Corporate governance report

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Corporate governance report

  1. 1. Case Study on ENRON CorporationHistory of ENRON Corporation: Houston Natural Gas Corporation and Inter north Inc. merged in 1985 to form EnronCorporation. Since its conception, Enron has distinguished itself as an innovative, prominentleader in the natural gas market. Enron, headquartered in Houston, is the largest trader of naturalgas and electricity in North America today. Enron also markets and trades other commodities,including water, paper, coal, chemicals, and fiber-optic bandwidth. Its telecommunications arm,Enron Broadband Services, is building a national fiber-optic network and creating a market totrade bandwidth capacity. The success of Enron’s aggressive strategies is demonstrated by the rise in its stock pricefrom a split-adjusted $3.20 per share in 1985 to $80.63 per share on November 20, 2000. In thissame period, revenues increased from $10.3 billion to $40.1 billion and net income improvedfrom a loss of $54.7 million to $919.0 million. As a result of its ability to discover new businessopportunities, transform traditional industries, and enter new ones, Fortune magazine namedEnron “Most Innovative Company” for an unprecedented fifth consecutive year in 2000. Enron’s focus on innovation has been demonstrated throughout its history. As a newlyformed company in the mid-1980, Enron pioneered the trading of natural gas when natural gasmarkets were deregulated. When Enron entered the electricity market in 1993, it revolutionizedthe industry by facilitating a market to trade electricity. Enron was also among the first energycompanies to expand beyond traditional energy markets by entering the telecommunicationsindustry. Enron has even entered the e-commerce sector by partnering with leading high-techcompanies to form Enron Online, a business-to-business website that facilitates the trading ofcommodities. Page 1 of 6
  2. 2. Factors of Success: What is the story behind Enron’s success? Enron is not wedded to specific industrystrategies. Rather, it has an overall strategy that calls for creating an environment and culture ofcreativity and idea generation. “Enron is a laboratory of innovation. Enron’s entrepreneurialapproach calls for new insights, new ways of looking at problems and opportunities trysomething different change a goal, change a habit, change a mind. Enron has an exceptionalability to leverage its intellectual capital. Individuals are empowered to do what they think isbest Enron’s philosophy is not to stand in the way of our employees. This environment spurs the innovation that enables Enron to revolutionize traditionalenergy markets and successfully enter new ones outside of the energy industry. “Enron’sprimary competitive advantage is to identify opportunities and gain a first-mover advantage thatwe never surrender. Enron often introduces a product or concept before the competition evensenses that a market exists”.Accounting practices: Enron created offshore entities units which may be used for planning and avoidance oftaxes, increasing the profitability of a business. This provided ownership and management with fullfreedom of currency transfer and the anonymity that allowed the company to hide losses. created adangerous spiral, in which each quarter, corporate officers would have to perform more and morefinancial deception to create the illusion of billions of dollars in profit while the company wasactually losing money. This practice increased their stock price to new levels, at which point the executives beganto work on insider information and trade millions of dollars’ worth of Enron stock. Chief FinancialOfficer Andrew Fastow directed the team which created the off-books companies, and manipulatedthe deals to provide himself, his family, and his friends with hundreds of millions of dollars inguaranteed revenue, at the expense of the corporation for which he worked and its stockholders. Page 2 of 6
  3. 3. Fraud Happened in ENRON: The Enron fraud case is extremely complex. Some say Enrons demise is rooted inthe fact that in 1992, Jeff Skilling, then president of Enrons trading operations, convincedfederal regulators to permit Enron to use an accounting method known as "mark to market." Thiswas a technique that was previously only used by brokerage and trading companies. With markto market accounting, the price or value of a security is recorded on a daily basis to calculateprofits and losses. Using this method allowed Enron to count projected earnings from long-termenergy contracts as current income. This was money that might not be collected for many years. The numbers were on the books so the stock prices remained high, but Enron wasntpaying high taxes. Enron had been buying any new venture that looked promising as a new profitcenter. Their acquisitions were growing exponentially. Enron had also been forming off balancesheet entities to move debt off of the balance sheet and transfer risk for their other businessventures. Because the executives believed Enrons long-term stock values would remain high,they looked for ways to use the companys stock to hedge its investments in these other entities.Business analysts began trying to unravel the source of Enrons money. The Raptors wouldcollapse if Enron stock fell below a certain point, because they were ultimately backed only byEnron stock. The deals were so complex that no one could really determine what was legal and whatwasnt. Eventually, the house of cards began falling. When Enrons stock began to decline, theRaptors began to decline as well. On August 14, 2001, Enrons CEO, Jeff Skilling, resigned dueto "family issues." This shocked both the industry and Enron employees. The Enron scandal,revealed in October 2001, eventually led to the bankruptcy of the Enron Corporation, thedissolution of Arthur Andersen, which was one of the five largest audit and accountancypartnerships in the world. Enron undoubtedly is the biggest audit failure. It is ever the mostfamous company in the world, but it also is one of companies which fell down too fast.Meanwhile, it makes analysis the moral responsibility From Individuals’ Angle andCorporation’s Angle. Page 3 of 6
