business

Fall of Enron

Introduction

Enron Company was formed in the year 1985 as an American energy company. The company was opened in Houston, Texas to unite with Houston Natural Gas and Intermonth. Enron was formed as a communications and energy trading company. Its main aim was to transmit electricity and gas. The distribution took place all over the United States. Additionally, Enron was involved power plants and pipelines development and operations in the whole world. Enron became one of the largest and fastest growing industries in the country. It is worth noting that Enron Inc. became independent producing and distributing gas and electricity in the United States. The electricity was from wind and solar renewable energy. Enron Company, therefore, became an innovative company trading natural gas and electricity both in retail and wholesale mostly in northern America. Enron company was said to be doing completely well in the business for at least six years. It performed well in the electricity and energy industry and emerging market. Due to the great sales, it made in the energy industry in Africa, America, and Philippines, Enron made a good reputation for its business. however, the business seemed to perform well through this was not the case. Therefore, its collapse came in 2001 when their strategies failed to work (Dibra, 2016).

Competitive Positioning

Every company or organizations aims at differentiating their products and services in order to remain competitive in their market. Enron Company was not an exception to this. The company was founded and involved in the business with the aim of being unique in the services it offered to its customers. The management of the company understood that in order to remain competitive in the market, there was a need to come up with a unique strategy. Therefore, the company indulged in differentiation. This strategy enabled Enron to involve in the businesses of trading different assets. Rather than concentrating on energy production, Enron company also operated other services such as the pipelines, broadband services, water plants, electricity plants and paper plants. The company ensured that it was active in all the businesses surrounding the industry. Therefore, it continued to do great in the energy industry since it was able to obtain high revenues, unlike its competitors.

The differentiation strategy created a good image for Enron company which in turn attracted many investors. Within a short period of diversifying into trading energy, water, and electricity, Enron company was considered a high-tech global organization. It became recognized all over the world. To keep on blooming, Enron would publicize the actions it made to achieve the high profits after formulating every strategy that it came across (Lemus, 2014). Additionally, Enron’s culture involved installing a competitive advantage for every employee. The employees recruited and maintained in the company had various educational backgrounds as well as experiences. Through the employees, Enron company was able to remain at the top of its competitors. The bankers, advisors and also auditors played a significant role in maintaining the public image of Enron company. These employees would work hand in hand with the managers to ensure that the shoddy businesses practices of the company were not revealed. Due to this strong management strategy in Enron, the company was able to reflect huge profits which were termed as a success for the company (Rantanen, 2007).

Potential Causes of Failure

Enron’s rise in the energy industry was a mystery. The competitors did not understand how Enron was able to keep up with the business in the growing industry. However, the company would soon face a tragedy that led to its collapse and eventually failure (Lemus, 2014). Although the failure of Enron cannot be accredited to any specific issue, it can be connected to various reasons.

One of such reasons was the use of mark-to-market accounting strategy. This means that the company used the market value to measure its security. In this strategy, Enron company would come up with an expected profit for an asset it produced. The expected profit would then be included in the books without the asset even being sold. Unlike the method of book value which is used by most businesses, the mark-to-market accounting strategy would hide the financial losses incurred by the company. This is because the losses achieved by the company were not included in the balance sheet, instead, once the expected profit was projected in the books, the amount would not be tampered with or changed (Rantanen, 2007). The losses achieved therefore always went unreported. The strategies very good at making the company seem more profitable than it actually was. Although the mark-to-market accounting strategy worked to maintain the public image of the company, it later backfired. Most of the profits that Enron Inc. had been only in papers. The losses had become extreme and the little revenue and profit that the company was could not maintain it to that level. This lack of enough money to keep on trading meat a cash crisis which led to the sudden collapse of Enron company (Dibra, 2016).

Enron company was also involved in serious accounting irregularities. The management involved in irregularities that enabled them to fabricate earnings. Additionality, the financial misconduct enabled the company to hide its losses from investors as well as the public. The misconducts also went a long way in that the company failed to account for the owns and debts it had. Most of the capital that used to run the Enron company came from investors. Therefore, when the debts and accounting misconducts of the company became revealed, the investors and employees stopped involving in the company’s activities. It is worth not that Enron was not independent and therefore it was dependent on the investors. The withdrawal of these investors thus meant there was no capital to run the businesses hence leading to the collapse of the company (Barreveld, 2002).

The other issue that contributed to the failure of Enron company was its culture. The company was recognized for having pride in its employees. Therefore, the management would give awards to employees randomly. The employees in Enron company were worth any kind of incentive if they were considered to bring in an extra amount of money into the business. The employee would therefore always compete with each in order to obtain the rewards, the bonuses that were in the form of stock or cash would flow into every employee who closed their deals at a high speed. Due to this fact, the employees did not care about the results achieved but rather about the rate at which they worked. Instead of working as teams to achieve specific objectives, the employees in Enron company worked solely. The employees were used to competing with each other (Li, 2010). The competition among the employees in Enron meant that the services and products being offered to the public were not of a high quality. This, in turn, led to a decrease in purchase of the good and services. Moreover, the high amount of bonuses and incentives given to the employees increased the expenditures of the company. This would mean that the company did not have enough money to run it businesses hence causing bankruptcy which contributed to the failure of the company.

