appointing Fastow as CFO was
Enron‘s second biggest mistake (it probably would not have been made if the first mistake of
allowing the departure of Rich Kinder had not been made).
Rich Kinder
In November 1996, Enron announced that Rich Kinder was leaving Enron. Shortly before
that announcement the Enron Board of Directors (and Ken Lay) had failed to appoint Kinder
as the CEO. The decision not to appoint Kinder as the President of Enron had very little to do
with Kinder‘s acknowledged managerial abilities. Kinder was (and is) a world-class manager,
one of the few effective hands-on managers at Enron. The departure of Kinder was the most
significant negative event for Enron during the 1990s. It would likely have been a different
firm in 2001 if he had stayed. When he left, Kinder bought from Enron the Liquids Pipeline
Division for $40 million. With Bill Morgan and the $40 million pipeline he formed Kinder
Morgan Corporation. Kinder Morgan went public, but in 2006 Kinder and Morgan took the
firm private (the corporation had a market cap of $14 billion). In 2006, Rich Kinder was one
of the world‘s richest persons and will be even richer when Kinder Morgan goes public again.
The $14 billion of Kinder Morgan value could possibly have been value-added to Enron if
Kinder had not been rejected as CEO. Enron needed effective managers of real assets, and
Kinder was among the best.
John Wing
John Wing was another great manager (of power plants) who was shown the door by Enron
in July 1991. He helped execute the original deal that created Enron and was in and out of
Enron from the early- 1980s to 1991. He made money for Enron with hard assets. His biggest
moneymaker for Enron was a power plant in England called Teesside. He also did many
other profitable deals for Enron. John Wing did not fit easily into the Enron management
structure. He was not the type of person with whom Ken Lay felt comfortable. When Wing
wanted to separate his power group from Enron and form a separate publicly owned
corporation, Lay facilitated his departure from Enron.
It is interesting to conject what would have happened if Enron had financed Rich Kinder‘s
gas pipeline company and John Wing‘s power company. These two entities certainly would
have developed into two very interesting merchant assets.

The Year 2001
In the year 2001, Enron was the seventh largest US Corporation (based on revenues) and
possibly would have been ranked larger if the revenues of all the subsidiaries and special-
purpose entities (SPEs) were factored into the calculation. It would have been ranked much
lower if trading transactions were not treated as revenue. Interestingly, Enron was ranked
number five in the Fortune 500 listing for 2001, published in March 2002. But no matter
where we exactly rank it, Enron was a large profitable corporation before October 2001. If
we consider only the available public information as of August 2001, it was a very profitable
corporation. On 17 December 2001, the Enron Corporation filed an 8-K report with the
Securities and Exchange Commission (SEC). It stated that on “December 2, 2001, Enron
Corp. (the “Company”) and certain other subsidiaries of the Company (collectively, the
“Debtors”) each filed voluntary petitions for relief under chapter 11 of title 11 of the
United States Code (the “Bankruptcy Code”) in the United States Bankruptcy Court for the
Southern District of New York…” Thus, in December 2001, Enron filed for bankruptcy. How
did a seemingly healthy, profitable corporation transform itself into the biggest corporate
scandal of the new millennium? The newspapers have reported extensively on the clienteles
that have been harmed by the Enron collapse. These include: Employees with 401-K plans
heavily (or exclusively) invested in Enron stock; Employees who have lost their jobs at
Enron; Employees and investors who held worthless Enron stock; Debtholders who owned
debt that had lost most of its value (including bank debt). But, the list of those affected
greatly is much longer, including: Top management with reputations in shatters and
significant reductions in wealth. Arthur Anderson — A once highly respected public
accounting firm was struggling to stay afloat and subsequently was forced to shut down
operations. Security analysts who recommended Enron stock. Bond rating agencies who had
imperfect crystal balls. Politicians who accepted donations from Enron. At the beginning of
2001, Enron‘s common stock was high compared to its earnings. How does a CEO manage a
company whose stock is overvalued? Enron management chose to take actions that presented
a sunny smile to the public while painful events occurred. There were some executives who,
fooled by the firm‘s own accounting and financial tricks, actually thought things were bright.

