Enron Corporation from United States, that was considered as the largest electricity and the natural gas trader around the globe, on 2nd December 2001 declared bankruptcy. It was the largest bankruptcy in the the history of US during that time that left the world in shock. Thousands of employees from the company became jobless and at the same time they lost their savings from the retirement amount. Moreover, the shareholders experienced their investments to be crushed on and hundreds of Enron’s creditors went to the bankruptcy court, who were expected to get very little amount out of their dues.
The implications on the accounting profession, politicians, pension funds, managers, directors, investment analysts, board committee and the politicians were huge. The way in which the business was used to be conducted were under more scrutiny following the case of Enron. The policies of remuneration are questioned more closely and more frequently. To be more specific, the practices and affairs of the business will not going to be the same as before again (Enron Corporate Governance Issues, 2017)
Early in the year 2001, the company had the plans for large earnings for the financial years 2001, after consecutive increase of earning the the previous two quarters. However, the company found one major problem in achieving their goal, that is, the concentration risk with regard to the business of energy trading. They expected that the strong earnings report for the 2nd quarter will offset the liquidity risks that they were facing that time. The liquidity risks were expected to be off set with the fact that Enron was the world class organization that had worldwide business network and were having the market capitalization amounted to $ 36 billion and the assets amounted to US$ 65 billion, out of which $ 288 million were cash and $ 7.3 billion were current assets. Much attention was paid to the balance sheet of the company, particularly how they hid the debt through distributing it among the private partnerships. However, the share price of Enron’s jet engine due to the increase in revenue rather than the increase in the assets. During 1996 to 2000, the company reported the increase in sales from $ 13.3 billion to huge $ 100.80 billion. They explained the reason behind their huge increase in sales that they were experiencing the double revenue, which was not the case actually (Sonmez & Yild?r?m, 2015).
The actual reasons behind the huge growth rate in sales were that the company was able to exploit the loopholes in accountings. The loophole found as the Financial Accounting Standard Board (FASB) was failed to decide that how the contracts for energy is to be accounted for. Therefore, Enron used to record the revenue from the contracts of energy-derivatives at the gross value rather than recording them at the net value like other securities transactions.
By that time, when they filed for bankruptcy during December 2001, they were subject to various investigations related to the disclosures and accounting policies. It was found that there was lack of internal control that led to the company towards bankruptcy. This disaster was associated with the various partnerships of the off-balance sheet items. To hide the debt, they were engaged with aggressive accounting. They generated partnerships with the independent organizations, most of which were offshore based. These were utilised to make the debt exposures incomprehensible and cover-up the losses from the broadband sector. Generally, these organizations were headed and set up by Andrew Fastow, the previous CFO (Chief Financial Officer) of Enron and were backed up by the stock from Enron. Further, they never accounted for their partner’s debt through usage of off-balance sheet method of accounting. However, the aggressive use of the partnership was questionable as they did not disclose the amount of contingent liabilities. Further, as Enron went into liquidation, shareholders realised that their investment amounted to $ 50 billion simply vanished. Moreover, in the worst scenario, the saving of their employee’s pension fund were wiped out, small part of which converted into the equities by purchase of the stock from Enron.
Management utilised the stock option to align the interests of management with the shareholders without affecting the balance sheet. Jeffrey Skilling, the former CEO of Enron commented on the Senate testimony as follows – instances are there where the equities can be used to affect the income statement or the one used by most of the company in the globe is the stock option of the executives. The method used here is that the company issues the stock option to reduce the expenses towards compensation and increase the profitability. Owing to this, the company manages to pay-off the excessive salaries to the directors, which was found in case of Enron without affecting the income statement of the company. This also allows the growth in the price of the shares that not only benefitted the shareholders but also the directors who had the options to the shares (Nakpodia et al., 2016).
In today’s competitive business world, the corporate governance is not just an option, it the lifeline for the corporate industries where the implementation of corporate governance assists in removing the wastes and provide oxygen to the business. Corporate governance assures that the internal controls of the organization are in place and the risks are managed appropriately. While scrutinizing the circumstances of Enron clearly and extremely, it was found that initial motive of the company was not to commit the fraud, rather it was more like a normal business strategy for not delivering the forecasted result and finding a short-term solution to the issue that led the situation to slip out of the hand with the times. Owing to this, an extended circle of good people also headed towards the term that is known as passion for greed through the pressure imposed by the company.
As per the previous outcome of 1980 with regard to the trading scandal, the company did not take any strong steps to improve the corporate governance of the company to remove the likelihood of further failures in the internal control aspects of the company. Apart from this, the poor reporting practices of the company led to lack of over the employees, which in turn, allowed the executives to enhance their position of expenses of the company. However, while the stocks of the company were increasing and the shareholders were getting rich, little incentives were there for the board that led to close investigation of the executives. The fault was from the part of the board for allowing the suspension of the code of conduct that was required to be followed by the company that led to various accounting conflicts (Sorensen & Miller, 2017).
As per the management theory, the board is responsible for performing the three roles:
Out of the above mentioned three roles, the role of control is the most traditional and basic role that are of major importance to the company. Further as per the report of the Permanent Subcommittee on Investigations (PSI), the board of Enron failed in the below mentioned aspects:
Though in some instances there were the indications that the members of the board were not informed or misinformed, the investigation of PSI found that the board received the overall information regarding the activities and plans of of the company and unambiguously allowed or authorised various questionable transactions, policies and strategies (Yahya & Thurasamy, 2014). The high-risk accounting policies were also not concealed from the board members. The board were well aware of the facts and did not take any steps for preventing the company from utilising those strategies. The failure on the part of the board members for not taking any steps and not accepting any responsibility on personal level was a crucial indicator that the board failed to recognize the fiduciary obligations for attaining the overall strategic direction of the company and assure the responsible reporting of the financial position of the company (Tricker & Tricker, 2015).
Conclusion
It is concluded from the above discussion that the accountants failed on their part as they failed to take into consideration the energy contracts. Further, the auditors failed as they did not maintained their independence and integrity. Moreover, the company failed on their part as they failed to provide enough power to the internal control and risk management committee. For each of them, the failure was not of secondary nature; rather these were the primary reason for the existence of themselves.
References
Enron Corporate Governance Issues. (2017) (1st ed.). Retrieved from https://www.resbank.co.za/
Nakpodia, F., Adegbite, E., Amaeshi, K., & Owolabi, A. (2016). Neither principles nor rules: Making corporate governance work in Sub-Saharan Africa. Journal of Business Ethics, 1-18.
Sonmez, M., & Yild?r?m, S. (2015). A Theoretical Aspect on Corporate Governance and Its Fundamental Problems: Is It a Cure or Another Problem in the Financial Markets?. Journal of Business law and Ethics, 3(1), 20-35.
Sorensen, D. P., & Miller, S. E. (2017). Financial Accounting Scandals and the Reform of Corporate Governance in the United States and in Italy. Corporate Governance: The International Journal of Business in Society, 17(1).
Tricker, R. B., & Tricker, R. I. (2015). Corporate governance: Principles, policies, and practices. Oxford University Press, USA.
Yahya, T. T. Y. A. S., & Thurasamy, R. (2014). Corporate Governance Development: New or Old Concept?. Corporate Governance, 6(7).
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