An Organizational Crisis of Enron - Case Study Example

An Organizational Crisis of Enron 1. Introduction In the last decade, the increase of the complexity of corporate activities worldwide has led to the simultaneous increase of the relevant corporate legislation. The introduction of detailed legal framework for the regulation of corporations’ operations (for instance, the Sarbannes Oxley Act) was considered as an effective tool for ensuring the alignment of corporate actions with the relevant legal rules. However, this target has not been achieved. The cases of organizations that managed to cause severe damages in individuals and organizations prove the expansion of the specific problem. Enron is a firm, which has achieved an extremely high level of performance. However, it was revealed that its growth was mainly the result of the provision to the public and the authorities of false information in regard to the firm’s financial status. The specific practice of the firm is explained using the appropriate accounting theories. It is concluded that Enron would still be capable of achieving a high performance without violating existing law; the failure of its management team to manage the firm’s financial data and align the corporate strategies with the market trends should be considered as the main reasons for the firm’s collapse. 2. Organizational Crisis and Provision of Information in practice: the case of Enron In the context of the modern market, firms operating in various industries need to follow the rules regulating the activities developed in the local market; in case that the activities of a firm can impact the international market, then it is necessary for additional measures are taken – for instance, continuous monitoring of these firms’ activities and obligation for submission of detailed corporate reports. The US market is highly regulated. However, in the past the importance of corporate activities for the market’s performance was not adequately appreciated. In fact, it was through a series of severe corporate scandals (for instance, Enron and WorldCom) that the existing US legislation on organizational operations was updated. The introduction of the Sarbanes Oxley Act of 2002 has minimized the chances for severe violations of corporate laws; the provision of accurate information through the corporate financial statements is an issue mostly addressed in the current US corporate legal framework. Through this framework it is expected that major market turbulences because of corporate failures – like in the case of Enron – will be easier avoided in the future. 2.1 Framework of organizational crisis in Enron The collapse of Enron has been mostly related with a series of severe accounting failures. These failures have been extensively researched and are evaluated using different approaches. In accordance with Sterling (2002) the accounting problems appeared in Enron could be summarized as follows: a) ‘the financial statements on the firm’s special entities should not be consolidated with the corporation’s financial statement’ (Sterling, 2002, p.113), b) derivatives should not be used in order to influence the firm’s accounting data (Sterling, 2002, p.113), c) the liabilities of the firm were not appropriately listed (Sterling, 2002, p.113). Because of the above accounting problems, the firm’s stakeholders could not be aware of the corporation’s actual financial status. In this way, the firm continued to increase its capital – by attracting investments – even if its actual financial status was continuously deteriorated. The failure of Enron to provide precise information on its operations had another aspect: the changes on the firm’s financial statements were not limited to the firm’s profits/ expenses/ liabilities. In fact, as revealed through the investigation of federal regulators, the prices of gas included in the firm’s statements had been alternated – a fact that led to ‘severe energy crisis in the West’ (Anastasi, 2003, p.96) – among other consequences. The firm’s managers have probably understood the risk from referring to the actual prices of gas – the limitation of the firm’s profitability would be just one of the results of the publication by the firm of the actual gas prices; the decrease of the value of the firm’s assets would be possible, as well as the decrease on the investment attracted to the organization. 2.2 Reaction of the organization in terms of provision of information – explanations using appropriate accounting theories The development of the crisis in Enron has been gradual. In fact, the firm’s managers had adopted a particular technique when developing the firm’s financial statements: the information provided was related to the firm’s overall performance – there was no specific reference to the firm’s special entities. This practice has been part of the firm’s strategy in regard to the information provided through its financial statements. For this reason, in 2000, when the existing laws referring to the information included in corporate financial statements changed, the firm’s managers refused to appropriately align the firm’s financial statements – a letter was sent by the firm’s managers emphasizing on the need for keeping existing practice regarding the information provided through the financial statements because ‘by including full information on SPEs in financial statements would contribute to disclosure overload’ (Fox, 2003, p.217). In a report of the agency (FSB) in September of 2000 it was