CHAPTER-3
LITERATURE REVIEW
Baker (2003)1
has analyzed the fall of Enron from different perspectives he discussed the
business model of Enron and external factors such as deregulation of industry in that era. He
has examined the growth of Enron which transformed itself from regulated gas distribution
Company into an international trading company and through all the stages of its collapse he
investigated Enron as American public private partnership
Then David Baker (2005)2
views Enron‘s bankruptcy as an accounting failure in which the
investors and creditors of the company were misled and presented with false financial
information .In his view the bankruptcy losses of the investors could have been reduced to
some extent if they had been provided with the transparent financial information and its
result.
Joanne and john (2006)3
discussed the some issue and use the term ‗Hypermodern
Organization‘ they argued that the continuous growth of Enron as an organization was based
on hyper flexibility in terms of size and survival of its business units. In reaction to the
market opportunities Enron acquired and disposed off businesses. It acquired Portland
General Corporation to enter to the market of utility electricity.
Konstantin (2005)4
, showed that during the period1996-2001 there was increase in the
revenue of the company while the net income decreased from 5.66% to 0 .97%. In this
research different ratios were used like price to earnings, Price to book value, ratio Return on
asset, and use of Net margin and use of risk management.
1
James Baker , “the fall of ENRON” (2003)
2
David baker, “ENRONS accounting violation” (2005)
3
Joanne and john, “hypermodern organization” (2006)
4
Konastantin, “ accounting analysis of ENRON” (2005)

Coffee (2003)5
has discussed the same issue in his working paper ―what caused Enron
―states: as in late as October 2001 sixteen or seventeen security analysts recommended buy or
strong buy for Enron‘s stock however the stock price of Enron already in 2000was six times
of its book value and 70 times earnings, however the first brokerage firm which
recommended ―sell‖ recommendation for Enron was prudential securities which at that time
was not engaged in the investment banking business.
Giovanni and Andrew (20026
) discussed the institutional activism in Europe they argued that
crisis in public model security and reforms in stock market exchanges and birth of the single
market in Europe has changed the domestic institutional investors.
Levi (2001)7
statement: ―difference in outcome is derived from DNA of companies i.e.
which is the organizational infrastructure, its capabilities, culture and leadership…these are
the elements that create the working context for operating and managing intangibles
Enrique (2003)8
have studied the reaction of Enron and discussed its aftermath. He found that
the reaction on collapse of the Enron on Europe and UK has been Different than USA. In his
view Block holders of European Companies must have been working more effectively than
the institutional investors and monitors in USA. After Enron in USA there are quite a few
companies who faced serious problems in Europe
5
Coffee “What caused Enron?” A Capsule social and Economic History of the 1990’s: (2003)
6
Giovanni and Andrew, “ Enron in Europe” (2002)
7
Levi , “ organizational structure of Enron” (2001)
8
Enrique “Bad Apples, Bad Oranges: A comment from old Europe on post Enron corporate governance
reforms” (2003)

Higgs (2003)9
recommended that half of the board members should be non executive
directors and the role of CEO and the chairman should be separate. In his view independence
of auditors and directors is very important. Luca Enrique 2003discussed the developments in
EU countries in the post Enron era. On May 25, 2003,the European commission issued to
council and European parliament setting out its agenda to modernize European Corporate
Law and to enhance corporate governance in E.U. With respect to U.K post Enron corporate
Governance reform there has been study on non executive directors commissioned by
government funded organization sand also some initiatives on audit and accounting issues.
Chatzekal(2002)10
view that the changing nature of finance enterprise and accounting
capability should be in parallel and the one way to achieve is through reviewing the
accounting for intangibles and he raises the important question of how to reduce the
opportunity for new Enron in future.
9
Higgs “ CEO role in Enron” (2003)
10
Chatzekal “ Enron failure” (2002)