Enron’s Competitors

There are many companies that operate in the energy industry. Therefore, Enron company has a lot of competitors. However, Enron did not consider its competitors a threat that would bring its business down. Some of Enron’ competitors included Dynegy Inc., El Paso, Duke Energy, Reliant Energy, and Williams. All of these energy companies had the desire to reach the top and beyond Enron. Therefore, most of the companies would come up with strategies that would see them obtain more customers to purchase their products and services. Some of these strategies used by Enron’s competitors included the use of the new technologies to come up with innovations in their businesses. Consequently, Enron competitors would provide cheap energy products and services to attract and retain more customers. Additionally, these competitors would indulge in research of how Enron was working so as to develop in a better way than Enron. Despite being Enron competitors, these companies would try to copy Enron in its businesses. Enron had registered a big margin in the revenue obtained as compared to its competitors (Li, 2010). Therefore, the competitors would try to copy the ideas from Enron and in turn develop those ideas and make them better. Through this strategy, the competitors aimed at putting to an end Enron’s competitive force. However, the strategies would not work until Enron faced the tragedy and collapsed.

Growth of the Energy Industry

It is worth noting that the energy industry is rapidly growing. The increase in the use of electricity and other energy services has led to an increase in energy demand in the whole country. Additionally, the production that is done by the existing companies in the industry is not enough to meet the consumer needs. Every other industry uses energy for its manufacturing and production of goods. Additionally, many other industries are also emerging. This thus means that the energy produced by the companies in the industry needs to be increased in order to cater for all other sectors that require energy for their operations. However, the energy industry may be considered to have matured. This does not mean that the energy produced is enough. Instead, it reveals that the energy industry keeps on changing from time to time. New innovations and developments are made in the energy sector and therefore the production of energy is increased (Lemus, 2014). This facilitates the continuous growth of the energy sector. Due to this growth, there is also an increase in the number of companies developing in the industry. This increases the competitors available to compete with Enron in the market.

Position of Enron

Enron is ranked as the highest performing company in the United States the energy industry. The company was so successful that the revenues it obtained were much higher than those of any other company in the industry. Enron Inc. took advantage of all available opportunities to expand its business. Unlike its competitors, Enron was in a unique position to provide the services and products required by customers from the energy sector. The management of the company used distinguishing strategies to facilitate the flow of revenue as well as profits for the company. The use of these business strategies placed the company in a higher position than its competitors. Additionally, the company was able to reach to and maintain more customers than any of its competitors. The company was also known for hiring the best employees since it chooses the most skilled and qualified persons (Barreveld, 2002). This, in turn, facilitated a better performance for the company hence increasing the amount obtained to keep the business running and performing. The company was doing great and registered at least shares worth $90. It was considered to be America's m most innovative company. Every investor wanted to be associated with the businesses taking place in Enron. This meant that it had a great advantage over its competitors which meant it was at a higher position than its competitors. This, thus, led to the transformation of Enron into the world’s largest energy trading company.

Enron’s Products and Service

Enron company involved in a wide range of operations. The initial business of the company was to provide and supply pipeline gas to customers. However, it sought to diversify into various other products and services so as to have many ways of obtaining revenues. Enron company involved in the sale of natural gas, electric power as well as other energy products. Consequently, the company involved in energy plant, paper plants and water plants services production. This meant that unlike its competitors which only concentrated on energy manufacturing and production of natural gas, Enron provided extra services and products such as the production of electricity and supply of wind and solar energy (Barreveld, 2002). The company also use the Enron online platform to sell its products and services. The online platform helped the firm to reach a larger market hence facilitating its growth. The diversification and involvement in the gas futures and weather futures also enhanced the growth of Enron Inc. therefore, the various business platforms it involved in led to its development.

Enron’s ERM

Enron company was regarded to have a great the enterprise risk management program. The society believed in the ERM of Enron to protect the company against all risks. The progress of the company showed that the company was perfectly performing. However, the collapse of the fir in 2001 showed a different perspective. The collapse revealed that the risk management of Enron was weak and did not have the capabilities to assess the risks in the energy industry. The collapse of the company was a significant corporate and financial failure that revealed all the weak points of the system. It would have been important if the management of Enron company had evaluated the risks present in the industry. This would have helped to avoid the risks by using and implementing all the strategies that would work towards the prevention of business risks occurrences (Dibra, 2016).

