Management Systems of Enron - Essay Example

Corporate Governance Affiliation Corporate Governance Corporate governance refers to the mechanism, relations and processes by which corporations are directed and controlled. The governance structure categorizes the distribution of responsibilities and rights among different participants in the corporation and includes the procedures and rules for making decisions in corporate affairs. Therefore, corporate governance includes the procedures through, which corporations’ objectives are pursued and set in the context of the regulatory, social and market environment. In the United States, the Enron case was a landmark case that showed that there were issues that needed to be sorted in relation to corporate governance. This essay will examine the Enron case in relation to legislations and literature recommendations that were made in the United Kingdom. Furthermore, the essay will establish whether the recommendations have been effective to ensure that corporate governance is in the right order to avoid fraudulent acts from the directors and stakeholders. The Enron Corporation was an American energy, services and commodities company that was based in Huston, Texas. Before, Enron was declared bankrupt on December 2, 2001 it had employees approximately 20,000 staff members and it was the world largest electricity, communications, natural gas and pulp and paper companies. In 2000, the company claimed revenues of up to $ 111 Billion, where it was named as America’s Most Innovative Company for six years consecutively. However, by the end of the year 2001, it was established that the Company’s financial condition was sustained by an institutionalized, creatively and systematically planned fraud know what is referred to as the Enron scandal (Johnson, 2002, p. 787-795). The Enron scandal leads to de facto dissolution of Arthur Andersen being that they had failed to audit the company properly as the Scandal was held to be the largest bankruptcy reorganization in the United States. The reason for the downfall of Enron was the fact that the Company had complex financial statements that were confusing to the analysts and the shareholders. Additionally, they had an unethical practices and complex business models that required the organization to use accounting limitations in order to misrepresent earnings and modify the balance sheet in order to indicate favorable performance (Downes & Russ, 2005). As a result of these issues the company became bankrupt; however, these actions were perpetrated through direct or indirect knowledge and actions of the company executives that is Lay, Skilling and Fastow Andrew among others. Lay at the time was working as the chairman of Enron in the last few years when it was in existence and most cases approved the actions of Fastow and Skilling even though he did not inquire about the details of those actions. Skilling, on the other hand, constantly focused on the meeting of Wall Street expectations and advocated the use of mark-to-market accounting that is accounting that was based on the market values, which by then was inflated pressuring the Enron executives to find ways in which the company would hide its debt (Mclean & Elkind, 2004, p. 56). To enable them to hide their debts Fallow and other company executives created complex financial structures, off-balance sheet vehicles and some deals that were so bewildering that very few people could understand what they meant. The plan to hide the losses was brought into play by Andrew Fastow, when he ensured that the company appeared to be in great shape, despite knowing that many of the subsidiaries were losing money. In relation to corporate governance on paper, the Company had the best board of directors as they comprised predominantly of outsiders who has significant ownership stakes, as well as talented audit committee. In a review that was conducted in 2000, it was established that Enron had the best corporate boards because the Chief Executive included Enron among the best boards. Thus, even with Enron having complex corporate networks and governance of intermediaries it still managed to attract large sums of capital to fund their questionable business activities and also conceal the true performance through various financial and accounting maneuvers and also hype its stock to very high unsustainable levels. This structure was supposed to be rewarding for the management systems of Enron, but that was not the case. This is because it leads to dysfunctional corporate structure that made the employees become obsessed with short-term earnings that were very good at maximizing bonuses. In that, the employees effortless tried to start deals in most cases disregarding the quality of profits and cash flow in order for them to get better ratings in their performance review. In addition, the accosting results were recorded immediately in order to keep the company’s stock price high. By so doing, it assisted the executives and deal-makers to receive huge stock options and bonuses. Furthermore, to ensure that the Company stayed afloat Enron ensured that there were sophisticated financial risk management tools. These tools were very critical for the Company not only as a regulatory measure, but also because of the business plan they had chosen to conceal their debts. However, this move was said to be a reckless one because the company had established long-term fixed