The Enrons Success - Assignment Example

ENRON CASE STUDY Student’s name Code & Course Professor’s name University City Date Question 1 In the late 1990s, Enron’s stock rose by a considerable 31 percent. Consequently, it furthered by a 56 percent increase in the wake of 1999 followed by an unprecedented increase in 2000 by an auxiliary 87 percent. In this regard, Enron was considered as the most innovative company having attained a stock price of $ 83.13; given its $ 60 billion market capitalization. The company’s success was expedited by a number of factors before 2000. At the time Enron’s inception, the U.S. gas markets were de-regularised. The Federal energy regulatory commission dictated that long term commitments purchase should correspond the purchase minimum gas volumes, under regulated prices. Accordingly, the gas pipelines providers protracted the high cost incurred to the consumers. Pursuant to FERC Order No. 436, a consequent decoupling of purchase and delivery of the gas resulted to cost saving in the purchase of gas. Resultantly it exposed the users to a short term volatility in gas spot pricing. In response, Enron Company took advantage of its position in the market to manage such volatility. As such, by 1993 it was the largest seller of natural gas contributing about $v 136 million of its total revenue. The inception of Enron Online facilitated the purchase of commodities online at a global scale, enabling the company grows its trading platform. The company transformed its assets management through its hold on massive assets –useful for information generation. As such, Enron commenced divesting and syndicating in substantial assets garnered at pursuing “asset light” strategy. It was estimated however that by the 2000, it had sold over $ 27 billion of its heavy asset, contributing to the sale, 20 times its pipeline capacity. Enron ventured into different, markets with the aim of taking advantage of markets that were highly inefficient. In each market, it sought to acquire all physical capacity in guaranteeing the delivery of gas to the customers. Moreover, the company ventured into electric power generation acquiring the Portland General Electric and the electricity distribution in Argentina and Brazil; tremendously increasing its revenue base. However through effective trading models, the company managed various challenges at succeeding levels. For instance, it managed to create peak plants that provided power during the peak operation hours. The formation of the Enron Broad band Service as an extension of its trading model resulted to an increased revenue growth of about 168 percent. The company was active in international energy –asset construction industry. In essence, under Rebecca mark, it was solely created to construct and manage energy assets out of the U.S. The construction of the $ 1.4 Teesside power plant in the UK saw the first project completion of the initiative. Upon its completion, the company was the single largest gas supplier that channelled its participation in the gas trading in Europe. Contrariwise it entered into construction contracts that saw its participation in the Africa, Eastern Europe, China, the Middle East and central and South America. By the end of 1993, the company had invested well over $ 3 billion in assets in the developing markets of Brazil and India, totalling a growth from $ 10 to $ 15 billion (Citation 10). The company invested into the global water business. Through its acquisition of Wessex PLC in 1998, they sought to take advantage of the augmented prioritization and consolidation in the water industry. Question 2 The company was fixated on innovation given its position in the markets. Its achievement was based upon its very accounting culture of attaining excellence in superiority in any market. A successful company is described by its competent employees as such the company recruited the best and the brightest students at its time-through lucrative signing bonus. Its evaluation process was centred on a biannual feedback system relative to a 360 degree view of the employees from supervisors and peers. This information was indispensable to the review committee which sorted the employees into different job description positions throughout the firm (Salter, p.13). Bottom ranked employees were at the risk of being fired (Salter, p.13). Enron’s performance evaluation was incorporated in driving employee compensation strategy. Its compensations and bonuses exceeded other companies at its time. Evidently, in 2000, the company signed $ 750 million in bonus to traders and superior originators that oversaw new deals (Salter, p.15). The originator's salary ranged from about $ 150,000 to about $ 200,000, but annual bonuses exceeded an unprecedented $ 1 million (Salter, p.16). Senior corporate executives were subject to phantom equity and bonuses for important accomplishment in closing major deals (Leopold, 2002). Accordingly, employees were encouraged to accept bonuses in the form of stock. Risk Management Practices It was evident that the innovation was propelled by high mobility levels coupled by decentralized decision making process. As such, it necessitated for a robust management system. Under Rick Buy’s governance, the Risk Assessment and Control department was crucial in analysing its financial and nonfinancial risks throughout its operation and business. Through the use of available information tool, RAC was tasked with evaluating Enron’s risks and rewards. The company was the earliest to incorporate VAR systems that estimated the company’s loses upon consequent investment in a given day, given the correlations of the commodity prices. This approach was supplemented by a Monte Carlo’s simulations that evaluated the impact of sudden shocks. Tentatively, RAC divided all contracts and traders into 1217 trading portfolios with respect to the type of exposure (Salter, p.17). Traders that were specialist in management of the risks were designated to manage separate portfolios that were supported by research groups. In