CHAPTER-4
RESEARCH METHODOLOGY
Research methodology is a systematic approach in management research to achieve pre-
defined objectives. It helps a researcher to guide during the course of research work. Rules
and techniques stated in research methodology save time and labour of the researcher as
researcher know how to proceed to conduct the study as per the objective.
SELECTION OF TOPIC: The selection of topic is a crucial factor in any research study.
There should be newness and it should give maximum scope to explore the ideas from
different angles.
After consultation with the internal guide, the topic was finalized and titled as-―ENRON‘S
FAILURE”
RESEARCH DESIGN: “A Research design is the arrangement of conditions for collection
and analysis of data in a manner that aims to combine relevance to the research purpose with
economy in procedure‖ The research design followed to study ENRON‘S FAILURE is
Descriptive and Analytical Research Design.
SOURCES OF DATA COLLECTION:
1. Secondary data collection
The secondary data are those which have already collected and stored. Secondary data easily
get those data from records, journals, annual reports of the company etc. It will save the time,
money and efforts to collect the data. Secondary data also made available through trade
magazines, annual reports, books etc.

CHAPTER-5
RESULTS AND DISCUSSIONS
Gains and Losses from Stock Investment:
Assume an independent entity buys 1,000,000 shares of Enron stock at a price of $50 per
share and the price increases to $80. The independent entity has made an unrealized gain of
$30 per share or $30,000,000 in total. Following mark-to-market accounting this gain will
affect the independent entity‘s income. Enron‘s income will not be affected. Now assume an
entity, completely owned and controlled by Enron, buys 1,000,000 shares of Enron at a price
of $50. When Enron did this sort of transaction, it would sometimes accept a notes receivable
in exchange for the stock. Good accounting would require that there be no increase in stock
equity or assets of Enron when the asset received is a note receivable. For this example,
assume the entity paid $50,000,000 cash to Enron for the stock. Now assume the stock price
goes up to $80 per share. When the entity buying the stock was independent of Enron, there
was a $30,000,000 gain. Now generally accepted accounting requires that there be no gain or
loss for Enron associated with transactions involving Enron stock.
: Consider the following table:
Enron an owned and controlled subsidiary
Assets 50,000,000 50,000,000 (Enron stock)
Stock equity 50,000,000 50,000,000
If we consolidate the financial affairs of the two entities we have:
Consolidated
Assets 50,000,000
Stock equity 50,000,000
Now assume time passes and the controlled entity (and Enron) earns $20,000,000 and the
value per share increases. The controlled entity is not marked-to-market. We now have:
Enron An owned and controlled subsidiary
Assets 70,000,000 70,000,000
Stock equity 70,000,000 70,000,000

If we consolidate the financial affairs we have
Consolidated
Assets 70,000,000
Stock equity 70,000,000
But assume the controlled entity uses mark-to-market accounting and the value of its asset
(Enron stock) increase to $80,000,000. The parent (Enron) should not record the $10,000,000
of market appreciation (above the $20,000,000 of earnings) as income. It results from the
stock price change of Enron stock and this should not affect Enron‘s income. The
$30,000,000 increase in the Enron stock price does not give rise to Enron income or an
increase in Enron assets. The $20,000,000 of Enron earnings are recorded.
Reported net income Decrease in income
1997 $105 million $28 million
1998 703 million 133 million
Total 2680 million 405 million
Enron‘s reported debt would be increased by $628 million in 2000 as a result of the
consolidations

In this analysis they used the following valuation model:
They found that the Enron stock price which was $90 in 2000 at the time was consistent with
the ROE and its revenues but the important point here is that theses earnings and returns were
based on the information which was fraudulent therefore any assumption that stock price of
Enron in (2000) created value to its shareholders would be wrong. This is the reason the fund
managers were led to wrong decision. Palepu (2003) states that:
―Several reasons have been proposed that why the leading managers were so slowing to
recognize the problem to Enron, they were misled by the accounting statements or by sell
side annalists or the incentives of fund managers to seek out high quality information were
poor.‖

