Corporate Governance - Enron - Case Study Example

Corporate governance Contents Contents 2 Introduction 3 Enron case 4 Literature review 6 Conclusion 11 References 13 Introduction Corporate governance codes are often developed or modified when new accounting scandals come into picture. Time and again there has been a list of accounting scandals that has rocked the world. The list of accounting scandal started from waste management scandal in 1998, to Enron scandal in 2001 followed by world com scandal in the next year. The list of scandals has grown ever since and the amount of dollars involved in the accompanying scandals has also increased progressively. After each corporate scandal of massive scale has happened, the corporate governance codes are revised and revisited to find out what went wrong and what loop holes in the rules fuelled the scandal. After analysis of the loopholes the corporate governance rules are changed to reflect upon the changes and new corporate governance rules are enacted to prevent such scandals from occurring in future. The classic case of Enron is an example in this regard. The Enron accounting scandal which is seen as the largest accounting scandal in the history of world led to a loss of $74billiion for the shareholders of the company, and the employees of the company. After the scandal there were sweeping regulations enacted mainly in the form of Sarbanes-Oxley Act that included increased penalties for destroying altering or fabricating records in federal investigations. The regulation also involved changing of auditors and rotation of auditors so that no auditor can actually influence or get influenced by the company management and may not remain unbiased about the company. In the following pages the accounting scandal of Enron is discussed and how the lessons learned from it were fed into the Olympus case and all other future accounting scandal. Discussion Enron case Enron accounting scandal in brief (source: Accounting degrees. 2014) Enron was formed in the year 1985 when its founder Keneth Lay merged two companies namely Houston natural gas and InterNorth to result in the formation of Enron in the early 1990s (Healy, and Krishna, 2003). Keneth Lay helped selling electricity produced from natural gas at market prices. Soon after this the US government deregulated the price of natural gas. As a result of this regulation companies like ENRON started selling their natural gas at a price they liked thereby increasing their revenues many fold. Local government opposed this regulation later on but strong lobbying by companies like Enron prevented the legislation from being revoked (Gerth, and OPPEL, 2001.). As Enron became one of the largest players in the natural gas markets in America its earnings soared and it started earning huge amounts of profits. As Enron started earning profits expectation of analysts regarding the company started on increasing (McLean and Elkind, 2013). However in reality the company was making huge amount of losses and was accumulating debt. As the company started accumulating debt it understood that if it disclosed those debts then it share process would be badly affected. It is at this time that Enron hired Jeffrey Skilling. Jeffery skilling in turn used accounting loopholes to continually project that his company was making profits. Before Skilling had joined the company the company followed straight forward accounting methods in which the company reported the actual costs that it incurred in gas production and actual revenue that it earned by selling the gas. However after Skilling joined the company he ordered that all the accounting results that would be recorded or reported would be done so using the mark to market principal. Enron actually became the first non financial company to use this method off reporting for it long term complex financial contracts. Mark- to- market actually requires that once a long term contract is signed its income from the project is estimated and its future income is transferred to the present value which is then written in the books of accounting. However the problem with this method of accounting is that the viability of these future contracts was themselves in question and so were the earnings that were recorded from these projects. Since these projects future earnings were misleading to estimate, so many a times there were discrepancies in the actual profit and the value that was recorded in the books of accounting. Using this method ensured that profit from many projects could be recorded even if those projects never saw the light of the day or were actually loss making. However in future years when the time came to actually book the profit from the project it could not be done. So at that time new and additional incomes from new projects were to be included in the earnings in order to appease the investors (Kadlec, 2002). Jeffery skilling recruited Andrew Fastow who was promoted to the position of CFO. Fastow came up with an ingenuous plan to hide losses and project that the company was having a profitable run. The plan was supposed to hide the fact that many of the subsidies of the company were making huge losses and the company was actually in a pile of debt and to in turn project that the company was in a great shape and financial health. The scheme involved utilizing the special purpose entities to hide the losses (The economist, 2002). For those projects which were actually losses making but Enron had booked profit for them were shifted to this SPE. The SPE could be used to hide any assets that was making losses or any business venture that had incurred heavy losses. Thus this losses were prevented from coming up into the company’s balance sheet. In order to compensate for the losses that the investors of the SEC were incurring the company offered them company’s common stock as stock option plan. Andrew Fastow and other members of the executives board by this devious game not only misled the board of directors, employees of the company and the pension fund managers but also pressurized accounting firm Arthur Anderson to keep their mouth shut (The Economist, 2014). Literature review The author (Cunningham) in his research paper has focused on analyzing the case of the Enron in relation to the maintaining and adoption of corporate governance. Enron failed to adopt the corporate governance through which the internal control mechanism that has lead to the increase in the conflict of the interest at the cost of the interest of the shareholders .Enron was involved in the scandal for providing misleading