Corporate Governance in Banking Industry - Enron - Case Study Example

of Executive Summary The current financial crisis has revealed various aspects of financial system which are inherently flawed and thus lead towards bankruptcy. The banking industry, under the liberal economic order, has undergone complex alterations which not only create confusions for analysts but also contain elements which are either illegitimate tools to acquire wealth or involve such measure which are only beneficial in the long run. Enron is one such company which faced the wrath of flawed banking policies and thus led towards bankruptcy. The scandal was revealed in 2001 which raised various questions about the American energy corporation which is based in Houston (Prebble 2009). Though there have been many explanations found floating in the intellectual space, yet the most appealing and logically sound explanation relates to corporate governance in the banking sector which led towards such a catastrophic fall of the company. A rigorous study reflects that two major factors have led towards the demise of Enron in the long run. Firstly, the firm focused and invested in the pool of ‘financial engineers’ which imply that these qualified personnel would engage in research where they would be able to twist numbers and reflect positive trends for the company. Secondly, the derivates reflected profits, thereby incentivizing all stakeholders where oversight was minimum and policies went unquestioned. Thus, flawed corporate governance policies led towards the collapse of Enron in the long run, which is now a case for reference for the global critiques and analysts. Contents Introduction 4 Enron & Corporate Governance 5 Analysis & Evaluation 6 Recommendations 9   Conclusion 10 Corporate governance in banking industry Introduction The current financial crisis has revealed various aspects of financial system which are inherently flawed and thus lead towards bankruptcy. The banking industry, under the liberal economic order, has undergone complex alterations which not only create confusions for analysts but also contain elements which are either illegitimate tools to acquire wealth or involve such measure which are only beneficial in the long run. Enron is one such company which faced the wrath of flawed banking policies and thus led towards bankruptcy. The scandal was revealed in 2001 which raised various questions about the American energy corporation which is based in Houston. Though the company saw its profits skyrocketing given the new fiscal policies that the management has employed, yet in the long-run; once the scandal was revealed, the inherent inconsistencies are a major topic of discussion amongst the financial analysts. Though there have been many explanations found floating in the intellectual space, yet the most appealing and logically sound explanation relates to corporate governance in the banking sector which led towards such a catastrophic fall of the company. For this reason, the corporate audit analysts also often quote Enron as being the biggest corporate governance failure. Though there have been other companies which followed similar fate given the corporate governance, yet the case study of Enron seems relevant since there has been immense research and analysis in the area which is crucial to conduct an in-depth study. Prior to taking up the case study for research purposes, it is crucial to get a glimpse at what the concept of corporate governance entails. The Organization for Economic Cooperation and Development (OECD) has defined the concept quite accurately where it states that corporate governance comprises a set of decisions taken after deliberations by the management of the company, the board of governors, the stakeholder of the company and any other relevant stakeholders (Gup 2007). Since every company has a set of objectives which it intends on achieving, each company also sets a structure and a policy to see how to reach the bar set by the company, which mainly comprises of the corporate governance strategies of the company. However, another significant aspect of corporate governance which allows for the company to set incentives for various board members and the management is what comprises those complex procedures which may be gruesome for the company later. The priority of these stakeholders relate to seeking profits where the interests of these stakeholders overpower other morally bound incentives for the company or the society as a whole (Kohler 2008). Also, given the competition in the market and the greed to acquire more shareholders for the company, these corporate governance strategies may also sometimes use illegitimate ways to acquire profits. When many firms employ such amoral corporate strategies in unison, an economic crisis is bound to be incurred. Therefore, financially speaking, corporate governance includes all such policies and strategies used to govern the business complexes of these institutions which are governed via board members and the managements. Furthermore, corporate governance also incorporates the managerial aspect of compliance with respect to laws and regulations. Therefore, the focus on the practices of corporate governance is quite acute where banking sector is the one most impacted