Evaluating Arthur Andersen:
Let us consider the performance of the accounting firm Arthur Andersen. It destroyed
documents related to the Enron collapse. Early in 2002, it was revealed that documents were
destroyed in October 2001 after the world was aware that Enron‘s accounting was faulty and
would be investigated. The author of this book cannot judge the legality of the document
shredding, but he does know that at a minimum it was bad public relations. It would be
surprising if there were revelations on the shredded documents that were as bad as interested
parties thought they were after the shredding. Arthur‘s second error was in not keeping
Enron‘s Board aware of its concerns early in 2001 or before. Duncan and others at Arthur
Andersen were aware in February 2001 that Enron had significant risks that were not of
public knowledge. Why not inform the Enron Board? Let us assume that Arthur Andersen did
not know in 1997 that Chewco did not have 3% independent equity. Thinking Chewco
qualified for nonconsolidation it was reasonable not to consolidate Chewco until 2001 when
Arthur Andersen found out that Chewco and JEDI should have been consolidated since 1997.
Did Arthur Andersen truly find out in 2001 or did it know previously that there was not a 3%
independent equity? There is also the issue of the $1.2 billion entry (debit) to notes receivable
and entry to stock equity (credit). Accounting principles do not allow one to record an
increase in stock equity balanced by a promise to pay in the future. Recording the increase in
stock equityis not acceptable accounting, but it is not a high crime. Why was Arthur
Andersen fooled? It is possible that the complex array of SPEs hid the true nature of the
transaction until 17 October 2001. Or it could be that Arthur Andersen allowed an incorrect
accounting entry. It is very difficult to see why Arthur Andersen would knowingly allow an
incorrect accounting entry. It is more likely that the complex manner of structuring the
transaction hid the transaction‘s basicnature.
At what stage should Arthur Andersen have demanded that the curtain be drawn on the
Raptors? Before the assets held by Enron decreased in value there was no important
accounting issue concerning the Raptors. At some stage the Raptors could no longer honor
their put liabilities to Enron. We do not know when this happened, but it was somewhat
before October 2001. The Enron Board should have been informed that the puts held by
Enron were not fully effective.
There are many issues regarding the recording of debt, the timing of revenues, the timing of
expenses, and the recognition of gains on sales of assets, where it is possible that the assets
were not actually sold (the buyer had puts to sell back to Enron). We need more information
before determining guilt.
Arthur Andersen was tried in the court of public opinion and found guilty before its legal
trial. The fact that the US Government indicted the firm did not help Arthur Andersen‘s
customer relations. It became very difficult for a public corporation to hire Arthur Andersen
as its auditor. CFOs did not want to defend the choice of Arthur Andersen as the firm‘s