commitments that was needed to be hedged in order to prepare for the invariable fluctuation in the future in relation to energy prices (Leeds, 2003, p.76). Conversely, this leads to their downfall because it attributed to their reckless use of special purpose entities and derivatives. This meant that with hedging the risk with special purposes entities that Enron owned it meant that they retained the risks that were associated with the transactions. The Special Purpose Entities initially were meant to hide any assets that were said to be losing money or business ventures that had already gone under; thus, keeping filed assets of the organization’s books. In return to hiding the losses, the company issued the investors of the SPE shares of the Company’s common stock in order to compensate them for their losses. However, this fraud would not go on for long as some of the financial analysts began to question the transparency of the Enron’s earnings. The financial analyst realized what the executives were up to and when Enron realized that their game was over they filed for Bankruptcy. The Enron Case shows how and what company leaders are capable when they are obsessed with making profits at any cost even if it is the detriment of the employees livelihood who do not understand what the executives are doing. Nonetheless, in the United States there were some lasting effects of the Enron Scandal because there was the enactment of the Sarbanes-Oxley Act of 2002. This Act tightened the disclosure and also increase the penalties in case of any financial manipulation on the part of the corporate body. Additionally, the Financial Accounting Standards Board extensively increased its levels of ethical conduct; thus, ensuring that the audit boards were very careful when making financial statements for corporate bodies (Bernardi & Lacross, 2005, p. 36). Furthermore, the board of directors was made more independent; hence, monitoring the audit companies and swiftly replacing the bad managers. Although these effects are reactive, they have been various loopholes in corporate governance because companies are finding ways to avoid accountability. The development of Corporate Governance in the United Kingdom had begun long before the Enron scandal happened. However, these developments were not as seriously until the Enron Scandal occurred in the United States exhibiting many loopholes that were found in corporate governance. For that reason, in 2001 there was a review of the relationship between companies and institutional investors that was commissioned in the Myners Review. The major objective of the review was to ruminate whether there were factors that were distorting the investment decision-making institution. Additionally there were suggestions for the improvement of communication between the companies and investors. This was also supposed to encourage the institutional investors to consider their roles as owners, as well as, how they should exercise their rights on behalf of their beneficiaries. The Enron case raised a lot of issues when it came to corporate governance not only in the United States, but also other parts of the world. For example, in the United Kingdom there was the enactment of the Combined Code of 2003. In 2002, the Department of Trade and Industry with the HM Treasury initiated a review of the Combined Code following a review that was conducted on Company law. DTI and HM Treasury prompted the Higgs Report on “The Role and Effectiveness of Non-Executives Directors.” The recommendations from the report included a definition of the term independence and the proportion of independent non-executive directors on the board and its committees (Heath & Norman, 2004, p. 247). Secondly, there was an expansion of the role of the high-ranking independent director who provide an alternative channel to shareholders that lead to the evaluation of the chairman’s performance. Thirdly, the report emphasized the process of nomination to the board through a rigorous and transparent process and evaluating the performance of the board and it committees and individual directors. In the same year, the Financial Reporting Council issued the Smith Report “Guidance on Audit Committees”. The Smith and Higgs Reports were then published on January 2003, and the recommendations from the two reports led to the changes made in the Combined Code on Corporate Governance. Some of the provisions provided under the Combined Code that were meant to help corporate governance to ensure that there was accountability under all levels included. First, in the Enron scandal the chairman and other executives were given the power to manage the running’s of the organization and they took it upon them to ensure that, even though, the company was bankrupt they still had to make profits. To ensure that this does not happen in the United Kingdom the Code stipulates that” there should be a clear division of responsibilities at the head of the company and no one individual should have unfettered power of decision.” (FRC, 2003). By so doing, there will proper accountability at the highest ranks of the corporate ladder with no one person having to go unchallenged or unquestioned whatever their role in the organization might be. In relation to auditing and whistle-blowing, there is a need for independence when it comes to external auditors. This is because in case of lack of independence then room for fraud is opened as