Overview

Most companies emerge with the aim to bloom and stay at the top of the industry. This, in turn, calls for the implementation of various strategies that work in a competitive industry. Enron company is no exception. Enron Inc. entered the energy industry with great hopes. It ventured into the business and succeeded in its operations. This saw the company rise above its competitors. However, the strategies used by the company were not the best to keep it progressing. Enron used strategies that would only lead to its success for a short while and later one cause a tragedy. The tragedy then led to the failure and finally collapse of the company. Therefore, it is important for businesses to use the best strategies for running their business to facilitate long-term success.

Failure Audit and Root Cause Analysis

Undesired Outcome

Enron’s broadband business, which was forecasted that would add $40 billion to Enron’s stock value, only created $16 million in revenue in second quarter of the second year, then was closed.

Contributing Factors

On March 2001, Blockbuster terminated the deal with Enron about providing video-on-demand through using Enron’s energy giant’s infrastructure network. Because it did not make any profit.

The price of fiber-optic circuits dropped sharply, which made Enron tried to attract telecommunications giants that used broadband, like MCI WorldCom Inc. and Verizon Communications Inc., to trade with it and create a true market. However, Enron failed.

Enron broadband trading did not become the main income of Enron revenue. It calculated for only $408 million of Enron's total $100 billion in reported revenue.

Proximate Cause

Enron executives and directors sold $924 million of company stock in 2000 and 2001, in order to gain the profit of share price appreciation.

Enron sold its dark fiber to the private partnership----LJM2, which run by its then-chief financial officer, to gain a large profit. LJM2 sold part of its fiber to other private partnership created by Enron. Therefore, Enron could act as banker to the new partnership and underwrote the purchase. In fact, Enron still had $61 million of original $70 million debt.

As broadband prices continued to fall, Enron still insisted it was not influenced by the problems. The officials thought that the company would gain profit from the glut by buying surplus space cheaply and reselling it at a profit.

Enron accounting models would decide a future date when the fiber would be upgraded from "dark" to "lit," and thus multiplying the revenue that the circuits would generate after they became operational. Even though no person could make sure when or if the circuits would become operational, the increase in expected value would be added to Enron's current income.

Intermediate Cause

Enron broadband gained large profit through trading with private partnerships it had set up itself. This situation was similar with trading with themselves. Thus, it could use enterprising accounting practices to exaggerate the value of its broadband contacts and greatly increase its actual revenue and profit.

Enron broadband continued to lie that its trading operations were growing rapidly.

Enron had Two-Path Strategy for its broadband trading. It bought or leased cable in USA and abroad to create and connect its Internet lines tied in with other major networks. Meanwhile, Enron’s traders would start to buy and sell space on those broadband networks, in deals including both Enron and its competitors.

Enron was not about patience. In the company's hard-driving corporate culture, compensation and bonuses were inextricably tied to constant gains in revenue and stock market value, particularly for top executives.

Enron used the "mark-to-market" accounting method, which recognized the total value of a multi-year contract at its beginning and then recorded any gains or losses in value over time as the market dictated. However, this kind of contract is only suitable for ready market. But there's not an active and ready market for broadband, so Enron assigned values and recognized revenue upfront as it wishes.

The main objective of Enron’s strategy was not to enhance the long-term sustainable growth of its company and to increase shareholders’ value, but to enrich its executives.

Root Cause

Enron’s management was heavily compensated using stock options. This can motivate managers to make decision that pump up short-term stock performance, but not a long-term value. That compensation structure created a myopic vision that focus on short-term profit rather than long-term sustainable growth. And the executives tend to play down the underlying risk in this situation.

A conflict of interest. The CEO and executives’ goals were to enrich themselves, not acting on behalf their shareholders. This risk flowed from Enron’s top management to the lower in the hierarchy. This was because the Enron lacked independent management framework. This lack of independence resulted in a conflict of interest allowed for fraudulent activity to occur.

The speculative nature of Enron made the company face high market risk and economic risk. Enron mainly acted was becoming an intermediary and getting profit by arbitraging price differences. However, financial instruments were highly volatile, so it is hard to forecast its price accurately. Most of ventures were too dependent on the dot-com bubble. So, when the bubble was exploded, Enron started to widely use market-to-market accounting to cover losses and high debt in broadband field, in order to maintain its share price at a high level.

A firm usually has two auditors, one external and one internal. In generally, Internal auditor prepares the balance sheet of the company and the external auditor would review the work of internal auditor and determine if it is correct and provide a fair view of the firm financial conditions. However, Arthur Anderson acted both as advisor and external auditor for Enron. That seems like Arthur audit its own works. That’s exactly disadvantageous for audit of corporation.

Corporate Audit committees were infrequent and covered lots of agendas. As external directors, they only could rely on information from management as well as internal and external auditors. It was difficult for audit committee to find the malpractice of company and challenge the strategy of company. Therefore, the audit committee was more of a formality than being an effective risk control.

