Abstract
The Enron collapsed will probably remain one of the most shocking and extensively studied corporate failures in the history of the business world. Enron had set an ambitious target of becoming the world’s largest company and it had held the capacity to fulfill this objective. However, its sudden collapse revealed major lapses in management and corporate governance, especially in the areas of accounting, communications, business ethics, leadership, and organizational structure. This paper aims to evaluate the leadership of the corporation a year before its collapse and recommend a strategy to prevent the eminent disaster.
1 Enron – Overview
In July 1985, Internorth, Omaha and Houston Natural Gas merged to form Enron which soon became one of the leading petrochemical and energy companies in the US . By the late 1990s, the company has added steel, metals, shipping, coal, credit derivatives and even commodities to its operations. Enron’s performance peaked raking in $80 billion in revenues and $1 billion in profits . It was ranked as America’s Most Innovative Company by Fortune consecutively for six years .
However, despite such remarkable progress, Enron began showing signs of trouble when Clifford Baxter, it’s Vice Chairman, unexpectedly resigned in May 2001. Close on his heels, Jeffery Skilling, Enron’s CEO, resigned in August 2001. Both men had served about a year in their last positions and their decision to leave such a lucrative job raised suspicions . Several of Enron’s top executives owned or were a part of firms that were engaged in partnerships with the company and this aspect of its leadership was fast emerging as one of the main reasons for its downfall.
In October 2001, Enron took $1.2 billion from shareholder equity and another $544 million from earnings to support transactions with partner LJM which was owned by Andrew Fastow, Enron’s CFO. It also announced that the accounts related to LJM and other partnerships, including Chewco Investments and LJM Cayman, will be restated from the year 1997 to 2001 to correct accounting errors . This sparked an investigation by the SEC which found that the restatements were massive and that Fastow was being paid over $30 million for managing the LJM partnerships. With these revelations, investor confidence in Enron was crushed and its stocks plummeted. Enron filed for bankruptcy protection on 2 December, 2001 . Table 1 highlights the key phases of Enron, from its formation, its peak to its ultimate fall in 2001.
At the time of its collapse, Enron operated on a highly complex organization structure that did not do much to promote transparency between units and functions. Having over 21,000 employees and offices in over 40 countries, Enron focused on decentralization of its units, giving each unit near autonomy over operations. However, while this may have empowered units, there was limited or no interaction between them and hence employees were not able to view the organization holistically. Figure 1 highlights the isolated nature of Enron’s organizational structure, with each major business line being run by select executives, each reporting directly to the Chairman.
Kenneth Lay was the Chairman of the Board while Jeffery Skilling was the President and CEO. The Board itself consisted of 15 members, all of whom were ex-chairpersons or CEOs of major corporations, having sound knowledge of business, investment, governance, finance and accounting . The board met 5 times annually, with further meetings being called on an ad hoc basis. The Board had five sub-committees, namely: a) The Executive Committee – calling and arranging urgent Bard meetings, b) The Audit and Compliance Committee – running the company’s compliance, accounting and auditing programs and liaison with Anderson, c) The Finance Committee – approval of high value transactions, risk management, formation of finance policies and guiding decision making, d) The Nominating Committee – selecting Directors, and e) The Compensation Committee – draft and control the company’s compensation strategy and policies for employees, officers and directors .
Figure 1: Enron Organizational Chart June 2000
Despite the presence of such committees and a code of ethics that was considered to be the best in the industry, Board members as well as top executives received remunerations that were significantly higher than what being offered to executives in competing firms . For example, in 2001, Kenneth Lay earned $152.7 million, Jeffery Skilling earned $34.8 million, and Clifford Baxter earned $16.2 million while Andrew Fastow earned $4.2 million . While Anderson was responsible for the auditing of the company, Vinson & Elkins were the chief outside legal counsel and helped in Enron’s filings to the SEC .
