Enron Case Study: Overview

• What activities and practices of Enron’s management team do you believe were unethical and/ or illegal?

Concealing debt By using SPEs, Enron’s balance sheet understated its liabilities and overstated its equity and earnings. Enron disclosed to its shareholders that it had hedged downside risk in its illiquid investments using special purpose entities which were lies. Enormous spending Extravagant expenses were rampant in the company which included enormous salary expenses. In 2000, the top 200 highest-paid employees received $1. billion based on inflated operating results. Insider trading Fastow(CFO) earned $30 million from compensation arrangements when managing the LJM limited partnerships. This was not known to Enron’s BOD even until the bubble popped up.

• What factors caused the concerned managers to engage in these activities?

Compensation Management was compensated extensively using stock options. This stock option awards caused management to make up a look that the company is aggressively growing and it actually kept the stock price going up and up. Enron’s statement of 2010 stated that, within three years, these awards were expected to be exercised. Mark-to-market accounting This accounting practice requires that once a long-term contract was signed, the present value of net future cash flow is calculated and written as a full income although it is not fully earned. It inflated the financial earnings on the books. Such a sudden jump in one year’s report lead to a pressure on the employees because they were expected to come up with bigger numbers otherwise they might see the stock price spiral down. Adventurous and unreasonable projects/contracts continued. Despite potential pitfalls, the U. S. Securities and Exchange Commission(SEC) approved the accounting method for Enron in its trading of natural gas futures contracts.

• Why were these activities not noticed and corrected until it was too late?

Ignorance of the board of directors Enron’s aggressive accounting practices were not hidden from the board of directors. The board was informed of the rationale for using the Whitewing, LJM, and Raptor transactions, and after approving them, received status updates on the entities’ operations. Although not all of Enron’s widespread improper accounting practices were revealed to the board, the practices were dependent on board decisions. Even though Enron extensively relied on derivatives for its business, the company’s Finance Committee and board did not have enough knowledge about derivatives. If there had been a detailed understanding of how the derivatives were organized, the board would have prevented their use. Pressure on external accounting company Anderson’s auditors were pressured by Enron’s management to defer recognizing the charges from the special purpose entities.

Since the entities would never return a profit, accounting guidelines required that Enron should take a write-off. To pressure Anderson, Enron would occasionally allow accounting companies E&Y or PWC to complete accounting tasks as a mean of threatening. Complicated businesses and accounting methods Fastow and other executives created off-balance-sheet vehicles, complex financing structures, and deals so bewildering that few people could understand them. Even many of Wall streets analysts did not know how to correctly read the financial statements.