Enron Corporation Bankruptcy - Case Study Example

?Background Enron Corporation was the 7th largest company in the America and the market leader in the energy industry. In 2001 the company filed for at the time the biggest bankruptcy in United States history. The accounting scandal broke out when a whistleblower within the organization called Cheryl Wadkins talked to the authorities. The company used several mechanisms to cook up the books including market to market accounting and by hiding debt using off balance sheet transactions. The organization had a culture of greed and deception. The top executives of the company prior to the demise of the company violated the SEC insider trading bylaws by selling over $600 million in stocks. Executive Summary Some stories are so unbelievable that they become Hollywood movies. One of those stories is the Enron scandal. The movie called Enron the Smartest Guys in the Room was created based on the Enron story. Enron was once the biggest company in the energy industry, but a complex fraudulent scheme that began many years prior to the revelation of the fraud led to its demise. The corporate executives of the company were the primary agents that designed one the biggest accounting scandals in United States history. Two of the accounting tools that were used by Enron to cook up the numbers were market to market accounting and off balance sheet liabilities. The company would own only 49% of a subsidiary in order not to have to report liabilities of the entity. Debt from Enron was hidden in thousands of hedge funds or subsidiaries. It was all a huge scam. The organization violated or used to its advantage a variety of organizational theories. Five of the theories that influenced the behavior of Enron management and its employees were agency problem, corporate culture, teamwork, perception, and leadership. Agency problems exist at Enron in terms of the yearly bonuses, inside trading activity, and in the partnership scheme particularly the LJM partnership. The executive management team colluded with each other in a team effort. The leadership abilities of the top executive managers were outstanding. The corporate culture of the company was based on greed, disloyalty, and unethical behavior. The managers of the company were able to create a perception of a superb company that had tremendous financial performance. This was not true since the company was a fraudulent firm. Statement of the Problem Enron Corporation cooked up the numbers by violating the conservatism principle in market to market transactions and used deceptive accounting practices to hide liabilities by creating a complex network of partnerships. The mastermind of the network hedge funds was Andy Fastow. All the top corporate executives were crooked. The traders were unethical and money hungry. In a partnership called LJM Fastow stole $45 million. The company had a rotten corporate culture where the employees had tough pressures to perform or they would be fired. The company got corrupted and collusion occurred which led to the biggest corporate crime of the 21 century. Analysis of the Problem The Enron accounting scandal was a well orchestrated machine. Prior to the whistleblower revealing the truth nobody knew that the accounting of the company was not truthful. The Securities and Exchange Commission approved the use of market to market accounting for Enron. They could have never imagined that it was going to be used as a tool for deception and financial fraud. When the company got a new energy contract they would recognized the profits immediately without any cash coming in. The executives exaggerated the benefits of the energy contracts in order to boost profits and receive bonuses and rewards for fake money. The company was creating monopoly money that did not really exist. In the year 2000 the company reported $1 billion in profits. The truth was that they did not make any money whatsoever. The company for years was overstating the value of the energy contracts. As time passed most of the earnings did not manifest themselves. The company in reality was facing major cash flow problems. The firm lost over $1 billion in an Indian energy project. Some of the key thieves that created this financial debacle were Chairman, Kenneth Lay; Jeff Skilling, CEO; and Any Fastow, CFO. Other corrupt executive that participated in the fraud include Cliff Baxter and Ken Rice. The auditor company Arthur Anderson colluded to hide the truth due the fact they were getting paid one to two million dollars each week. Organizational Behavior and Theories There were many organizational theories that were violated and that affected the organizational behavior at Enron. An organizational theory that was violated at Enron is agency problem. An agency problem can be defined as a conflict arising when people entrusted to look after the interests of others use the authority or power for their own benefit instead (Businessdicitionary). The CFO of the company had agency problems issues that enabled him to rob the firm of $45 billion in the LJM partnership. All the executives that got involved in inside trading prior of the demise of Enron also violated agency problem theory because they put their personal interest ahead of the integrity of the stock market. A second theory that influenced the behavior of the employees at Enron is corporate culture. A corporate culture can be defined as the collective way of doing things within a corporation (Sergaygroup). The company had an aggressive culture where the employees competed against each other in a survival of the fittest scenario. The bad example for the employees came from leadership of the corrupt CEO, CFO and Chairman of the company. They were corrupted and the falsified the earnings of energy contracts to achieve growth every year. The earnings that the company was making were not normal in comparison with other players in the industry. A third theory that impacted the Enron Corporation was teamwork. There was a lack of teamwork among the employees of the company due to the competitive nature of the corporate culture of the company. Teamwork worked very well though at the corporate level. The top executives worked together in order to create a massive accounting fraud. Enron was cooking up the numbers and it was being done in the eyes of the public without anyone noticing. Arthur Anderson was also another team player that contributed to hide the truth about the financials of Enron. A fourth organizational theory associated with the Enron case is perception. Perception can be defined as the process through which people receive, organize, and interpret information from their environment (Schermerhorn, Osborn, Hunt, pg. 84). Enron become one of the fastest growing companies in America to generate multibillion sales by creating a fake perception of reality. The company was named the most innovative company by Fortune Magazine for six years in a row. The firm had a tremendous corporate image and brand value. In 2000 the price of the common stock hit an all time high of $90 a shares. After the scandal broke out in 2001 the Enron Stock became a penny stock. A fifth organizational theory that impacted in the Enron scandal was leadership. Kenneth Lay and Jeff Skinner were both charismatic leaders that convinced others through the power of persuasion and expert negotiating skills. Both leaders were so good at their jobs that the marketplace saw no reason to question the numbers the company was releasing. Nobody could have predicted that these two wise men would be able to collude with Arthur Anderson to hide the fraud. Despite the fact that these two gentlemen used their leadership skills to defraud Enron their leadership skills were tremendous, but it was put to bad use. Conclusion The Enron story can be viewed as one of human suffering due to unethical executive managers. The employees of the company lost over $2 billion in pension funds because the company backed its pension fund with Enron common stocks. The shareholders lost everything. When the price of the Enron stock collapsed thousands of Enron employees lost their life savings. Corruption and a lack of ethical conduct were the seed that caused the business to collapse. The use of market to market accounting was one of the main tools that Enron misused. Accountants are always supposed to comply with the principle of conservatism. Enron took advantage of accounting loopholes to defraud its shareholders out of billions of dollars in equity. The market to market accounting rules were used to overstate the value of energy contracts. There were agency problems occurring at this firm as the top executives were motivated to create earnings, even if they did not exist in order to collect large performance bonus checks. The executive staff worked as a team to hide the financial fraud. Ever since the Enron case corporate America was changed forever. A year after the Enron bankruptcy the U.S. Congress in alliance with the Securities and Exchange Commission (SEC) passed the Sarbanes Oxley Act (SOX) of 2002. The law was passed to increase investor confidence in the marketplace by improving auditor independence, internal controls, accountability, and by imposing capital punishment of up to 25 years in prison for violators of SOX. Work Cite Page Businessdictionary.com. 2011. “Agency Problem.” 8 November 2011. Schermerhorn, J., James Hunt and Richard Osborn. Organizational Behavior. 8th ed. New York: John Wiley & Sons. 2003. Sergaygroup.com. 2011. “What is Corporate Culture?” 8 November 2011. Read More