auditor. The fact that Arthur was later found not to be guilty did not help the already
dissolved firm.
There is some significant probability that the accounting errors that were made by Enron
were not Arthur Andersen‘s responsibility and that, aside from shredding, no crimes were
committed by Arthur Andersen prior to 2001 (whether the shredding was a crime is for
history to decide; Andersen was not convicted of that crime). Arthur Andersen, as of May
2002, seems to have gotten a raw deal from the press and the US Justice Department.
Arthur Andersen had a group of outstanding accounting experts available in its Chicago
office to answer questions as to the appropriate accounting for difficult issues. This service
was available at no cost to any operating office. However, the operating office having
received the expert opinion did not have to follow the advice, though it normally did. It is
likely that the Chicago experts offered the Houston office advice that could have avoided the
issues that ultimately trapped the firm.
Kenneth L Lay
By one definition Lay is responsible for any mistake that was made by an Enron employee.
This follows the US Navy tradition that a ship‘s captain is responsible for anything that
happens on the ship. This rule is great in theory because it causes the captain to take a deep
interest in all activities that could lead to trouble. Captains of US Navy ships at sea do not get
to sleep through the night very often. Ultimately, a captain is a single person of limited scope.
He or she cannot be everywhere. Informed of all possible dangers the captain will soon be
exhausted and will become a walking zombie. There are things that happen for which it
would not be sensible to hold the captain responsible. Similarly, Lay delegated
responsibilities to Enron‘s senior officers. Lay retired as the CEO in February 2001 and
Skilling was named as the CEO. On 14 August 2001 Skilling resigned for personal reasons.
Lay resumed the job of CEO. But Lay was more interested in big issues and the political
scene than the details of accounting and finance as they applied to Enron. Lay hired Skilling
and Fastow to take care of the accounting and finance. The accounting problems that
ultimately led to the need to revise the operating results for 1997–2001 (first half) were very
technical. Now, the world is aware of the nature of Enron‘s accounting problems, there will
be differences of opinion as to whether or not Enron should have been allowed to record the
entries that they did. Even though, when Enron was in error as with Chewco, it was an error
because of a technicality. Chewco failed to have a 3% independent equity, that should have
been consolidated. But why 3%? Also, how is the 3% to be measured and what should be
included as equity? The rules should have been followed, but these rules were not carried
down by Moses from the Mount.

The Extent of Corruption
Was Enron corrupt? How evil was the Enron management? Let us leave out from
consideration the shredding of documents by both Arthur Andersen and Enron when they
knew investigations were pending. Also, leave out the amounts taken by Fastow and other
employees from the several related entities. While upsetting, these actions were not the core
elements of Enron‘s bankruptcy. Consider the SPEs that were established or utilized for
hedging purposes and the accounting for these entities (for example, Chewco and the
Raptors). To a minor extent these were actually hedges (for small price changes of the hedged
asset). The accounting and economic problems came into being when the losses became
large. It is interesting that the accounting for Chewco would have been technically acceptable
(if not admirable) if an additional $7 million of independent equity had been raised. The
failure to raise the $7 million is stupidity or carelessness, not corruption. There were several
other (maybe ―many other‖) departures from good accounting. These were not consistent
with the traditional objectives of financial accounting, but they did not necessarily indicate
the existence of corruption. It was desirable for Lay and Skilling to pay more attention to the
accounting and financial details, but one can conject that they did not. Fastow was both too
clever and not knowledgeable enough. He failed to consider the consequences of a severe fall
in the value of the merchant assets and the value of the SPEs‘ assets. Fastow established a
house of cards that could not withstand a slight breeze. The auditors and the CFO of Enron
did not keep the Board adequately informed. The investment banks and commercial banks
helped to raise the capital necessary for Fastow to play his games.
Analysts recommended Enron stock after the investment banks knew that there were
difficulties. This could be an illustration of the analysts bailing out the investment banks or it
could be that the wall between investment banking and security analyses actually worked.
Sharing the Blame:
Identifying the entities that can share in the blame for the Enron collapse results in a long list
that includes:
1. Enron‘s top management and Board did not stop transactions that they did not understand
(and maybe did not know about).
2. Investment banks and commercial banks, for not identifying the pitfalls for Enron
associated with complexity and large amounts of leverage.
3. A law firm that seemed not to keep the Enron Board informed of all conflict of interest
situations.
4. Rating agencies and security analysts that did not insist on better information.
5. The auditors seemed to be too permissive.
6. The CFO initiated many of the transactions that can be criticized.
7. Investors who paid too much for the stock (hindsight helps us with this one).
8. The designers of the accounting rules that facilitate the hiding of debt.

