Corporate Governance Failures in Enron Company - Case Study Example

Corporate Governance and Regulatory Process (Corporate Governance Failures in Enron Company) Course Institution Date Corporate Governance and Regulatory Process (Corporate Governance Failures In Enron Company) Introduction After the 20th Century, there has been serious thought on effective management of organizations. Management has been the focal point for running of organizations in the 20th century. However, a new dimension is required. This has brought primary focus on corporate governance. For any economy that is advanced or one that is advancing, codes of corporate governance have been enacted to spur the growth of the company further forward. The collapse of Enron Company was one of the reasons for the push to have organizations embark on corporate governance (Tricker and Tricker, 2012). Enron’s failure in 2001 represented the world’s most embarrassing bankruptcy. It was also a demonstration of the corporate failure in the company and in America (Silverstein, 2013). While the heydays of Enron are long gone, there are lots of lessons to be learnt and organizations have made various references in their governance so as to avoid such a failure. The case of Enron might not be the last of cases in corporate governance failures; but the lessons learnt formed a new era and age in ethics of business. This paper shall present the failures in corporate governance as witnessed in the case of Enron. Enron started its business in 1985, venturing as a pipeline company. From the pipeline sector, the company started moving into other fields and it launched a unit for broadband services and the Enron Online. This was the company’s site that was used for trading commodities and it was soon the world’s largest business site. The growth realized by the company was rapid and in 2000, the company realized annual revenue of $ 100 billion US. It was even ranked as the 7th largest company on Fortune 500. At this rate, the company was flourishing in its business. However, cracks started appearing in 2001. After the resignation of the then CEO, Jeffery Skilling, and the incoming of a new one, Lay, the company realized a $618 million loss. It dint take long before the company filed for bankruptcy, in what was America’s case of bankruptcy up till then. This demonstrated key flaws in the governance of the company. An investigation of the corporate governance failures will reveal some of the failures that were noted from the case. Corporate governance refers to the structure that makes sure that the right questions are asked and makes sure that any checks and balances are put in place so as to ensure thee answers given reflect the best for the establishment of long term sustainable and renewable value (Monks and Minow, 2012). It is only after this structure is subverted that the temptation to indulge in self-dealing by managers and people in the corporate sector leads them to succumb. One of the failures in corporate governance by Enron was the failure by the board to fulfill the fiduciary duties it owed to the shareholders of the corporation. The stakeholders of Enron had invested their capital in the firm. It was therefore the responsibility of the management to allocate and ensure the funds are used appropriately. In the Enron case, the management used a transfer pricing technique with the partnerships that it had created. This technique occurs when managers set up an independent company that is owned by them and will then sell outputs of the main company to their companies. Some of the partnering companies that Enron management formed were with JEDI and LMJ. These companies made profits on every transaction that they made with Enron. Some of the management of Enron, Fastow and Kopper, had partial ownership of these partnering companies. Some of the dubious transactions that were done by the companies included purchasing of assets and selling them back to the company at prices that are higher than what the company had previously bought them at. In this case, the sales and purchases of assets by Enron were benefiting investors in partnerships. This implies that the management was expropriating the funds of the firm. The management of Enron was in this case enriching itself and other investors in their partnership. When the management of a corporation and its ownership are separated, such a problem is bound to arise. Enron management expropriated the funds of the firm and this was a breach of the corporate governance responsibility of protecting the shareholders of the firm. The governance mechanism holds that a firm’s management and more particularly the chief financial officer, owes a fiduciary duty to the company’s shareholders. For the case of Enron, the management neglected the duty and opted to enrich themselves. Enron management manipulated financial statements so as to make an impression to the public about the status of the company. For effective operation of a company, corporate governance requires that financial statements be used in reflecting the true position of the company. One of the aims of corporate governance is to ensure the long term sustainability of the company. This can be achieved through reports that indicate the performance of the company. Corporate governance requires that directors of a company provide annual and semi-annual financial statements that indicate that the company’s business is a concern that is going. Supporting assumptions should be made and any qualifications made as necessary. The management of Enron Company recognized this role. However, they made false statements on the performance of the company and this was a key flaw since it did not reflect the true position of the company. The board also allowed 50 % of the company’s assets to be shifted to sheet entities that were off balance. The financial statement of Enron for the year 2000 had some confusing footnote. The disclosures made by the statement casted doubts on the quality of the earnings of the company and the transaction’s business purpose. Various analysts questioned the fact that there was no transparency in the disclosures of Enron. The company management under Skilling and Fastow did not consider that these actions created greater skepticism in the perception of the company and this eroded the trust and the reputation of the company. It is more troubling that after the issues began to surface gradually, the company CEO, Lay, retired and named Skilling to be the new president and CEO. The management of Enron clearly did not fulfill their responsibility of protecting the fiduciary rights of stakeholders and they did not pay attention to the indications that they got on the performance of the company. While the indications came earlier on, the management