US accounting standards were mechanical and unable to capture intricacies in newly devised synthetic derivative products. This motivated tailored financial engineering designed specifically to bypass these rules. In accounting for some of its SPEs, Enron was able to design transactions that satisfied the regulations without reflecting its true financial risks.

Framework Selection

Based on the RCA mentioned in the last section, three frameworks are recommended to help Enron in terms of strategic decision-making process, risk management process and compensation structure.

Strategic Decision-Making Framework:

Enron should establish an effective strategic decision program that consists of three pillars. The first pillar is that greater integration of Risk Management and the business to help Enron take smart risks. The second pillar is that enhanced strategic tools and methodologies to help Enron better identify strategic and emerging risks. The third pillar is that understanding the impact and uncertainty to the strategy, business, product offering (Mok, 2017).

First pillar: integration of risk management and strategic planning (Mok, 2017)

Construct a strategic development group that are consist of both chief strategic officer and chief risk officer, (Enterprise risk management is normally also one of the responsibilities of CRO). Therefore, whenever chief strategic officer proposes new opportunities, strategies, CRO could provide his/her insights on the inherent risks in each proposed strategy. Furthermore, CRO who also runs the ERM program, would know whether strategy is acted in line with Enron’s objective, risk capacity and risk appetite.

Also, in order to ensure the strategic meeting subject does not favour one particular area, and to consider every possible aspects, the strategic development group should have senior executives from different areas to avoid convergent thinking and to provide useful inputs.

Strategic development group members are required to conduct certain strategic planning process such as the SWOT analysis, a complete strategic planning process before developing any strategies. For example, In the case of Enron’s broadband, the entire strategy was developed and decided solely by their CEO, Jeffrey Skilling. The main reason why Skilling decided to take this strategy was that he believed that the old strategy that worked for Enron, a old strategy which was emerging as the biggest player in each field, could also work on this new markets. That belief itself is a classic logic fallacy as everyone knows that what worked in one field does not guarantee success in another due to the differences in operating environment.

SWOT Analysis (Behr.P, 2002)

Strength

Diversify away the risks taken from energy trading sector.

Ideally, broadband service that trade communication bandwidth would have a relatively high demand due to the internet boom in 2000.

Enron had a valuable brand name as well as its reputation. Such a reputation was good for Enron and would have continued to attract investors and it would also have drawn the trust of clients and their loyalty. That is one of the strongest comparative advantage Enron had.

Enron had an extensive base of capital and investment in broadband telecommunication, it would allowed its expansion.

Weakness

Extremely costly. The optical fibre network itself cost Enron around $1.3 billion to build. After the establishment of the network, people could then buy and sell bandwidth on this network.

The initial cost was too high that Enron had to charge customer extremely high to recover from the initial cost.

Enron did not have any expertise in Broadband service, not to mention establishing a continually R&D team. In order to gain the technology, Enron had to either take-over broadband service providers or entered joint venture. But Enron did not have expertises and methods to identify which venture had the potential to be the dominant one in the future. Enron also bought multiple ventures at one go, instead of taking on a step by step approach , and all those ventures were strongly dependent on the doc.com bubble burst, which coupled losses that were un-recoverable.

Enron overestimated the demand of bandwidth at that time. While broadband internet access increased rapidly, the vasts majority of consumer continued to surf the internet using dial-up connections.

Due to the technological deficiencies, there was not a huge differences in terms of transmitting data, but the price was totally different. Therefore, demand for broadband service was small.

Enron’s main weakness that lead to its failure was the concealment of failures and misshapes that were occuring within the company. Failed ventures and losses were hidden instead of being exposed and as a result there were no remedial measures taken in time to alleviate future problems

Opportunities

Sharp rising user of internet surfing due to the internet boom. Based on the statistic, % of internet user per household rises sharply from 21.2% to 41.5% from 1999 to 2000.

Threat

Enron were way too aggressive in terms of expansion without careful and well-paced consideration of expansion.

Apart from SWOT analysis, a throughout strategic planning process can be conducted, in order to help better developing decision. Strategic planning process can help Enron see a set of both risks and opportunities more broadly. Enron needs to focus on the following areas to complete its strategic planning. The detailed processes to address following areas are included in the Appendix I.

If Enron is heading the right direction

If Enron has the right talent and capabilities needed to execute

If the chosen strategies create unintended new risks

Also, conducting strategic risk review jointly and in concert with strategic planning processes will improve management’s decision making process by enforcing a disciplined approach to considering the continued relevance of set strategies, reduce uncertainty and human bias.

Second Pillar: Enhanced tools and methodologies (scenario planning and assumption test)

Enron should conduct scenario planning and assumption testing to help Enron manage

potential futures or alternative scenarios that might challenge it current strategic assumptions, and to spot potential sources of risks that may not surface in other ways.

Scenario planning is basically considering various likely future scenarios that broadband

service industry may be facing, so that Enron could have came up with various controls and plans in place to deal with those adverse scenarios. Enron should have prepared to manage the scenarios individually and collectively. The detailed possible scenarios are included in the Appendix II.