by the policies. Enron & Corporate Governance The corporate governance of banks are relevant to the stakes of individual companies since it is the ownership of these companies which contribute towards making them a significance stakeholder to these complex procedures and practices. To prove the point, Enron would be taken as a case study and the flaws in the governance practices which lead towards the collapse would be discussed. However, the point to be noted here is that that banking practices are also subject to complexities involving risk management, internal control, capital adequacy and even compliance to the governance matrix, which must be favorable enough to attract capital from companies like Enron. In this context, the instance of Enron seems relevant since not only was it deemed as a huge bankrupt reorganization, but also a huge audit failure which makes it all the more interesting for analysts commenting on the subject. Enron came into being back in 1985 after Kenneth Lay managed to merge Internorth with Houstin Natural Gas company (Cruver 2002). However, later when Jeffery Skilling joined the managerial staff, he managed to build a team of executives who utilized unfair governance practices alongside special entities while employing questionable financial reporting standards. As a result, the company was able to keep the records of high debts and accounting loopholes off the public record for quite some time. Not only were the management and board of directors kept in dark regarding the real profits` report but also was Anderson pressurized to show ignorance towards the issue. Though in the short run, the situation was favorable for the company, but later when the company collapsed, the entire world saw the fate of once an economic giant, Enron. Therefore, it is critical to look into these corporate governance failures which led towards the collapse. Analysis & Evaluation In this context, various financial analysts and business studies have compared the fate of Enron and the unraveling of scandal with various other scandals like the demise of Aholds or the disaster of Union Carbide or even the Bhopal tragedy of 1984, since corporate governance failures are inherent to all of these disasters. Various underlying causes for their collapse have been debated ranging from the greedy measures undertaken by the top management to the failure of compliance measures to government limitations. Also, employing questionable accounting practices and flawed financial tools have led towards the collapse of Ernon. Yet, the underlying factor common to all the loopholes identified above is the failure of corporate governance which happens to be the sole driver of all other complexities. Thus, structural failure can be attributed as the single most important trigger which led towards the fall of cards for the company, and when the symptoms of the issue went unchallenged and uncontrolled, the demise was bound to occur. Enron collapse can clearly be related to the banking crisis which was caused by intense division of labor and complex specialization, especially in context to financial sector of the firms. More specifically, Enron was one of the pioneering companies which brewed up the concept of ‘financial engineers’ as part of corporate governance policies, and these engineers in turn sought complicated financial instruments to trick the audit firms. However, these financial instruments didn’t really understand how the energy objectives and patterns of the firm and the stakeholders quite synced with the banking practices. Therefore, their priorities were attached with manipulated governance practices and banking outcomes to reflect a positive trend to attract investments and shareholder to keep the standards and profits of the company erect. Therefore, these drivers of change employed as part of governance strategy by Jeffery Skilling created a mess of the situation where both the organization itself and also the other participating firms had outgrown the comprehension capacity of individuals working in the orthodox system of economics and governance (Swatz & Watkins 2003). In other words, these financial engineers went a little too far in building an artificial scenario which was hard to catch up to. Furthermore, once these artificial and complex instruments were employed, they reaped immense profits and thus, the confidence of stakeholders and shareholders in Enron did enhance. As a result, the governance practices started employing these financial instruments with a higher intensity. Those trying to counter this system and raise concerns with the structural governance practices which were hard to comprehend were muted and these financial engineers became bolder and continued with their obsession with employing banking policies to these individual firms. As a result, Enron paved way for a trend factor where other firms weren’t only following these trends but also were critiqued for being too conservative if they weren’t too comfortable with the experiment. Therefore, even the regulatory firms came under immense pressure to ensure that the innovative fiscal practices aren’t hampered. While investment Banks were reaping immense profits with Enron, the modern business practices acquired appraisal globally. Magazines