essence, the research groups were indispensable in offering tools and models that dictated the strategy employed; whether to hedge, trade or hold certain investments. Principally, books were reprices at the end of the day and the reports were generated, showcasing Enron’s position. Before implementing new business ideas, RAC fast tracked a review of the business plans, which assessed their relation to the prevalent core business; monitored by a value –at –risk analysis. A deal of the approval sheet followed the process offering possible recommendations and five to six related risks. Consequently, the plan was presented to the boards, with expectations that it could parallel the company’s core business. Vital to its operation was the company’s 64 page code of ethics, which presented the behavioural operation in the firm (Salter, p.17). All employees had to certify in writing that they complied with the code of ethics, and any subsequent violations were to be reported. Probable conflicts that arose from investments by the senior managers had to be approved by the chairman of the boards and CEO. Question 5 Unsuitable conflict of interest. Whilst the clear conflict of interest in the company, the Board of Directors were involved in the approval of the unplanned arrangements that facilitated the establishment of LJM (private equity) at the company’s expense. As such, the board’s inadequate realisation of LJM’s compensation and transaction control, failed to protect the company’s shareholders from unfair dealings. The Board of Directors admittedly allowed the company to operate at billions of dollars on off the book activities that made its financial reports appear successful than it actually was. Consequently, they failed to ensure a sustainable public disclosure systems that presented the materials in the off-the-book liabilities that significantly contributed to the company’s demise. Excessive Compensation. The Board of Directors facilitated the compensation of the company’s executive whilst its imperative monitor of cumulative cash drain that resulted from the annual bonuses and performances. Additionally, it failed to monitor or stop the Kenneth Lay’s abuse of the company’s finance and personal credit line. Evidently, Ken Lay’s compensation amounted to about $ 18.2 million, $ 7 million in bonus, $ 1.3 million in salary, $0.8 million is stock options among others. Inadequacy in independence. Enron’s Board of Directors was not independent given the financial ties between the specific board members and the company. Tentatively, it failed in considering the independence of the auditors, as such allowing Anderson to act as the company’s internal auditor and consulting services (George, 2006). High Risk Accounting Practices. Anderson admittedly confirmed that the company engaged in divergent high risk accounting. Backed by a disclosure of nine accounting practices that were used by the company were specifically of high risk. The Board of directors failed to act on this information. Its audit committee established that the company operated on strategies that have have never been engaged in any business practise hence its accounting was a “leading edge” (Enron: The Joint Committee on taxation’s Investigative Report, p.18). In the quest to prevent the demise of the company, the board of Directors was central to this realisation. Steps could have been taken in prohibiting transactions and practices that, may put the company at high risk of non-compliance as witnessed from Enron’s Chief Executive. In essence, they would have championed towards the incorporation of accepted accounting principles that would have otherwise present misleading and inaccurate financial reports. The prohibition of conflict of interest that facilitate the company’s transactions with the companies or business that are owned by a senior company personally as showcased through LJM1, LJM 2 and LJM3. Accordingly, they would not have been in support of the off-the-books activity that demean the shareholder’s consent. Nonetheless, off-the-books activities ensured that the company’s financial conditions seem better as opposed to the real values in the actual financial statements. Consequently, they would have garnered a full public disclosure of all its assets, activities and liabilities that impacted Enron’s financial conditions. Enron’s spending should have been closely monitored. As such, the board of Directors should have prevented the excessive compensation strategies through; i. Scrutinising ongoing oversight of the compensation payments and compensation plans. ii. Prevention of issuance of the loans financed by Enron and senior officials at the company. iii. Avoiding stock based compensation strategies, as they propelled company personnel to incorporate improper accounting plans that would increase the company’s stock price for personal benefits. The creation of clear differences between internal and external auditors. Principally, Enron’s outside auditors could not be used in the provision of consulting services to the company as witnessed by Anderson’s case. Contrariwise, strengthening of independence is instrumental in various dimensions. Majority of the directors should be free from the company’s financial ties other than his expected compensations. Additionally, strengthening of the auditor’s independence that prohibits the inclusion of outside auditors from the simultaneous provision of consulting and internal auditing. Reference List Ghemawat, P & lane, D., “Enron: Entrepreneurial Energy,” HBS No.700-079 George, R, Cashell, J & Martin, D, 2006 “Internal Audit Outsourcing,” The CPA Journal, Leopold, J & berthold, J, “Enron’s Filings Show Lavisg Compensation Was Awarded to Many Senior Exercutives,” Wall Street Journal, March 2002. Enron: The Joint Committee on taxation’s Investigative Report, p.18 Salter, “Innovation Corrupted (A),” p.13 Salter, “Innovation Corrupted (A),” p.15 Salter, “Innovation Corrupted (A),” p.16 Salter, “Innovation Corrupted (A),” p.18 Salter, “Innovation Corrupted (A),” p.17 Read More