The greatest source of risk to a strategy is often the assumptions underlying it (Mok, 2017). Making choices and assumptions about the state of the market is inherent in the strategy-setting process, but conditions will eventually change, potentially dislodging an initial set of assumption. Assumption test is needed to test how strong the underlying assumptions are. The following are the necessary steps needed to construct an assumption test.

The first step of this process would be to articulate all the assumptions used in the proposed strategy. Clearly, the biggest assumption in this strategy is that the strategy worked in one field would guarantee success in another. This biggest assumption does not hold even without testing, but still, Jeff Skilling still relied on that assumption.

The second step of this process would be to put all assumptions into a model and change its assumption value and see how it would have impact the final results. For example, in the case of broadband service, Enron may have made an assumption that the percentage of customer are willing to buy their broadband service was 20% and may have projected profit based on that underlying assumption. Keeping changing the demand assumption and seeing how much it would have impact the projected profit. By doing this, Enron would have determined whether this is a significant factor to their profit and would have developed metrics to monitor them in the future.

The last step is to identify key assumptions and establish monitoring practices to Enron when those assumptions change

This test allow Enron to establish indicators/triggers that can be monitored over time to alert Enron before those assumptions have been invalidated by external competitors or events.

Also such assumption testing need to be continually and certain roles and responsibilities need to be assigned in the beginning.

Pillar 3: understand the impacts of change and uncertainty (Mok, 2017)

Executives need to understand how external trends, business models innovation, new approaches used by competitors and new products could threaten Enron’s broadband business. By asking and answering the following questions, executives could assess the impact of changes.

Enron needs to qualitatively and quantitatively assess the impact of changes on the three key variables: revenue, asset, and assumptions.

Asset: Enron should know the impacts of fast expansion would affect their asset and impacts huge investment in network would affect their asset. Enron should also know how their assets would be affected if it enters different fields.

Revenue: Enron should know the extents to which future economy would affect the broadband revenue; Enron should know the extents to which new entrants affect its revenue; Enron should know the extents to which future inflation, technological improvement affect its productivity and revenue. Enron should know the extents to which future change in customer behavior would affect their revenue; Enron should know the extents to which future retaliation from competitors or increased competition level in broadband industry would affect their revenue.

Assumptions: Enron should know that the confidence level of their assumptions; and the likely future events that would weaken, strengthen or even invalidate their assumptions. Enron should know the likelihood of those future events occurring; Enron should know what assumptions they do not have right now, but they need to include in the future as due to change in external environment.

Risk Appetite Framework

Based on the RCA in part two, Enron’s top management created a excessive risk-taking culture, inadequate strategic planning and risk management process in place so that Enron tend to jump in high-risk business activities without fully understanding the risks involved. Those root causes can be remediated by implementing a through risk appetite framework.

No business can thrive without taking on risks (Deloitte, 2014). A key benefit of deploying a risk appetite framework is that these risks are identified and quantified in a structured way that relates them to the firm’s business objectives and strategy. By deploying a properly embedded risk appetite framework, a firm can choose to take on particular amount of particular risks, in line with its overall business strategy and in contrast to proactively or passive risk-taking.

The following steps are proposed to turn Enron around:

First, Enron must establish a strong independent risk function that has the confidence and capabilities to design, build, launch and embed risks language and concepts across the firm (Deloitte, 2014). Although Enron had all the infrastructure of proper management control, a risk assessment and control group, a big-five auditor and conventional powers of boards and related committees, the lack of independences in those areas invalidates the intended used of those elements. To improve its effectiveness of those elements, the structure needs to be changed. To reduce conflict of interests and maintain independent, internal auditor cannot serve their client for too long; employees in audit firms cannot work for their client and external auditors cannot be their internal auditors. Moreover, CEO cannot be both the chairman of the board and executives, which means CEO cannot be in multiple committees at the same time.

Second, board members and executives need to be replaced. Senior management and

board must buy-in the risk appetite framework concept enough to make risk appetite the way that Enron approaches risks. The tone from the top must appreciate such framework and that is the reason why Enron had proper risk management policy, but still excessively take risk. At the same time, hiring board members and executives are willing to lead and are capable to articulate and recognize financial and non-financial risks in Enron business model and strategy.

Third, under the help of their independent risk functions, board members and executives

need to establish Enron’s risk capacity, the maximum level of risks at which Enron can operate, while remaining within constraints implied by capital and funding needs and its obligation to stakeholders.

The next essential step for board members and risk functions is to establish risk

appetite statements to various risks after considering their objectives and strategies. Risk appetite statements are a set of statements that articulate the various risks Enron is willing to take in the pursuit of their strategy. Risk appetite statements should be in the forms of qualitative and quantitative statements as some risks can be quantitatively expressed and some cannot. A useful quantitative risk appetite statement for Enron could be allowing a 5% chances to receive total loss of $2m in broadband service business. A useful qualitative risk appetite to Enron would be that Enron has zero tolerance to internal fraud.

