How The Fall of Enron Affected the United States Economy - Case Study Example

How the fall of Enron Affected the United s Economy Introduction Enron was created in 1985 whenKenneth Lay’s Houston Natural Gas merged with Nebraskan-Northern Natural Gas Company’s holding company, InterNorth, to form Enron. Before the merger, the two companies were primarily dealing with the distribution and transmission of oil as well as electricity in America. On a secondary level, they were also active in the construction, development and maintenance of power plants, pipelines and other similar infrastructure (Thomas, 2002). Under the new company name, Kenneth Lay was made the Chief Executive Officer and he wanted to expand Enron’s market share as well as the markets Enron was in since he had a very different vision for the new shape of the company (Welch, 2005). The Rise and Fall Houston Natural Gas had previously been in the business of generating their revenues from junk bonds from which its proceeds were used in the formation of Enron. Kenneth Lay aimed at becoming the biggest player in the energy sector through successful trade earnings from futures contracts (NPR, 2006). To his advantage, Spectrum 7, an oil-well concern welcomed a partnership with Enron a year after its creation. Spectrum 7 was headed by George W. Bush, son of the then-Vice President George H. W. Bush. With falling gas prices in the mid 1980’s, Enron and other gas firms vigorously lobbied for deregulation to get benefits for themselves (Thomas, 2002). It has been known for many years that political connections can help a business but such situations often come to light only if the business is unsuccessful (Medawar, 1976). The deregulation action came into effect when buyers switched to the cheaper alternative – fuel oil. No doubt fluctuating gas prices allowed Enron to start marketing gas futures; securing gas prices at later date promised to their stakeholders. Similarly, the company lobbied once again for electricity just before selling electric power futures contracts (NPR, 2006). From then on, Enron was aggressive in expanding its services in the other sectors such as the water utility sector by creating Azurix which partly collapsed on the NYSE in 1999 and finally shut down operations in 2001 (Thomas, 2002). Concurrently, Jeffery Skilling who had been hired in 1990 to lead the financial side of Enron’s operation became a major proponent of the energy trading businesses and became the president and COO for Enron. He built wealth for the company by trading in 30 different industries and was reputed as being one of the pioneers in the marketing and promotion of power industry (Thomas, 2002). Additionally the firm worked with steel and wood fiber contracts, financial instruments, weather derivatives and Internet bandwidth capacities. Its diversification into other market futures included the futures in sugar, coffee, grains, hog and other meat varieties (Wikipedia, 2006). The Enron’s business was expanded with numerous trading ventures along with creating partnerships for every contract. The company even created new markets for itself by being a new-economy trailblazer (NPR, 2006). However, the company was still providing products and services for its original industry i.e. electricity and gas via the construction, distribution and maintenance of its power plants. Enron had heavily invested in partnerships worth hundreds and billions of dollars within the few years of the early 90’s. Yet at the same time, those investments did not produce enough returns for the company to be profitable and such a situation was being ignored (Thomas, 2002). Ethics and honest business did not seem like the right way to go where market leadership and economic advantages were concerned (Lachapelle, 2005). In an effort to remain the biggest and leading player in trading businesses, Enron developed and launched EnronOnline in October 1999. EnronOnline (EOL) was to be the first web-based transaction system that would allow buying and selling commodities globally. EOL’s earnings came from being a third-party in all business transactions placed on its website. This venture earned a lot of money for the company before proving to be another fatal financial blow to Enron (Thomas, 2002). Subsidiaries like Azurix, Enron Energy Services, the closure of the original pipeline that generated the company’s revenue and broadband services also drained the company of its cash flow. However, these were not figuring largely in the reports of the company which maintained that it had a positive outlook (Adams, 2004). This placed more emphasis on the Enron Global Finance department to keep the company afloat and in an immediate effort to rescue their remaining assets, Enron entered into talks with a rival company, Dynergy, for a partnership. Dynergy accused the company of deceitful bargaining and pulled out of the deal within the initial weeks of negotiation. This final straw had lead Enron to open its books to the world and uncover the truth. On December 2, 2001, Enron filed for bankruptcy. Not only the financial world but traders and key investors worldwide were alarmed by the company’s latest action. What seemed to be the most stable and trusted energy company representing the American industry boiled down to nothing but smoke and mirrors (NPR, 2006). Enron had been listed in Fortune Magazine for the year 2000 as one of ‘100 Best Companies to Work for in America’. Its offices were of a quality their competitors would be envying. It was praised and hailed mainly by its labor and workforce as one of the best companies to work for. Long-term pensions, effective management policies and worker benefits were the reasons why people wanted to work for such a company. From a total of over 20,000 employees, Enron’s headquarters laid off more than 4,000 employees from its own division. The numbers kept increasing as the days of investigation and reporting were taking place (Wikipedia, 2006). Simply put, underneath all those flashy layers of state-of-the-art offices, long-term financial benefits and security for its employees, Enron was a company committed to its own executives’ financial gain rather than generating sales revenues (Bogle, 2005). The harshest known employee-ranking system in the country was introduced by its president, Jeffery Skilling. The Performance Review Committee (PRC) was also referred to as the 360-degree review which was based on the RICE criteria – respect, integrity, communication and excellence. Those with the lowest score of five were fired and those closer to one were the real performers or stars of the company. In this manner Skilling was known to replace up to 15% of his workforce annually (Thomas, 