  4. 4. ENRON: Discovering Fraud On August 15, Sherron Watkins, an Enron VP, wrote an anonymous letter to Ken Laythat suggested Skilling had left because of accounting improprieties and other illegal actions. Shequestioned Enrons accounting methods and specifically cited the Raptor transactions. Later thatsame month, Chung Wu, a UBS PaineWebber broker in Houston, sent an e-mail to 73investment clients saying Enron was in trouble and advising them to consider selling their shares. Sherron Watkins then met with Ken Lay in person, adding more details to her charges.She noted that the SPEs had been controlled by Enrons CFO, Fastow, and that he and otherEnron employees had made their money and left only Enron at risk for the support of theRaptors. The Raptor deals were written such that Enron was required to support them with itsown stock. When Enrons stock fell below a certain point, the Raptors losses would begin toappear on Enrons financial statements. On October 16, Enron announced a third quarter loss of$618 million. During 2001, Enrons stock fell from $86 to 30 cents. On October 22, the SECbegan an investigation into Enrons accounting procedures and partnerships. In November, Enronofficials admitted to overstating company earnings by $57 million since 1997. Enron, or "thecrooked E," filed for bankruptcy in December of 2001. Page 4 of 6
  5. 5. Share Prices before and after Fraud happens:Final Destination of Frauds: Enrons CFO, Andrew Fastow, was behind the complex network of partnerships andmany other questionable practices. He was charged with 78 counts of fraud, conspiracy,and money laundering. Fastow accepted a plea agreement in January 2004. After pleading guiltyto two counts of conspiracy, he was given a 10-year prison sentence and ordered to pay $23.8million in exchange for testifying against other Enron executives. Jeff Skilling and Ken Lay wereboth indicted in 2004 for their roles in the fraud. On May 25, 2006, a jury in a Houston, Texas federal court found both Skilling andLay guilty. Jeff Skilling was convicted of 19 counts of conspiracy, fraud, and insider trading andmaking false statements. Ken Lay was convicted of six counts of conspiracy and fraud. In aseparate trial, Lay was also found guilty on four counts of bank fraud. Kenneth Lay died ofa heart attack on July 5, 2006, and a federal judge ruled that his conviction was void because hedied before he had a chance to appeal. On October 23, 2006, Skilling was sentenced to 24 yearsin prison. Page 5 of 6
  6. 6. Conclusion: (1) There should be a healthy corporate culture in a company. In Enron’s case, its corporate culture played an important role of its collapse. The senior executives believed Enron had to be the best at everything it did and the shareholders of the board, who were not involved in this scandal, were over optimistic about Enron’s operating conditions. When there existed failures and losses in their company performance, what they did was covering up their losses in order to protect their reputations instead of trying to do something to make it correct. (2) A more complete system is needed for owners of a company to supervise the executives and operators and then get the idea of the company’s operating situation. There is no doubt that more governance from the board may keep Enron from falling to bankruptcy. The boards of directors should pay closer attention on the behavior of management and the way of making money. In addition, Enron’s fall also had strikingly bad influence on the whole U.S. economy. Maybe the government also should make better regulations or rules in the economy. (3) “Mark to market” is a plan that Jeffrey Skilling and Andrew Fastow proposed to pump the stock price, cover the loss and attract more investment. But it is impossible to gain in a long-term operation in this way, and so it is clearly immoral and illegal. However, it was reported that the then US Security and Exchange Commission allowed them to use “mark to market” accounting method. Thus, an accounting system which can disclose more financial information should be created as soon as possible. (4) Maybe business ethics is the most thesis point people doing business should focus on. As a loyal agent of the employer, the manager has a duty to serve the employer in whatever ways will advance the employers self-interest. In this case, they violated the principle to be loyal to the agency of their ENRON. Especially for accountants, keeping a financial statement disclosed with true profits and losses information is the basic responsibility that they should follow. *****XX***** Page 6 of 6

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