Next, using both Top-down and bottom-up approach to identify risks within each

business unit, controls in place, residuals risks in each business and aggregate them together to form an enterprise-level risk profile, the total amount of risk exposures Enron has at the moment.

After setting up risk capacity and have identified risk profile, Enron should now set

different risk appetite limits. Having established risk limits, Enron would be able to know where has gone wrong and take corrective actions in time. Enron can set upper and lower risk appetite limits, different levels of attentions are needed when Enron’s risk profile breach different risk limit level. For example, Enron might set their upper limit on business risk as $15m loss. So, if Enron loss more than $15m on broadband service due to the fact that Enron’s competitor launched a much quicker bandwidth services, then all current broadband business needs to be shut down and losses need to be reported to all board members.

For internal fraud risk appetite limits, Enron could set the following (KPMG, 2016):

If Enron should not have non-independent of auditor

If Enron have compromised quality of audit work due to reduced fees

If Enron has deliberate actions and misrepresentation by management to delay or divert auditor’s attention from problematics areas

If Enron have a person who is in charge of multiple position that gives him/her too much influences in company

If Enron leaders have excessive interests in maintain stock process

So if Enron breached 3 of them, immediate board meeting maybe needed and remediate actions need to be given in the board meeting. That would reduce Jeff skilling’s and Kenneth Lay’s capabilities and opportunities to committee internal fraud.

Moreover, after setting up risk limits and corresponding actions when Enron’s risk profile

breaches the limits, Enron need to establish the monitor practices and reporting lines. Also, owner of risks need to be assigned so that employees in Enron know who to talk to when different risk trigger events occur. The Key Risk Indicators, risk drivers and measures and limits need to be agreed at the outset, so that employees in Enron know what to monitor. Also, the frequencies of monitoring need to be set up. The monitoring frequency cannot be too short that would waste too much time and resources, but not too long that risk profile has breached the upper risk limits.

In addition, Enron’s risk management framework needs to be constantly reviewed and validated by independent third parties. Enron could invite external auditor to regularly check the effectiveness of their internal control, structure, risk management policies, process, risk governance, culture and refer to the best practices in industry and give recommendations.

The last but the most important step to be that Enron must aware that a risk appetite framework is just one piece of the puzzle. In order to ensure effectiveness of their framework, Enron must watch out other pieces of the puzzle, which are risk culture, risk governance, risk management tools and risk infrastructure. Once Enron has improved all of the pieces, they then can integrate risks into their decision making process and take appropriate amount of risks.

Compensation Structure Framework

From the broadband service failure, one of the key incentives for Enron’s executives to enter into this industry was that they know that they would definitely be able to gain personal advantage as long as they could figure out a way to boost the current price under the current compensation scheme.

In 1999, the US CEOs with top 50 income had average about 94.52% stock income

from their annual income, and this structure made CEO to maximize the profit of the company.

Especially in Enron, roughly 80% of CEOs’ total compensation came from cashing in stock

options. “In the report of 12 highest paid oil & gas CEOs, Enron’s CEO Rex W. Tillerson was

ranked 6th. His income is $28,138,329, and his salary is $2,717,000” (MIL, 2015). The CEOs only wanted to make the profit to be maximum, no matter in what way, and with how many

risks. And this was what they told their employees to do. All they want is increasing

company’s short-term profit and boosting stock price so that CEO will have higher income from the bonus and shares.

To begin with, Enron needs to do research of its current situation, then to definite the compensation principle and strategy. First thing to do is to collect information of Enron’s current situation, including organization structure, setting of every functional department and its starting point, function, responsible to whom. Second thing to do is to recreate Enron’s performance measures. The key problems with the previous performance measures were that Enron was only using single, simple performance measures in evaluating executives’ performance (short-term profit or share price rise percentage). That would lead to executives solely focus on the profitability and downplay other aspects, such as risks, working capital utilized when making strategic decisions. To change that, Enron needs to use multiple performance measures to evaluate executives’ overall performance. For example, RAROC (risk adjusted return on capital) can be a good performance measure to use, as it not only looks at profitability, but also looks at profitability after taking how much risks this project has taken and how much working capital it utilized into account. In the case of broadband service project where Enron utilized over $2 billion working capital with only around $20 million revenue, this project provides a incredibly low RAROC and no executives would have pass that project if RAROC was one of the performance measures. Also, the information of how to locate every functional department, and their existing staff’s assessment criterion and relevance of their system of rewards and penalties. Then, to grasp and analyze the framework of Enron’s compensation structure that currently in effect. Including the estimation of the total amount of income, which is the relationship and ratio of annual gross compensation and Enron’s profit. Also, the allocation proportion of every functional department, perspective every functional department’s highest, lowest, and the average income, the structure of income if there are any different structures between different department. Enron should consider what are in the compensation structure, how is the ratio, how is the bonus, and so on. Also, to analyze every employee’s hire date, education background and some factors that relate to income. Then, Enron needs to know its current position on market and their target, also the feature of its development stage and themselves’ strategic needs.