CHAPTER-6
CONCLUSION
The aim of this thesis is to examine and discuss the major scandal of Enron in relation quality
financial reporting and corporate objective of shareholder wealth maximization. Through the
analysis of Enron case I have tried to show that how the directors of the Enron used financial
reporting to mask the real financial position of the company. Discussion and analysis also
showed that financial reporting was not the only factor for demise of Enron there were other
factors such as business model of Enron, Auditors independence, deregulation energy
industry in USA, flaws in US Generally Accepted Accounting Principles (GAAP),
Accounting Standards and corporate Governance. But there is consensus that Enron
executives used financial reporting as a tool to mask the real financial position of the
company and also all these factors are linked directly or indirectly with financial reporting.
This thesis evidences of the corrupt practices of the Enron executives and their contribution
in reporting the fraudulent financial statements. In essence the lack of presentation of high
quality information, poor corporate governance and environment of corruption lead to
downfall of Enron. The discussion and analysis of this thesis suggest that Financial Reporting
of a company can be key factor in disclosing or hiding financial health. In this whole paper I
have emphasized on quest of transparent financial statements which can not only be achieved
through enforcing quality Accounting Standards but it is influenced by a number of other
institutional factors which I have discussed throughout in the discussion part of this paper
using the Enron case.
‗Transparency‘ and ‗Accountability‘ are the two key words and lack of both in the financial
systems result in scandals like the Enron. It is a basic conception in finance that ‗increased
debts can increase the financial risk‘ of an entity but how the investors of a company would
know if debts do not appear on the financial statements of the company? Therefore it can be
argued that if Enron had presented their financial reports with transparency and had shown
their assets and liabilities accordingly, the financial losses to the investors would have been
minimized. Financial analysts use financial information for valuations purposes and forecast
the earnings of the company which has impact on the security prices. The Enron‘s earnings
were inflated fraudulently and debts were shown as profits. Which in turn inflated the stock
prices but it did not create value to the shareholders as these prices were based on false
information. Therefore it can be argued that quality reporting can lead to quality forecast and
estimates, which will be based on true and fair view and can help investors in quality
decisions and it can create value to shareholders and value to corporate in the long run.

SUGGESTIONS
There are several lessons to be learned from the Enron:
First and most importantly, a finance officer can be ―too smart‖. Using clever financial and
accounting devices that confuse analysts and investors might work for a short while, but
when the system collapses the consequences are magnified. If Enron had reported its
merchant investment losses to go with the firm‘s trading and operating profits, the market
would have digested this information and Enron would have survived.
Any firm that is heavily dependent on short-term credit is vulnerable to bad news reports that
shake the market‘s faith in its reports. The media can bring down a firm that needs short-term
credit.
Enron did many transactions whose primary objective seemed to be to mislead the person
evaluating its financial performance. All the accounting hedges were of this nature as well as
many of the put purchase transactions with the SPEs. Unfortunately, these transactions then
led to a faulty accounting (failure to consolidate three entities) and a loss of faith by the
market in Enron‘s top management
There are many reasons why a firm‘s management should ―do right‖. First, it is the
honourable and correct thing to do. Second, it is likely to maximize shareholder value. Enron,
when it found it could not buy an economic hedge for its merchant assets, should have
reported the gains and losses as they occurred. If it had done this simple and the correct thing
the Enron Corporation would still be operating and growing.
Enron‘s stock price implicitly promised large and continuous profitable growth. Enron‘s
actual business activities were not always profitable and they did not promise continuous
growth. What do managers do when their stock is greatly overvalued? In the Enron case some
of the managers tried to sustain the illusion of continuous profitable growth. Unfortunately, it
was an illusion. The Enron stock price as of 1 January 2001 could not be justified by the
revised accounting numbers.

BIBLIOGRAPHY
Allen, C. E. (2002) ―Building mountains in a flat landscape: Investor relation in post Enron
Era‖ An International Journal. pp. 206-211
Barnes, P. (1987) ―The Analysis and use of Financial Ratios‖ Journal of Business Finance
and Accounting 14 (4) pp. 449-461
Chandra, prashana (2007) ―financial management‖
Bhattacharya, U., Daouk, H., Jorgenson, B. and Kehr, C. (2000) ―When and Event is not an
Event: The Curious Case of an Emerging Market‖ Journal of Financial Economics
Websites:
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www. Enron.com
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