ENRON: QUESTIONABLE ACCOUNTING LEADS TO COLLAPSE 2
Enron: Questionable Accounting Leads to Collapse
Tarek Thomas
Liberty University
ENRON: QUESTIONABLE ACCOUNTING LEADS TO COLLAPSE 3
Enron’s corporate culture was built on risk, arrogance, greed, and a flawed employee
evaluation system. “In 1985, Ken Lay, chair and CEO of Houston Natural Gas, orchestrated a
merger with pipeline company InterNorth and Enron was born. In 1990, Lay hired Jeffrey
Skilling as a CEO. Skilling brought along Andrew Fastow and Enron quickly adopted ‘off-
balance- sheet partnerships’, shifting losses to satellite companies. Lay named Skilling the
president of Enron in 1996” (Knottnerus & Ulsperger & Cummins & Osteen, 2006, pp. 177). A
company’s corporate culture is reflective of the organizations leadership. “Throughout the 1990s,
Chairman Ken Lay, CEO Jeffrey Skilling, and CFO Andrew Fastow transformed Enron from an
old-style electricity and gas company into a $150 billion energy company and Wall Street
favorite that traded power contracts in the investment markets. From 1998 to 2000 alone, Enron’s
revenues grew from about $31 billion to more than $100 billion, making it the seventh-largest
company in the Fortune 500” (Ferrell & Fraedrich & Ferrell, 2017, pp. 497).
With the new leadership in place excellence began to be an expectation, but there would
be a price to pay. Successful organizations reward their top employees. As one of the top
performing companies in the world at that time, the leaders of Enron had very lucrative
compensation packages. In 2001, “Enron Corp. paid out $744 million in salary, bonus and stock
grants to the company's 140 senior officers--an average of $5.3 million each” (Mulligan &
Rivera-Brooks, 2002). Once leaders began to earn this level of compensation it becomes more
difficult to settle for less. Enron wanted to be known as the best company in the world and the
leaders of the company ran the organization with the true spirit of competition.
How did the corporate culture of Enron contribute to its bankruptcy
ENRON: QUESTIONABLE ACCOUNTING LEADS TO COLLAPSE 4
There is a right and a wrong way to incentivize employees to perform. The leaders at
Enron made achieving profits a competition at all levels. “Skilling appears to be the executive
who created the system whereby Enron’s employees were rated every six months, with those
ranked in the bottom 20 percent forced out. This “rank and yank” system helped create a fierce
environment in which employees competed against rivals not only outside the company but also
at the next desk” (Ferrell & Fraedrich & Ferrell, 2017, pp. 497). This creates a highly stressful
work environment for all employees. Clearly Enron put performance above all else, including
employee loyalty.
Enron’s win at all costs approach ultimately drove the company to bankruptcy. “In
August 2001, the company’s then-CFO Fastow stated that Enron had established special-purpose
entities or SPE’s to move assets and debt off its balance sheet and to increase cash flow by
showing that funds were flowing through its books when it sold assets. Although these practices
produced a very favorable financial picture, outside observers believed they constituted
fraudulent financial reporting because they did not accurately represent the company’s true
financial condition” (Ferrell & Fraedrich & Ferrell, 2017, pp. 498). It was later discovered that
the SPE’s were entities in name only and were backed by Enron’s own stock. Enron could
effectively cover the cost of the SPE’s when they had a high stock price. However, once Enron’s
stock price collapsed they could not cover the SPE’s and the true value of Enron showed a
negative cash flow of $753 million. This was the beginning of the end for Enron. “Deviance in
organizations occurs because people have a perception of acceptable behavior unique to their
environment. Due to the complexity of organizations, they also have a bounded or limited
rationality. This occurs because of the prevalence of incomplete and restricted information about
present actions and consequences” (Knottnerus & Ulsperger & Cummins & Osteen, 2006, pp.
ENRON: QUESTIONABLE ACCOUNTING LEADS TO COLLAPSE 5
178). Achieving success for a few years is difficult, but what is even more profound is to achieve
success over decades. Enron took a high risk approach to win at all costs and that ultimately led
to their demise.
In what ways did Enron's bankers, auditors, and attorneys contribute to Enron's demise
Enron’s bankers, auditors, and attorneys contributed to the company’s demise by their
complicit actions. First, Merrill Lynch collaborated with Enron in 1999 to purchase Nigerian
barges for $28 million. “Merrill Lynch went ahead with the deal despite an internal document
that suggested that the transaction might be construed as aiding and abetting Enron’s fraudulent
manipulation of its income statement. Merrill Lynch denies that the transaction was a sham and
said that it never knowingly helped Enron to falsify its financial reports” (Ferrell & Fraedrich &
Ferrell, 2017, pp. 502). Enron used their influence over other financial intuitions. “In 2003 he
SEC was in settlement talks with Citigroup, the largest US financial services group, over loans it
extended to Enron that were disguised as commodities trades in order to lower its stated debt
ENRON: QUESTIONABLE ACCOUNTING LEADS TO COLLAPSE 6
levels. JP Morgan, the second largest US bank, is under investigation for engineering similar
transactions” (Chaffin, 2003, pp.1). Bankers were not the only business partners that were
compelled to go along with Enron’s questionable actions.