Secondly, Enron needs to proceed the work analyze for formatting the instruction of

every position in company. Thus, it can provide valuable basic information for the whole human resource management including the compensation management. If there is existing position instruction available, Enron can use it to classify, then analyze again based on its strategic direction and new principle. To make sure the compensation structure is fair, Enron can score every functional department based on categories of every position and the qualification requirement of taking office. Based on the order of the scores, it will have a hierarchy of every functional department. Then Enron can estimate the limited income of every department. Especially for CEOs, their income should be limited and lower.

When confirm the wage level, Enron needs to reference the wage level of labor market.

Enron needs to entrust professional consulting company to research the compensation for solving problems of its external competitiveness. Enron can use American Chamber of Commerce, William Mercer, Watson Wyatt, or Hewitt. Enron needs the consulting company to provide a whole statistic data of salary and welfare, and the research report of compensation practices.

Next thing is compensation positioning. After analyzing other industries’ compensation

data, Enron needs to choose different wage levels based on its current situation. Different positions will have different compensation structures. For sell department, is salary plus deduction percentage from a sum of revenue; for CEOs, is basic salary plus floating wage; for producing technology, is metering system. Enron’s problem is on CEOs’ compensation structure, so it needs to rebuild CEOs’ compensation structure. For compensation design, there are 3 types of strategies, they are 25P, 50P, 75P. These strategies that stand for 25th (low value), 50th (mid value), 75th (high value) if there are 100 companies. If a company use 75P as their strategy, it needs deep pocket, perfect management, and excellent product quality as supports. Now, Enron is facing so many problems, and it don’t have deep pocket or perfect management. For recovering itself, Enron should not choose either 75P or 50P. It should choose 25P as its strategy right now for a good beginning. At the most important, Enron needs to adjust the ratio of CEOs’ compensation structure to increase the basic salary and decrease the floating wage such as bonus, stock profit, and so on.

Framework Evaluation

Options	Losses saving	Cost	Time needed to construct	Total Score
Strategic decision-making Framework	0.5 (5)	0.3(4)	0.2(5)	4.7
Risk Appetite Framework	0.5(5)	0.3(2)	0.2(1)	3.3
Compensation Structure Framework	0.5(4)	0.3(5)	0.2(4)	4.3

Rating	Loss saving	Cost	Time needed to construct
1	Save more 10%	$6m	4 Years
2	Save more 20%	$5m	3 Years
3	Save more 30%	$4m	2 Year
4	Save more 40%	$3m	1 Year
5	Save more 50%	$2m	0.5 Year

The following assumptions are made for the above charts:

The first value is the importance weight that we think that specific dimension should have; the value should add up to 1

Loss saving account is the most significant dimension; cost of framework is the second most significant dimension, and time needed is the least significant dimension.

The second value in the parenthesis is the rating assigned on a scale of 1-5

Strategic and risk appetite framework save us around 50% more losses, with compensation framework save around 40%

Cost needed on strategic framework is around $3m, risk appetite framework need $5m, compensation framework needs $2m.

Strategic framework can be established in half year, risk appetite framework needs at least 4 years and compensation structure need 1 year.

These three above-mentioned frameworks are useful and crucial to help Enron recover and turnaround. Given that strategic decision-making framework option scores the highest with limited resources and time. The most appropriate and helpful framework after thorough consideration selected for Enron would be the strategic decision-making framework. Statistically speaking, weak strategic decisions and internal controls were identified in 60% of corporate failure cases (KPMG, 24). Since strategic risk is the most typical risk, it would be better for Enron to first consider and resolve strategic problems to avoid further losses. In addition, Enron is innovative, ambitious, and risk-taking. The company prefers to explore and enter new fields to maximize its profits. Hence, it is essential for the firm to develop a comprehensive and well-structured strategy program to prevent its recklessness. Furthermore, most of Enron’s decisions are solely made by its CEO, Jeffrey Skilling, who is also Enron’s president. Skilling, one of Enron’s senior management, has too much decision-making power and fails to discuss strategies with other management and board of directors. Thus, it is more necessary for Enron to have this framework to alter its decision-making modes. Lastly, this selected framework takes the least amount of time and money when compared to the other two. However, these three frameworks are not replaceable to each other. Although strategic decision-making framework is selected as the most vital and appropriate framework, these three frameworks can supply and rely on each other to generate better outcomes. Missing any one of the three would deteriorate the overall effectiveness. Therefore, it is strongly recommended that Enron should adopt all of the three frameworks if they have enough resources. Overall, switching the new proposed frameworks from the old should be Enron’s top priority.