chose to ignore them and nothing was done after the coffee was smelt on the looming danger the company was faced with. The questions that were raised on the transparency of the statement indicated a breach of the principle of disclosure and transparency as stated by corporate governance (OECD, 2004). The second failure that was demonstrated by the Enron management was their greed and the pursuit of their own interests. It is the role of the company’s management to work in the best interest of the stakeholders of the company. Another of the principles of corporate governance is the principle of integrity and ethical behavior. This requires that board members and corporate officers promote ethical behaviors and carry out responsible decision making. The Enron board and executives did not observe this principle when it carried out its business with its own self-interest. The executives indulge in dealings that they knew would benefit them. They did not care about the effects of their dealings ton the company. By indulging in partnerships with companies that they owned or had shares in, the executives did not consider how their business dealings would impact on the performance of the main company. It is for this reason that they traded in assets that would be sold back to the main company at a higher price. In such a deal, their partnering companies benefitted with every transaction. In fact, they made profits on every occasion. However, the main company made losses on some occasions. The executives did not care about this and went ahead to pursue their interests. No decision was made to protect the company from such a deal. This was because stopping transactions with the companies would mean low or no benefits for their companies. It is for this reason that the executives went ahead with carrying out transactions with the companies, knowing the main company did not benefit from the partnership. This indicates a high level of selfishness in the management of the company. This act is unethical and is against the principle of corporate governance (Thomas, 2002). Another flaw that was noted in the case of the Enron Company was the failure by the employees to report the wrong doings of the company executives. While some of the employees were aware of the wrong doings by the executives, they did not blow the whistle on the ongoing scams in the company. Corporate governance requires that the rights of shareholders be treated equitably. Among the stakeholders are the employees who should be allowed to exercise their rights to communicate openly and effectively. This implies that they should be allowed to report any matter that they feel concerns the management of the company. The employees of Enron are mandated to report the flaws that they spotted in the company. This is because the management of the company directly indicated its performance. Having recognized that there were some malpractices by the executives of the company, the employees were supposed to report the issue or to raise a public awareness so that external measures are taken before the whole issue blew out of hand. The responsibility of reporting the malpractices in the company would form part of ethical behavior by the employees. This is because acting to prevent a problem is seen as a responsible act that should be applauded. Most shareholders of Enron were its employees. This failure should have been noted at the time when they made most losses. This would have been a fast step in arresting the situation. Another flaw that was noted was the outsourcing of external auditing of the company instead of establishing an internal audit unit that was functional. The external audit should have been used only when the dealings in the company were questionable. The auditing of the company’s business was done using an external firm. Enron colluded with an auditing firm known as Andersen and the debts of eh company were hidden and collateralized with the stock of Enron. In addition, the firm used creative accounting techniques together with sheet transactions that were off balance. This was done using special purpose entities (Munzig, 2003). Recommendations to avoid what was experienced by Enron Proper corporate governance will be needed for companies to avoid what was faced by Enron. This implies that the organizations have to observe the principles of corporate governance (Applied Corporate Governance, 2013). The corporate society has to observe an ethical approach in their governance. This shall be addressed to the society and shall be established as a culture of the organization. In addition, organizations should have balanced objectives that will encompass the goals of all parties to the organization. Each of the stakeholders of the organization has to play their part. This includes the directors, staff and owners of the company. Decision making in the company has to be done with due consideration being made on the stakeholders. This would ensure the interests of the stakeholders are protected. In addition, there has to be equal concern with respect to all stakeholders. This implies that all the stakeholders shall be considered in the management of the organization. The organization also has to observe transparency and accountability. This will ensure that the organization’s status is well known and can be scrutinized so as to rectify any flaw. It will also prevent some selfish acts by the organization’s management. Further, organizations should not transact with partnering company’s without vetting the companies. Any dubious transactions with the partnering companies should be investigated before the company is adversely affected. Bibliography Applied Corporate Governance, 2013, Best Corporate Governance Practice, Retrieved on May 31, 2013 from: http://www.applied-corporate-governance.com/best-corporate-governance-practice.html. Cuong, N. 2011, Factors Causing Enron's Collapse: An Investigation into Corporate Governance and Company Culture, Corporate Ownership & Control Journal, Vol. 8, Iss.3. Monks, R. & Minow, N., 2012, Corporate Governance, 5th Ed., UK, John Wiley and Sons. Munzig, P. 2003, Enron and the Economics of Corporate Governance, Stanford, Stanford University. OECD, 2004, Principles of Corporate Governance, Articles II and III, OECD. Silverstein, K. 2013, Enron, Ethics and Today's Corporate Values, Retrieved on May 30, 2013 from: http://www.forbes.com/sites/kensilverstein/2013/05/14/enron-ethics-and-todays-corporate-values/. Thomas, W. 2002, The Rise and Fall of Enron, Journal of Accountancy, Retrieved on May 30, 2013 from: http://www.journalofaccountancy.com/Issues/2002/Apr/TheRiseAndFallOfEnron.htm. Tricker, B. & Tricker, R., 2012, Corporate Governance: Principles, Policies and Practices, 2nd Ed. UK, Oxford University Press. Read More