information about the market and the credit worthiness in accounting and also maintaining the financial stability of the company and Enron prepared the report which reflected the increase in the creditworthiness and sound financial position of the company which was not real and it misinterpreted it thus it provided unfair and misleading information . The regulations that existed failed to overcome and solve the problems that Enron faced. Enron did not follow the requirements for disclosures of accounting. Enron made an attempt to disrupt the discipline and the conduct of the market and it was involved in inflating the creditworthiness through its failure in maintaining or complying with the corporate governance the disclosure and the accounting standard and the fate of the Enron and the intentional deception has lead to the scandal of Enron (Cunningham, 2006). The researcher (Schwartz) in his research paper has emphasized on the accounting techniques that were adopted by Enron and found that the techniques that were used and adopted by Enron was conflicting with the standard and the accepted accounting rules and regulations. The techniques were mainly used or applied by Enron for converting its assets into liquid asset for including in the balance sheet, Enron attempted and reaped all the benefits and it was also involved in the tax deduction activity. The technique or the strategy of using swaps was applied by Enron for disguising the financial transaction that existed between the major banks and the firm (Schwartz, 2000).The writers (Healey and Isles, 2002) reflects in their study that the scandal in which Enron was involved included both the conduct of the unethical and legal activity of the firm and therefore it was charged for fraud and misrepresentation of fact. The scandal of Enron has left an ugly and deep scar on the modern business. The outcome of the scandal has affected a mass of people and especially it affected severely to the stakeholders who went bankrupt by losing the money that they invested (Healey and Isles, 2002). The researcher (Munzig) in his study has highlighted on the conflicting role of interest that is played by Arthur Andersen as an auditor and as a consultant for Enron. The lack of awareness of the board of directors of Enron in reviewing the books of account and the financial statement of the company was the major or the prime cause for the occurrence of the scandal and in order to safeguard and protect the image and reputation of Enron the senior level managers of Enron and the senior executives has made all possible attempt to bring back the reputation and image of Enron but they failed to overcome their failure (Munzig, 2003). The writers (Trevino and Weaver) in their study have focused on the corporate governance that is adopted by Enron for resolving its issues and scandals. Enron adopted the Sarbanes Oxley act which has been emphasized on improving and modifying the corporate governance of the company and complying with the accounting rules most remarkably by introducing the Public company accounting and the board for evaluating, assessing and monitoring the regulation and complying with the accounting standards and principles. Enron has adopted various methods for evading the self regulatory mechanism and Enron suffered the loss of confidence .The stock exchange commission has proposed for the accounting requirements that allow the shareholders to gain there right. Enron has formulated corporate governance and focused on maintaining the integrity and ethical conduct for developing the reputation of the company and handling all issues related to ethics. Enron has emphasized on improving the ethics and the integrity of the company which is considered as the main reason for the long and sustainable success of the firm (Trevino and Weaver, 2003). The researcher (Aronson.) in his study has focused on the case of Olympus which was also involved in the fraud and misrepresentation of facts and information accurately and provides correct data and figure about the profit generated and the losses that is incurred by the company. Olympus which is a very well known company and is famous for its camera was involved in the scandal of not revealing the loss of around 1.7 billion dollars that is faced or incurred by the company because the company was involved in earning superlative profit and the person who was involved in this activity was the newly appointed president of the company Michael Woodford. The unethical behavior and the abolition of the accounting code of conduct by Enron and Olympus has resulted in the overstatement of the operational value of the companies. But the companies were capable and able to gain the operational benefit by exploiting the accounting procedures, rules and regulations in the common operation of the business concurrent to the respective auditors of Enron and Olympus. As a result the management of both Enron and Olympus has been engaged or involved in deceiving its employees and mainly its shareholders. The fraud in which both Enron and Olympus was involved resulted in the financial manipulation of the facts and figures, conflict of interest, management abuse The Sarbanes act that was introduced in us for maintain corporate governance by the companies has reacted to the fraud committed by Enron and Olympus in the starting part of the century and this act has influenced the companies and the governments all around the world. The act was established in such a way that the public companies of US to maintain separate code of conduct and maintain separate code of ethics. But the act emphasized the Securities Exchange commission for issuing the rules according to the requirement of the companies. The scandal of Enron has paved the way for adopting the accounting standard for Olympus (Aronson, 2013). The researcher (Erwin) in his study has emphasized on the similarities in the scandal of Enron and Olympus has not revealed the correct financial position of their company. The auditors that were involved in the scandal of the companies are Arthur Andersen the auditor of Enron and Ernst and Young and KPMG are the auditors for Olympus. KPMG and Ernst and Young faced losses for not revealing the losses for the consecutive 13 years. The most important differences in involving in the fraud and misrepresentation of fact by Enron and Olympus is that Woodford has disclosed and revealed the fraud activity in which Olympus was involved after taking in charge of Enron. The event of Olympus is considered as the outcome of the Enron exposure which created a tough and strict