was seen in the Enron’s Case. According to the Combined Code on auditing and whistle blowing it indicates that the audit committee should be responsible for reviewing the organization’s risk management and internal control systems (Dewing & Russel, 2003, p. 309). By so doing, it would help in preventing and mitigating fraud with the company. In addition, the audit committee is responsible for the monitoring of the external auditor’s independence with its main focus being the supply of non-audit and its consequences on independence. In reference to the Enron’s case, the code provides that some arrangements should be made to allow the staff in confidence to raise any concerns about possible impropriations within the company. In case the employees are given that opportunity the audit committee should act on the information provided with systems; hence, allowing for appropriate follow-up action and investigation. This means that the information provided by the staff should not be overlooked or ignored because the employees understand better about the business dealings of the organization. For that reason, any information given by then should be looked up to avoid any detriments or damages that may result from ignoring such information. Even though, there was the implementation of the recommendation that were made in the Combined Code of Corporate governance, they have not been effective. For example, since the Enron case happened, other failures and deficiencies have been established in corporate governance that led to the financial crisis that led to the collapse of Lehman Brothers. This happened in September 2008, and this case was subsequently followed by several United Kingdom and European banking groups. These events have established that there are soaring pay packages that still go to the top bank executives that are mostly driven by risk taking rather than profits that are sustainable. However, various recommendations were made in the effort of making of streamlining the corporate governance in the United Kingdom. First, Sachs and Ruhli (2005) suggested that managers needed to change their values in order to allow better implementation of the stakeholder in the view of strategic thinking. This was a result of the view the stakeholders had in relation to corporations, where they indicated that the shareholders perspective was too narrow to enable them to account for some aspects of knowledge-oriented business. The current incentives were not appropriate for management based investors and for that reason they should not be considered. Therefore, the successful implementation of the stakeholders approach to corporate governance was to focus on the knowledge contributed by the employees as they play a major part in the strategy creation process. Tipgos and Keefe (2005), agreed with the authors point of view where they argued that employees in any organization must be recognized as key players in the corporate process instead of being seen as simply as a production factor. This is because the employees are managed to see the origins of the corporate scandals in the excess power that is given to the t op management. This means in order to reduce this power, a new revolutionary approach to corporate governance should be required. Such an approach should take into account the current imbalance in order to prevent fraud VIN the future. In order to achieve these goals, a comprehensive system of corporate governance is needed and to enable restructuring various main constituencies should be empowered, and that is shareholders, top management, directors, and employees. This should be done through a shared vision of clear goals and objectives of the corporation. In this case the new role of the board is to form and sustain a structure that ensures that there is cooperation and harmony between the employees and the management while they are pursuing the company‘s goals and objectives, as opposed to officially authorizing management’s actions. According to Ray (2005), the corporate bodies and the people who govern in more heterogeneous boards should be elected in a democratic fashion, to ensure that the people who are elected are transparent and honest. He further stresses the relevance of electoral competition and term limits where the board selection process should be very simple and the nominations should be only permitted by senior management, employees, existing board members. This is because self-perpetuating and homogenous boards are vulnerable to negative outcomes because of group-think and the limitations of leading corporate logic. Secondly, today organizations influence the lives of the public through their impact on the environment, their employment practices, their ability to change consumptions patterns as well as, their global operation. For that reason, the perspective of all the persons affected and the economic future of the society should be shaped by the board of directors who are either nominated or elected without any formal process of legitimacy or representation. Proponents of strong corporate social responsibility demand that top executives should always work for the benefit of the stakeholders even in cases where it means that there will be a reduction of shareholder value and profits. Therefore, the top executives should not see a profit as a necessary condition for the sustainability of the business. They also argue that the powers of the executives