The Enron Corporate Scandal - Assignment Example

 THE ENRON SCANDAL Corporate Social Responsibility in relation to Enron THE ENRON SCANDAL In the recent past, many corporate frauds have come to light which have involved some of the very famous names in the corporate history. These frauds have given rise to the special concern over the corporate social responsibility of all the people who are involved in the process of running the business. Recently, the fraud that took place in Houston, Texas has caught everyone’s eye. It is the fraud of the US based energy giant, Enron. BACKGROUND The company was found in 1985 after several mergers such as InterNorth and Houston Natural gas etc. The company was one of the leading energy producers in the United States, formed by Kenneth Lay. The company became the largest energy producers of United States in 1992 and were able to secure over $100 million pure income in the early 90’s. Following the formation of the company, staffs of executives was developed, who were led by Jeffery Skilling, who started to manipulate the accounting ambiguities and the meagre reporting of financial data were able to veil the deals that amounted to billions of dollars that had resulted in failures. This also involved their Chief Financial Officer, Andrew Fastow, who along with Jeffery Skilling misinform and deceived the Enron’s board of directors on the accounting issues and alongside they also pressurized their auditors, who were amongst the big-five firms of chartered accountants, to overlook the issues and keep giving the unqualified opinion on their financial statements. The auditor’s of the company, Arthur Andersons, ignored several of the accounting treatment errors and misleading prospects of the financial statements and continued to provide the supporting role to the making of one of the biggest corporate frauds of the century. CAUSES OF DOWNFALL OF ENRON There were numerous causes that came together to the downfall of the giant known as Enron. Some of what can be the accounting fallacy, misleading policies, unfair presentation and involvement of the auditors in the crime that lead to a loss of Billions of dollars to the shareholder and the bankruptcy of the company. The main reason why the company executives were able to hide the fraud was due to the complex structure of the company and their business which gave them an additional support to manipulate the accounts and portray a picture that showed that the company was highly profitable. The company’s motive was to keep the value of their assets inflated, income and cash flows shooting up, derecognize the liabilities and undermine the expenses to show a favourable picture in order to attract the investors. (Bodurtha 1997) Some of the main accounting practices that lead to the downfall are given below: Revenue Recognition: Revenue recognition was one of the leading aspects that led to the fraud and involved a lot of manipulation of the policies that are put forward by the IFRS. Since Enron was engaged in provision of service of maintenance of power plants, storage and pipelines the company chose to use the model where they had to bear the cost of the equipment and classify the corresponding sale as their revenue. However, companies that provide the service act as agents who does the dealing with the customer provides the service and gets the commission in return which is recognized as their revenue. Enron chose to report the whole sale as their revenue by using the ‘merchant model’ and not only that they also inflated their sales to show higher profits. This caused other companies of the same industry to adopt the same model, in order to keep themselves in the market. The growth as a result was humungous as they witnessed a growth in revenue of over 750% compared to a usual growth of 2-3% in the energy industry. (Bufkins 2008) Their use of the revenue policy and inflated sales later proved costly. Investments: Investments were another part of their accounting theory that got them to later pay heavily. Failed investments was one of the manor causes of their downfall as it largely invested in networks of fibre-optics, an Indian power plant and some other companies in the UK. This investment later created excess debt for them which an already bankrupt company had no resource to pay off. (Staton 2010) Mark-to-market accounting: Enron became the first company of the non financial sector to use the mark to market accounting method which is applicable to only the companies that belong to the financial sector. They utilized the present value of their current contracts and marked them to market by providing misleading disclosures to the valuers and investors. Furthermore, in order to keep the trends going they had to show better results every year to cope up with the rising income. Collapse of Energy prices: The accounting treatment was not the only cause of their downfall, the last nail in the coffin was put by the huge collapse in the prices of energy as the consumption of energy in California was less. Therefore the government had to apply caps of companies for the prices that they can charge per unit. Enron had to later announce their first loss in 2001 after four years which was a shocker for a company making $100 million profit, which led to a fall in the stock price on Enron and which fell to 26 cents per share and later the bankruptcy. Failed corporate governance: One of the elitist board of directors used to look after the business of Enron who were mostly outsiders and had a great bit of stake in the business as well. Enron also had an impressive audit committee that looked after the affairs of the audit and even after that Enron was able to deceive the public as well as obscure their performance in order to give rise to the price of their stock. Another factor was that the employees were also driven by making profits for themselves and ignored the benefit of the company and in order to show better performance and to obtain a good rating, the employees looked to seize high value deals which gave