2002). The Aftermath Labeled as Fortune Magazine’s “America’s Most Innovative Company” for six consecutive years (1996 to 2001) Enron had suddenly turned non-existent (Wikipedia, 2006). The US Congress immediately took note of this and since a lot of shareholders had lost money in the company, they started an investigation and summoned Enron’s executives into the Congressional hearings. Kenneth Lay did not appear in two of those hearings. While the company’s annual reports make no mention of wrongdoing (Chwastiak & Young, 2003), investigative reports revealed that all relevant documents had been destroyed while top government administration officials were being sought for help. Allegations were made that company officials ignored earlier warnings about the company’s position while pocketing millions of dollars in their personal accounts (NPR, 2006). The largest and most successful trading business of the world had seen its decline with persistent rumors of bribery and political pressure in gaining worldwide markets. Central and South America, Africa and the Philippines were the regions Enron had keen eyes on for their business interests. They earned their notoriety when they used political connections from the Clinton and Bush administrations in finalizing a $3 billion contract with the Maharashtra State Electricity Board in India. The controversy which resulted from this deal ended whatever negotiations Enron had made with the Indian electric supply company for good (Wikipedia, 2006). Investigated information later revealed insider trading from the company’s initiation that let to fraud and deceit. In 1988, Enron’s two auditors - David Woytek and John Beard – found millions of dollars from the company’s account being moved into unknown personal accounts. Later revealed, the accounts belonged to the consorts (Louis Borget and Thomas Mastroeni) for the rulers of Kuwait and Saudi Arabia to gain information regarding OPEC’s moves. The auditors’ insider information led to increased cash flows from oil dealings while the senior executives believed the rumored details. The seemingly responsible CEO informed the auditors to continue their investigation (Wikipedia, 2006). This investigation was meant to return every rightful penny back to its lawful owners. However, when the reports were complete, no immediate action was taken against the accused. The two auditors pursued their findings only to be told that Borget had brought in tens of millions of dollars to the company and so they should stop further investigation. A total of sixteen people pleaded guilty for the crimes committed at the company after Enron filed for bankruptcy. Five others were former Merrill Lynch employees who were founded guilty. Eight former Enron executives testified, mainly John Fastow, against his former bosses Lay and Skilling (Wikipedia, 2006). Enron’s shortcomings uncovered the secret mishaps of the accounting world where Arthur Andersen, their auditing company, was charged on obstruction of justice for the same company. The scandal at Enron took place under the very eyes of Arthur Andersen’s auditors who worked there round the year. The telecommunications company, WorldCom was also declared bankrupt creating the domino effect for the discovery of other accounting malpractices. Amongst them, high-level corruption, accounting errors and insider trading were the main reasons for several companies downfall (Thomas, 2002). Enron had donated a total of $7 million in 1990 in contributions to political figures for their campaigns. Three-fourth of the US contribution was donated to the George W Bush’s presidential campaign (Wikipedia, 2006). It can be asked if the political consideration a major cause for Enron’s fallout and eventually demise. Millions of dollars were lost and/or misplaced as a result of the scandal. The US economy is still recovering from the aftershocks yet people are suffering. Kenneth Lay, died after a going through cardiac arrest while vacationing in Colorado on July 5, 2006 (Wikipedia, 2006). An empire that grew too fast too quickly was only meant to crumble some day. It was praised as a new-economy trailblazer, and then belittled as a beleaguered and bankrupt (NPR, 2006) but it seems that everyone forgot the rule that when something is too good to be true it usually is. Enron had reached heights that no other company had dared achieving let alone dreaming. As those involved in the scandal are being tried and sentenced, the accounting and financial world has taken a 360-degree turn in its accounting practices and policies (Thomas, 2002). Conclusion Today we have things such as the Sarbanes-Oxley Act 2002 to prevent companies and their managers from engaging in dubious accountancy practices. As discussed by Lundgren (2006), this Act was passed to establish more stringent standards for public company boards, management and their public accounting firms. The requirement for this act was seen because several scandals involving major US companies, namely Enron, WorldCom, KPMG and many others shook public confidence in big corporations. Companies such as these had ethics policies and accounting guidelines, but like many other things which companies say but do not do (Alleyne, 2005) ethics did not seem important for the firm. Of course, the government did make regulations after the case was closed but it may seem like a case of becoming wise after the event and it also looks like the preventive measures are too late in coming for those who have been defrauded by Enron and other companies (Graham, 2005). However, it has certainly changed the economy of America in terms of compliance and regulation which can be expected to take a greater part in how business is done in the United States. Perhaps this shock and the resulting changes are exactly what the economy needed since it is likely to prevent greater misfortunes in the future. Word Count: 2,186 Works Cited Adams, C. 2004, ‘The ethical, social and environmental reporting-portrayal gap’, Accounting, Auditing and Accountability Journal, vol. 17, no. 5, pp. 731-757 Alleyne, S. 2005, ‘But Can You Walk the Walk’, Journal of Black Enterprise, vol. 36, no. 2, pp. 100-105. Bogle, J. 2005, The Battle for the Soul of Capitalism, Yale University Press. Chwastiak M. & Young J. 2003, ‘Silences in Annual Reports’, Critical Perspectives on Accounting, vol. 14, no. 1, pp. 533-552. Graham, J. et. al., 2005, ‘The Economic Implications of Corporate Financial Reporting’, Journal of Accounting and Economics, vol. 40, no. 1, pp. 3–73. Lachapelle, E. 2005, ‘Morality, Ethics, and Globalization’, Perspectives on Global Development & Technology, vol. 4, no. 4, pp. 603-644. 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