cannot be more than those of the stakeholders. For that reason, Norman (2004) challenged the position given by Ray. He affirms that shareholders must be taken with the seriousness needed in the Post-Enron Era because they have a special position among the stakeholders. This is because the return on the stakeholder’s capital that they provide is not fixed because it depends on the performance of the corporation. In response to the corruption issues that were depicted in the Enron’s case Norman (2004) indicated that the new ways if holding the senior executives accountable in a stakeholder-oriented firm must be found. He further calls for the reduction of discretion given to the managers while choosing between multiple stakeholder benefits and profit maximization. He alleged that the board of directors could not effectively judge whether the top management was doing a good job if it did not have a specific, measurable target. Therefore, it is important to create standards for measuring improvements in some areas of stakeholders benefit and standards should be flexible if not ambiguous. By so doing, it will allow the management to assume their responsibility with actively, and they will be committed to corporate social responsibility. However, this assumption cannot be verified because accepting a moral hazard will allow corruption among the agents causing the program of the stakeholder benefits, not to be efficient, but fraudulent. Another recommendation was given by Vinton (2003) where he suggested that more attention should be devoted to the proper induction, development and training of board members. He further criticized the old fashioned view of directors who” were born not made” where he asserted that directors should be certified, mentored and chartered through appropriate institutions to avoid fraudulent issues in the organization. This opinion or recommendation was supported by Johnson (2002), where he indicated that training would allow the directors to have a more professional director role. He further emphasizes that these should not give the professionals an idea that they should create a class of individuals who have the directorship as their only occupation, but it should rather reflect on the process that educates the directors to be more effective shareholder representatives. In conclusion, the amendments that were made in the combined code of corporate governance have been effective to some extent and not entirely. This is because in 2008, there were some issues in relation to the bank that rose due to corporate governance fraud. For that reason, although the legislation was meant to make changes in corporate governance, it is clear that there are some loopholes. There is a need to establish bodies that will help in the implementation of the Combined Code on Corporate Governance in organizations. By so doing, they will ensure that the individuals employed in the executive positions have the professional ability and transparency to run the organization in a manner that is not fraudulent. References Bernardi, R. & Lacross, C., (2005). Corporate transparency: Code of ethics disclosures. The CPA Journal, 75 (4), pp.34–38. New York: New York State Society of Certified Public Accountants. Dewing, I. & Russell, P., (2003). Post-Enron developments in UK audit and corporate governance regulation. Journal of Financial Regulation and Compliance, November, 114, p.309. Bradford: Emerald Group Publishing, Limited. Gordon, J., (2002). What Enron means for the management and control of the modern business corporation: Some initial reflections. The University of Chicago Law Review, Summer, 69(3), pp.1233–1251. Heath, J. & Norman, W., (2004). Stakeholder theory, corporate governance and public management: What can the history of state-run enterprises teach us in the post-Enron era? Journal of Business Ethics, September, 53(3), p.247. Dordrecht: Springer Science & Business Media. Johnson, K., (2002). Rebuilding corporate boards and refocusing shareholders for the post-Enron era. St. Johns Law Review, Fall, 76 (4), pp.787–800. New York: St. Johns Law Review Association. Leeds, R., (2003). Breach of trust: Leadership in a market economy. Harvard International Review, Fall, 25 (3), p.76. Cambridge: Harvard International Relations Council. Mclean, B. & Elkind, P., (2004). The smartest guys in the room: The amazing rise and scandalous fall of Enron. London: Penguin Group. Norman, W., (2004). What can the stakeholder theory learn from Enron? Zeitschrift für Wirtschafts- und Unternehmensethik, 5 (3), pp.326–337. Mering: Rainer Hampp Verlag. Palepu, K. & Healy, P., (2003). The fall of Enron. Journal of Economic Perspectives, 2, Spring, 17.Nashville: American Economic Association. Ray, D., (2005). Corporate boards and corporate democracy. The Journal of Corporate Citizenship, Winter, 20, pp.93–106. Sheffield: Greenleaf Publishing. Sachs, S. & Rühli, E., (2005). Changing managers values towards a broader stakeholder orientation. Corporate Governance, 5 (2), pp.89–99. Bradford: Emerald Group Publishing, Limited. Tipgos, M. & Keefe, T., (2005). A comprehensive structure of corporate governance in post- Enron corporate America. The CPA Journal. 74 (12) pp.46–51. New York: New York State Society of Certified Public Accountants. Vinten, G., (2003). Enronitis—dispelling the disease. Managerial Auditing Journal. 18(6/7), pp.448–456. Bradford: Emerald Group Publishing, Limited. Read More