accounting system in the economy (Erwin, 2011). The author (Saarni) in his study has focused on the various codes of conduct and the accounting standard and also the legislation that is required to be adopted by both the companies for complying with the corporate governance and resolving various issues and scandals. In case of legislation it is expected that the companies are expected to enact the laws to forbid the malpractices and restricting the mismanagement of the books of accounts and complying with the rules and standards according to the accounting principles. The legislation has been formulated for the companies to comply with the moral values ethics and maintain integrity of the company. The companies are expected to adopt the standard accounting rules and standards. The government of the country as an independent body is expected to comply with the rules and regulations for formulating the accounting standard. The codes of conduct are considered as the requirement for monitoring and controlling the process of the organization or the firm. The companies are expected to maintain corporate governance (Saarni, 2012). In consideration with the Olympus scandal the foreign investors have focused on the criticism of the practice of corporate governance that were previously considered as inadequate by Olympus before encountering the scandal. The accuracy in the financial statement is being considered as the fundamental issue for maintaining corporate governance. For prevention of the case the outside directors of Enron did not extend any help but in case of Olympus the directors from outside has extended help to the company for the prevention of scandal. The scandal case of Olympus is considered as the reminiscent of the case or the scandal of Enron and it is considered as similar not only because it is occurred at a innovative and respective company and it raises the question of functioning of the fundamental issues that are related to the maintaining of corporate governance and Olympus did not have any weakness in maintaining the corporate governance structure and it had converted its low quality camera into superior quality camera and it also had directors from outside. Out of the fifteen directors that the company had three directors were from outside and the outside directors have extended help to prevent the scandal of Olympus. On the contrary Enron had large number of directors from outside as compared to that of Olympus but the outside directors of Enron were ineffective and inefficient in preventing the wrong doing and misrepresentation of the company and also safeguarding the severe financial consequences. Conclusion The scandal of Enron had dealt a nasty blow on the Enron as it filed for bankruptcy soon after the scandal. The scandal also affected the lives of the employees who depended on Enron for their livelihood and the pension funds who had invested in the company’s shares in addition to dealing a huge financial blow to the investors of the company. The accounting scandal also meant a closure of business for Arthur Anderson Company. As per as the rules and regulation changes as a result of this scandal Sarbanes-Oxley Act was created in the year 2002. The act meant greater regulatory pressure on any company and greater amount of penalties in case of financial discrepancies. In another change to the laws the Financial accounting standard board raised its levels of ethical conduct significantly and the board of directors was given greater independence. It has been observed that both the company Enron and Olympus have been involved in the fraud practice in misrepresentation of the facts and figure and not revealing the losses that is incurred by the firm and it is very difficult to restrict detect and prevent the intentional fraud that is committed by the auditors of the company . The auditor of Enron, Arthur Andersen and the auditor of Olympus, KPMG and Ernst and Young have been alleged for the fraud and unethical practice in which they were involved. And it has been observed that the Olympus scandal has been regarded as the biggest problem in case of the corporate governance in Japan. References Accounting degrees. 2014. The 10 worst corporate accounting scandals of all time. [online] Available at. < http://www.accounting-degree.org/scandals/ > [Accessed on 14 February 2015] Aronson, B.E., 2013. The Olympus Scandal and Corporate Governance Reform. [pdf] Available at < http://sydney.edu.au/law/anjel/documents/2013/ZJapanR35_05-Aronson.pdf > [Accessed 14 February 2015]. Cunningham, G.M., 2006. Enron and Arthur Andersen: The case of the crooked and the fallen. Global Perspectives on Accounting Education, 3(1), pp.27-48. Erwin, P., 2011. The effects of code content and quality on ethical performance. Journal of Business Ethics, 2(1), pp.535-548. Gerth, J and OPPEL, R. A. 2001. Regulators Struggle With a Marketplace Created by Enron.[Online]. Acailable at < http://www.nytimes.com/2001/11/10/business/regulators-struggle-with-a-marketplace-created-by-enron.html > [Accessed on 14 February 2015]. Healey, M. and Isles, J., 2002. The establishment and enforcement of codes. Journal of Business Ethics, 39 (1), pp.117-124. Healy, P. M. and Krishna G. P. 2003. The Fall of Enron. Journal of Economic Perspectives 17 (2): 3. Kadlec, D. 2002. Under The Microscope: After Enron, investors are looking more skeptically at companies whose bookkeeping seems confusing. [Online]. Available at < http://content.time.com/time/magazine/article/0,9171,1001741,00.html > [Accessed on 14 February 2015]. McLean, B, and Elkind, P. 2013. Enron: The Smartest Guys in the Room. London: Penguin. Munzig, P. G., 2003. Enron and the Economics of Corporate Governance. [pdf] Available at < https://economics.stanford.edu/files/Theses/Theses_2003/Munzig.pdf> > [Accessed 14 February 2015]. Saarni, J., 2012. Financial fraud - importance of an internal control system. [online] Available at [Accessed 14 February 2015]. Schwartz, M., 2000. Why ethical codes constitute an unconscionable regression. Journal of Business Ethics, 65(1), pp.309-323. The economist. 2002. Enron the real scandal. [Online]. Acailable at < http://www.economist.com/node/940091 > [Accessed on 14 February 2015]. The Economist. 2014. Accounting scandals. The dozy watchdogs. .[Online]. Acailable at < http://www.economist.com/news/briefing/21635978-some-13-years-after-enron-auditors-still-cant-stop-managers-cooking-books-time-some > [Accessed on 14 February 2015]. Trevino, L.K. and Weaver, D., 2003. Managing ethics in organizations. CA: Stanford University Press. Read More