It is important to note at this point that a majority of the executives’ compensation came from stock options. For example, in the year 2010, Lay earned over $140 million, of which $123 million came from stock options . Contracts that offer high returns on stocks often encourage executives to manipulate accounts and finance policies to their advantage . Gordon notes that, as a result of their compensation being tied to stocks, Enron executives began undertaking high risk investments, with the intention of making huge profits for them and, in the case of a loss, passing the losses to shareholders .
This mindset of the leadership of Enron gave rise to a culture wherein employees believed that they would be allowed to take risks and even act illegally, as long as it earned the company good returns and the employee did not get caught. The gap between the company’s Code of Ethics and its actual implementation was massive. Table 2 describes the shift in Enron’s organizational culture since its inception in 1985 till its collapse in 2001 . The change in the overall mindset is evident and it can be seen that the company had started following charismatic leadership, wherein the thought and approach taken by the company’s leaders was enacted by the organization as a whole.
3 Enron’s Charismatic Leadership and Cult Culture
DuBrin lists the qualities of a charismatic leader as including: a) visionary, b) masterful communication skills, c) ability to inspire trust, d) making members of the group feel capable, e) expressiveness, f) romanticizing risk, g) unconventional strategies, h) self-promoting personality, and i) dramatic and unique . Enron’s leadership reveals all of these traits and used charismatic leadership to promote a cult culture whereby its managers as well as employees began to consider themselves part of another world, being better than the rest.
Figure 2: Charismatic Leadership Traits and their Relevance to Enron
Adapted from DuBrin’s explanation of charismatic leadership and the characteristics displayed by Enron, Figure 2 illustrates the commonalities between the two and the cult culture that arose as a result.
4 CEO Role and Recommendations
As Enron’s CEO who has just discovered the horrid ethical lapses and accounting fraud within the organization, it would be my responsibility to act in a discrete yet ethical manner to put into place a plan that will salvage the organization from its current state of financial and potential reputational ruin. For this purpose, I would implement the following measures and changes:
- Communicate with the Board – It is crucial that every member of the board be aware of and understand the situation that the organization finds itself in and also know how it got there. The fall of the corporation is eminent and I am certain that, should Enron survive this crisis, it will prove to be much more profitable to all parties involved. Cooperation of the board members will be solicited and attained by any means possible.
- Separation of Anderson from the auditing and consulting functions: Having the same company provide employees and then having them audit the books is not only unethical, it is also simply insensible. Public disclosure of the scandal would only lead to legal implications for Anderson and hence their cooperation will be sought in migrating the auditing and consulting functions to two separate companies to avoid any conflict of interest.
- Legally binding non-disclosure agreements to be signed by every member of the board, chief executives of Enron as well as auditing and consulting firms. Causing mass panic and a stock market crash ahead of time should ideally be avoided.
- Hire a reputed consulting firm to guide the resolution of legal and financial complications arising from the LJM partnerships. Rescue and contingency plans should be drawn to gradually regulate the asset holding and trading of the company towards a legal and ethical set up.
- Communicating with employees and the general public to re-iterate the company’s code of ethics, its implementation and practice. Review the existing committees and form a fresh group to devise a plan on how the code of ethics can be implemented across the organization.
- Although I would retain the decentralized structure of business units, a revised reporting structure would be created to increase transparency and place accountability on all positions. This will enable better monitoring and control of actions that go against the code of ethics.
- A phase by phase action plan will be created wherein the progress of the financial, auditing, consulting and ethics initiatives will be tracked on a month to month basis, with fixed goals. The end-objective would be to firstly slow and finally curtail the financial disintegration of the organization and change the organizational culture towards a more responsible one.
5 Conclusion
Enron is the perfect example of how a perfect opportunity to be the greatest company in the world can be squandered due to greed of a few top executives. However, the scandal has led to several positive changes in the corporate world with much greater emphasis being laid on aspects such as corporate governance and following a code of ethics. Auditing firms and consulting firms too have more stringent requirements governing them now. Although, as evidenced by the Worldcom scandal in 2002 and Satyam scandal in 2009, corporate frauds that run into billions of dollars still do take place. However, in each case, it is the lack of accountability, transparency and governance that leads to the downfall of potentially great organizations.
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