Vinson & Elkins based in Houston, was the primary law firm for Enron. In fact, Enron
accounted for about 7 percent of the law firm’s revenue. After reviewing an internal memo from
a top Vice President within Enron about the companies improper accounting practices, the law
firm of Vinson & Elkins dismissed claims that the company could be breaking several laws. It
may have been conceivable that Vinson & Elkings decided to look the other way as it pertained
to laws being broken, because of their involvement in some of the unethical acts. “It was alleged
that Vinson & Elkins helped structure some of Enron’s special-purpose partnerships. In her letter
to Lay, a whistleblower indicated that the firm had written opinion letters supporting the legality
of the deals. In fact, Enron could not have done many of the transactions without such opinion
letters. The firm did not admit liability, but agreed to pay $30 million to Enron to settle claims
that Vinson & Elkins had contributed to the firm’s collapse” (Ferrell & Fraedrich & Ferrell,
2017, pp. 502). Without question the primary law firm that advised the company had a duty to
advise Enron of the potential laws that might have been broken.
The audit firm of Arthur Andersen LLP were Enron’s auditors. While providing this
service, Arthur Andersen LLP was ethically bound to provide an honest evaluation of Enron’s
financial statements. This obligation was not to merely to serve Enron, but to also serve
investors. Once again and independent orginizatioin that serviced Enron was complicit in their
actions by misrepresenting their client’s performance. This misrepresentation was also due to an
unhealthy amount of leverage that Enron had against Arthur Anderson LLP. “The accounting
firm was one of Enron’s major business partners, with more than 100 employees dedicated to its
account, and it sold about $50 million a year in consulting services to Enron” (Ferrell &
ENRON: QUESTIONABLE ACCOUNTING LEADS TO COLLAPSE 7
Fraedrich & Ferrell, 2017, pp. 503). To hide some of the misconduct of Enron during the federal
investigation, representatives of Arthur Anderson LLP were caught shredding documents that
pointed to the unlawful actions of Enron. These actions led to obstruction of justice charges in
2002. Consequently, the firm is no longer permitted to perform audits.
What role did the company's Chief Financial Officer play in creating the problems
that led to Enron's financial problems
The Chief Financial Officer, Andrew Fastow was the orchestrator of the
partnerships used to defraud people out of billions dollars. “In October 2001, after it was forced
to cover some large shortfalls for its partnerships, Enron’s stockholder equity fell by $1.2 billion.
Already shaken by questions about lack of disclosure in Enron’s financial statements and by
reports that executives had profited personally from the partnership deals, investor confidence
collapsed, taking Enron’s stock price with it” (Ferrell & Fraedrich & Ferrell, 2017, pp. 498). This
collapse lead to Enron filling for bankruptcy.
Once the federal investigation started Fastow initially stated that auditors and lawyers
approved the partnerships which gave him conviction that he actions were within guidelines.
However, after further investigation it was found that Fastow profited individually from the
partnerships. “Fastow made about $30 million both by using these partnerships to get kickbacks
that were disguised as gifts from family members, and by taking income himself that should have
gone to other entities” (Ferrell & Fraedrich & Ferrell, 2017, pp. 499). Enron created a culture of
winning at all costs and once they had achieved success, the leaders of the company were not
ENRON: QUESTIONABLE ACCOUNTING LEADS TO COLLAPSE 8
willing to relinquish their position. The CFO, auditors, lawyers, and bankers all played a
significant role in establishing the partnerships and pushing Enron into bankruptcy.
Rules and laws can not account for every situation; thus organizations must have a moral
compass to aide them in making the correct ethical decisions. “In the wake of the Enron collapse,
the US authorities have proposed changes to the accounting rules. Increased transparency is
required with regard to transactions with associated companies and their employees. Companies
also have to describe the most critical accounts items and state what effect various scenarios
would have on the results. The proposal emphasizes in particular that the accounting rules shall
not be used to conceal information from investors” (Anonymous, 2002, pp. 1). The employees of
Enron were also negatively impacted by the bankruptcy. “Shares of Enron, which in January
2001 traded for more than $80 per share, were in January 2002 worth less than 50 cents each.
Consequently, the company's bankruptcy had substantially reduced the value of many of its
employees' retirement accounts. The financial losses suffered by participants in the Enron
Corporation's 401(k) plan prompted questions about the laws and regulations that govern these
plans” (Purcell, 2002, pp. 36). Enron failed, because they were greedy, over confident, and had a
dysfunctional company culture. Unfortunately, the leverage that Enron possessed against its
business partners outweighed the moral compass possessed within any of those individual
organizations.
ENRON: QUESTIONABLE ACCOUNTING LEADS TO COLLAPSE 9
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ENRON: QUESTIONABLE ACCOUNTING LEADS TO COLLAPSE 10
Mulligan, T., Rivera-Brooks, N. (2002). Enron paid senior execs millions.
Los Angeles Times
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Purcell, P. (2002). The enron bankruptcy and employer stock in retirement plans.
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