noted that not all SPEs should be listed in financial statements (Fox, 2003, p.217). However, the firm’s practices in regard to the provision of information on its activities could not be hidden; these practices – as explained in the previous section – were against the laws. By not publishing certain figures – SPEs – and changing the figures that had to appear in the financial statement the firm has managed to give a false impression to its stakeholders in regard to its financial status. The common practices of the firm for misleading its stakeholders have been the following ones: ‘transforming the losing investments into independent partnerships, shifting the losses to the shareholders and alternating the gas prices’ (Anastasi, 2003, p.95). The above practices of the firm should be evaluated using appropriate theories. Enron has been a firm where the continuous innovation has been set as a priority; however, the firm’s potential for such initiatives was not precisely estimated: through this way, the firm’s stability has been set in risk – an assumption which is based on the Jepperson theory on institutional risk (1991) through which the following issue is highlighted: innovation in regard to the organizational structure may set in risk the organizational performance especially when the organizational structure had kept its structure intact for a while (Arndt et al., 2000, p.495). The above view is based on the legitimacy theory on institutionalization; this theory accepts that in most organizations legitimacy is related to organizational structure. However, there is also the potential for an appropriate impression management plan to be used – in the context of the impression management theory – so that the view of the public on a firm’s status to be positively influenced (Arndt, 2000, p.496). In accordance with Ashforth et al. (2000) ‘an organization is legitimate to the extend that its means and ends appear to conform with social norms, values and expectations’ (Ashforth et al., 2000, p.177). The principles of the legitimacy theory – as described above – can ensure the legitimacy of an organization but have the following weak point: it is sufficient for an organization’s practices to appear as legitimate in order to be considered as such; at this point, the effective use of impression management techniques – as noted above – can reverse the negative views on the organizational practices. On the other hand, the institutional theory notes that the decisions of firms in regard to their strategic plans need ‘to focus on the alignment of corporate and social values’ (DiMaggio and Powell, 1983 in Berrone et al., 2009, p.4). Therefore, the actions of managers in Enron would be possibly justified as serving the following purpose: the increase of the corporate performance but also the simultaneous support of the society, through ‘the increase of job positions and the improvement of coordination with corporate partners’ (Berrone et al., 2009, p.4). 3. Conclusion The success of corporations in markets worldwide is depended on a series of factors. In many cases, the achievement of organizational goals becomes more difficult under the pressure of the market performance and the status of the economy. The violation of existing legal framework on corporate activities is then considered as non-important giving an extension for the actual development of corporate performance. It was probably the above approach that was adopted by managers in Enron. The potentials of the firm to protect its position in the market had been put in risk. The need for attracting capital was emergent and the alteration of the firm’s financial data was considered as the most appropriate solution in order to meet the market’s standards and keep the confidence of customers at high levels. The evaluation of the firm’s relevant practices using the appropriate accounting theories has led to the conclusion that the development of these initiatives was partially justified – referring to the need for protecting the capital of the shareholders; however, despite the initial good intentions of the firm’s managers, the provision of false information regarding the firm’s financial data did not have the expected result; instead, it caused the firm’s collapse influencing adversely the performance of the national market – in international level also, the performance of firms depended on Enron has been radically decreased. The case of Enron proved that corporate activities, even those that are may considered of low importance, can have severe impacts on the market harming the interests of the public and the state. For this reason, these activities should be carefully monitored as of their alignment with the existing corporate law. References Anastasi, J. (2003). The new forensics: investigating corporate fraud and the theft of intellectual property. John Wiley and Sons Arndt, M. and Bigelow, B. (2000). ‘Presenting Structural Innovation in an Institutional Environment: Hospitals' Use of Impression Management’. Administrative Science Quarterly, 45: 494-522 Ashforth, B. and Gibbs, B. (1990). ‘The double-edged sword of organizational legitimation’. Organization Science, 1(2): 177-194. Berrone, P., Gelabert, L. and Fosfuri, A. (2009). ‘The impact of Symbolic and Substantive actions of Environmental Legitimacy’. Business School – University of Navarra. Working Paper WP - 778 Fox, L. (2003). Enron: the rise and fall. John Wiley and Sons Sterling, T. (2002). The Enron scandal. Nova Publishers Read More