Appendix I

Is Enron heading the right direction?

What are the objectives of the strategy? What are we trying to achieve? Are the objectives of the proposed strategy consistent with Enron’s business objectives?

What is the future trend of internet surfing and broadband service?

How likely is the broadband service going to be the dominant trend for future internet surfing? Why do you think customer would choose broadband service instead of free dial-up connection?

What are the unique advantages that Enron had in terms of broadband service that could make Enron the market leader

Is this strategy achievable in the given time? What are the initial costs? How long can Enron start to make profit?

What are the needs of customers? Can we meet their needs and their future needs in the foreseeable future?

Is the demand for internet surfing elastic or inelastic? What is the ideal price we should charge on our broadband service that it would not lower our demand?

Does Enron have the right talent and capabilities needed to execute?

What expertise and technologies do we have?

What is the maximum speed of data transmitting at the moment? What is our speed of data transmitting can we achieve at the moment?

How much time and money do we need to invest in order to be the technology leader in broadband service?

Who is responsible for Enron’s broadband service and what unique talent he could bring to the project and help our project to succeed?

Could the chosen strategy create unintended new risks?

What are the critical uncertainties shaping the future of internet and broadband service?

What are the potential risks of taking the strategy? What are the new risks if we decide to take the strategy?

What are the estimated likelihood and severity of the risks and uncertainties?

What controls, mitigation plans, contingent plan and exit strategies do we have in place to reduce our risk exposure? How effective are those? What are the residual risks? What do we do with the residual risks?

Appendix II

What if the future Economy worsens? What if the demand for computer and broadband service reduce as a result of reduce in income level?

What if the Internet bubble burst?

What if Enron could not develop the quickest data transmitting speed?

What if Enron is out of R&D funding?

What if Enron is out of cash flow?

What if computer manufacturers decide to develop their own internet surfing service?

What if Enron do not generate enough revenue to cover its initial cost and ongoing costs?

What if Enron’s other business suffer a lot and most of the profit earned from broadband service needed to be fill the hole in other business? Where can Enron find other ways to support R&D?

What if all the above scenarios occurred at the same time?

References

Barreveld, D. J. (2002). The Enron Collapse: Creative Accounting, Wrong Economics Or Criminal Acts? : a Look Into the Root Causes of the Largest Bankruptcy in U.S. History. iUniverse.

Behr, P. (2002, January 01). Broadband Strategy Got Enron in Trouble. The Washington Post https://www.washingtonpost.com/archive/business/2002/01/01/broadband-strategy-got-enron-in-trouble/86ce87f6-33e6-4efe-90c5-067c795e9e8c/?utm_term=.aaff93077bb0

Chorafas, Dimitris N. (2004). Risk Management: The Bottleneck is at the Top of the Bottle. Online E-Book. Palgrave Macmillan, 2004. Page 111-117.

Deloitte US (2018) Audit, consulting, advisory, and tax services. (n.d.). February 24, 2018, from https://www2.deloitte.com/

Dibra, R. (2016, June). Corporate Governance Failure: The Case Of Enron And Parmalat. European Scientific Journal, 12(16), 283-289.

https://eujournal.org/index.php/esj/article/viewFile/7580/7307

KMPG. (2016). Corporate Failures. Forensic. Kpmg.co.za

Lemus, E. (2014). The Financial Collapse of the Enron Corporation and Its Impact in the United States Capital Market. Global Journal of Management and Business Research: Accounting and Auditing, 4(1), 41-50.

https://globaljournals.org/GJMBR_Volume15/E-Journal_GJMBR_(D)_Vol_15_Issue_1.pdf

Li, Y. (2010). The Case Analysis of the Scandal of Enron. International Journal of Business and Management, 5(10), 37-41.

http://citeseerx.ist.psu.edu/viewdoc/download?doi=10.1.1.663.9418&rep=rep1&type=pdf

Miller, Thomas. (2015) “The 12 Highest Paid Oil & Gas CEOs.” OilPrice.com, 16 Mar. 2015, http://oilprice.com/Energy/Energy-General/The-12-Highest-Paid-Oil-Gas-CEOs.html

Mok Anna. Saha Ronnie. (2017). Strategic Risk Management in Banking. Deloitte. https://www2.deloitte.com/content/dam/Deloitte/lu/Documents/financial-services/Banking/lu_inside_issue14_strategic_risk_management.pdf

Rantanen, M. (2007). CHAPTER 11: Reasons of Systemic Collapse in Enron. In R. Hämäläinen, & E. Saarinen, Systems Intelligence in Leadership and Everyday Life (pp. 171-185). Helsinki University of Technology.

http://sal.aalto.fi/publications/pdf-files/systemsintelligence2007.pdf

Shen, Yang. (2017)“Compensation Design Thoughts and Methods.” Baidu, http://jingyan.baidu.com/article/915fc414d70dc151394b2015.html