them stock options and bonuses. Another notable fact is that the employees as well as the CEO and CFO of the company had enormous stake in the business as reportedly, Kenneth Lay and Jeffery Skilling owned over $800 million of the company’s stock. (Martin 2002) Auditor’s contribution: The auditors also contributed largely to the downfall on Enron. The auditors of the company, namely Arthur Anderson, who derived over 25% of their audit as well as their consultancy fees from Enron, played a crucial role by concealing the crime that was taking place in the company through manipulation of the accounting practices. When the Enron scandal got public, Arthur Anderson also contributed by destroying the data that they had maintained for the previous years of the audit that had contributed in the financial manipulation. All of these factors, once they were revealed, shattered the giants known as Enron and the SEC came into action. The investors lost their confidence in the company and the company’s stock that was in the start of 2001 being traded at $90 per share dropped to under 26 cents per share. Numerous employees also lost their jobs along with their savings which were depended on the stock of the company. STAKEHOLDERS IN THE ENRON SCANDLE When the Enron scandal took place, there were numerous stakeholders that were affected by the bankruptcy of Enron. Not only the shareholders suffered humungous losses, but the employees also lost their jobs along with the savings that were based on the stocks of the company. Auditors: One of the most hit stakeholders of the Enron scandal are the auditors, namely Arthur Anderson as they not only lost the income they were earning from Enron but they also lost the name that they had made for themselves in the business of auditing where they were counted as one of the big five firms. Shareholders: The shareholders of the company were the worst hit stakeholders of the company as they lost around $11 billion due to the stock market collapse of Enron. Employees: Around 4000 of the employees of Enron lost their jobs and out of the employees, over 10000 employees lost their savings which were dependent on the stock of Enron which had, on the day of bankruptcy, fallen from $83 to 26 cents. Lenders and creditors: The lenders of Enron, particularly JP Morgan and Citigroup lost around $23 billion which was the actual liability secured from banks. The company owed around $67 billion to the creditors, banks and the employees. (Jonathan 2010) Prospective merger clients: The companies that were looking to merge with Enron were also hit by the sudden demise of the company and had to back off from the merger transaction. CORPORATE SOCIAL RESPONSIBILITY This kind of scandals call for the extensive corporate social responsibility and the role of the managers as well as the related people to look after the public interest along with the corporate interest that is in stake during their role in the running of the company. It is greatly argued by Karnani that the reason for which the hiring for the executives is carried out is purely to maximize the profits of the company which is supposed to be the responsibility of the managers as well as the executives towards their shareholders and when those executives are motivated by the benefiting of the society, they may only do that at the expense of risking their own jobs for it. (Karnanai 2010) Responsibility of the managers: In this regard that such incidents don’t happen often, the managers and the executives will have to exercise their social responsibility to the society along with their responsibility towards the shareholders. Managers, as they are looking after the business and are aware of the business activities better than the outsiders, can exercise better hindrances against such acts of proliferation of crime within the company. Government responsibility: As argued by Karnani, the best solution to regulate such cases is the regulation of the government where they can enforce laws rather than having faith in the intentions of any individuals. Activists and Watchdogs: The role of the activists and the advocates can also be highlighted as they can work for the creation of awareness of social responsibility among the corporate players of the society. Some nonprofit organizaitons have already come up in this respect and are working to voice the interest of the social and corporate concerns. Auditors responsibility: It is the reponsibility of the auditors to look after the instances of fraud as they are considered to be the watchdogs over the public interest and they are employed for the sole purpose to look after the affairs of the business. (Coram n.d.) It is one of the utmost responsibilities of the auditors to look guard the public interest as in this case the auditors were the accomplices to a fraud that was taking place inside the company which had billion of losses in store. Conclusion In the end, it can be properly said that the corporate executives should put their utmost efforts together in order to prevent the instances of window dressing as it shakes the very foundation of the society and rather try to protect the interest of the public and other stakeholders as it is a social responsibility. (Friedman 1970) Works Cited Bodurtha, James N. "Enron's Sheel Game." 2. Washington D.C.: McDonough School of Business, 1997. Bufkins, William R. "Red Flags in Enron's Reporting of Revenues and Key Financial Measures." 97-100. 2008. Coram, Paul. "The Importance of Internal Audit in Fraud Detection." The University of Melbourne. Friedman, Milton. "The Social Responsibility of Business is to Increase its Profits." The New York Times Magazine, 1970. Jonathan, Glater D. "A Bankruptcy Filing Might Be the Best Remaining Choice." The New York Times, 2010. Karnanai, Aneel. "The Case Against Corporate Social Responsibility ." 2010. Martin, John D. "Financial Engineering, Corporate Governance, and the Collapse of Enron." University of Delware, 2002. Staton, Michael. "Reasons for the Enron Bankruptcy." E-how, 2010. Read More