like ‘Times Magazines’ and ‘The Wall Street Journal’ further rubber stamped these corporate governance strategies being undertaken by these firms, and thus an irreversible and uncontrollable trend was surrounding the business environment. Since everyone was making profits and the investment banks were seeing the good fortune, no one questioned the fiscal values, while later after the scandal was revealed; many had to even end up in jail for hiding the reality behind dark curtains. (Fox 2003) The game behind the Enron success factor needs to be assessed as well. Basically, the entire structure of the corporate structure was built in such a way that the stakeholders were to be incentivized to be tricked into believing that the system was working. The traders in the game were thus incentivized and the top management was engaged in merely assessing how the stakeholders can be satisfied. Also, the real customers were also being tricked into believing that they are the ones at the gaining end, without even having to justify where the profits are coping from. Therefore, the dividends and the number games and the best deals were all that mattered and short selling of deals amounted to ever increasing profits. The financial institution of the firm was direly and desperately engaged in playing the numbers game where they could actually hide how these profits are being produced in the real sense (Markham 2011). Therefore, in this context, the problem with reference to corporate governance is two-fold. Firstly, Enron had set a precedent where a lot of capital and resources went into the financial evaluators or the financial engineers to hire the services of the most distinguished personnel to deal with the numbers game, Secondly, the derivates being generated rather those being reflected weren’t being questioned and instead, the oversight was to a bare minimum which hid the ethical, moral and even the technical issues which later created a recipe for disaster. Therefore, the corporate governance strategies, instead of ensuring transparency and accountability, were brewing up an incentives based market where the investment banks were happy as long as there were profits, which was the sole issue. Recommendations Therefore, the issue pertains to structural patterns dictated by corporate governance practices which involve the entire organization as well as the stakeholders by incentivizing the deals by utilizing financial instruments both in terms of quantity as well as applying unjustified financial controls with little or no accountability and oversights. The corrective measures for those entrapped in the matrix of these ‘modern’ corporate governance practices, will include a desire for these organization to incentivize community benefits rather than profits. Also, instead of narrowly focusing on personal fiscal interests, these companies and firms should focus on community efforts and a ‘human’ inclination to spread global good and improve on standards of equity. Also, a truer understanding of financial procedures is necessary where academic objectives should now incorporate on how the system works and how profits are geared rather than just brewing students with theoretical values, in order to correct the system in the long run.   Conclusion As result of these flawed corporate governance strategies, an irreversible matrix of event had unfolded which was now uncontrollable and yet, too good to be true. Therefore, Enron is now a pyramid of investments where everyone is reaping profits without questioning the process and values, until the bubble burst and the company collapsed. The structural collapse had devastating consequences not just for Enron per se, but also for all stakeholders, shareholders and even other companies who had followed the precedent set by Enron. Since Enron was only a part of the global system of interlocked firm all engaged in corporate governance practices highly similar in nature. Most importantly, these firms had an internal unprecedented linkage in context to financial system when led towards triggering the global recession. Though few individuals are analysts also justify the Enrol Scandal by stating that the global recession amounted to the disaster, yet a rational discourse would clearly explain how global recession was rather triggered via flawed policies predicated by companies like Enron. Works Cited: Cruver, B. (2002). Anatomy of greed: The unshredded truth from an Enron insider. New York: Carroll & Graf Publishers. Fox, L. (2003). Enron: The rise and fall. Hoboken, N.J: Wiley. Köhler, M. (2008). Blockholdings and corporate governance in the EU banking sector. (Blockholdings and corporate governance in the EU banking sector.) Mannheim: ZEW. Gup, B. E. (2007). Corporate governance in banking: A global perspective. Cheltenham, UK: Edward Elgar. Markham, J. W. (2011). A financial history of the United States: From Enron-era scandals to the subprime crisis (2004-2006) : from the subprime crisis to the Great Recession (2006-2009). Armonk, N.Y: M.E. Sharpe. Prebble, L., Chichester Festival Theatre., Headlong Theatre., & Royal Court Theatre. (2009). Enron. London: Methuen Drama. Swartz, M., & Watkins, S. (2003). Power failure: The inside story of the collapse of Enron. New York: Doubleday. Read More