Enron's Collapse and Ethical Framework - Essay Example

Enron’s Collapse and Ethical Framework Mark-to-Market valuation is a way of valuing assets and liabilities at a fair market price. It is different from the tradition historical accounting as values in this method change with the market conditions. If the market is extremely volatile than it is extremely difficult to assess the true or fair prices of assets and the balance sheet figures tend to become under or overstated. This method can only be used by companies where market is stable and there is not much fluctuation in the prices of different assets. Enron used to have a conventional accounting system where all the costs and revenues were listed down in order to arrive at the profits (Velasquez, 2005). However, when the new CFO Skilling joined the company he insisted on using the mark-to-market valuation for evaluating the value of Enron’s assets. This is where things started to go wrong for Enron. This also made Enron the very first company in such volatile business climate to use this kind of accounting system. Enron started cruising on a wrong track. They decided to value all their future contracts using the system promulgated by CFO Skilling (Benston, 2003). However, there were large discrepancies in the system as it was very difficult to assess the future costs and income streams from contracts that were to be implemented in the future. The new system required to value all investments to be written as a present value of future cash flows. This created a big problem for accountant. They decided that they cannot match the future cash flows with profits as it was humanly impossible task in a gas company. Hence, they started giving misleading information to the investors, shareholders and creditors. This was an eerie accounting policy that Enron came up with. Although the present earning look very appealing, but the profits earned today could not be shown in the future statements which made the future proforma financial statement looked a little weak. Enron adopted another extremely innovative accounting policy of starting to make more future contracts in order to make financial statements of future years also look better. This created a never ending spiral and at the end of that spiral was destruction for the company. There were certain other accounting malpractices at Enron. They kept a debt of $600 million off book just to make sure that the financial statements of the company looked good. The reason why this practice is not encouraged is because it does not reflect the true accounting position of Enron. Debt would have decrease the net value of the company, and share price would have come down. However, this action prevented this from happening and share prices of Enron’s stock remained constant. This is misleading because owners and investors were evaluating a company at a much higher price than the true value of the company. This is an example of an open violation of truth and trust. Investors usually select the board of directors to make the long term policy for them. Directors hire managers to run the business for them. This shows divorce of ownership and control. This means that owners are not directly controlling the business, but they entrust it to their people selected in the Annual General Meeting. These people than entrust the responsibility of day to day operations to managers. In this way, there is a series of trust contract being formed. Ethics of any action require that trust should not be betrayed and whatever happens truth should be told to the real owners who have trusted the directors with their responsibility. The first breach of trust in Enron case started when the directors started sending misleading reports to the owners to make the financial statements of Enron look healthy. This is open violation of truth and trust and shows that in the case of Enron there was a clear evidence of breach of trust. Another problem in this case is the abuse of powers from directors. They started a new system of accounting and started fooling the real owners. Hence, all the theories of ethics reject such kind of actions. (Cohen,2005) Sarbanes-Oxley Act 2002 is a business Federal Law that was passed to prevent future accounting scandals like those of Enron, Tyco International and WorldCom. The basic point of this law was that the public trust in modern accounting practices have reached an ebb after the malpractices of Enron and other big companies who mislead their real owners (shareholders) and other important stakeholders. The main purpose of this act was to discipline the financial engine of public limited company. It created a new board Public Company Accounting Oversight Board. This was done to make sure that the breach of trust that was seen in the Enron’s case should not occur against. It was also done to make sure that the auditors work independently from the company and its accounting departments. There was also an increase in the term of jail sentences for executives and directors who publish misleading financial statements and try to cheat the investors. This was done institutionalize ethical behavior in the corporate settings. The act also made way for employees to whistle blow the corporate fraud not to be fired or harassed in any way by the company. These employees will also be liable for any compensatory damages. This encouraged the employees to make any wrong doing in the company public without fear of losing their job. This increased the transparency of the actions of directors and executives as any wrong doing can be immediately made public. All of this allowed much higher levels of transparency and encouraged the people running the accounting engine of a firm to be more cautious or they can be fined and imprisoned. This institutionalized the ethical behavior as auditors were made independent and there was no room left for any accounting personnel to mislead the shareholders, investors and any other stakeholder. (Salaiman, 2011) Some other countries like Australia also tried to prevent such kind of corporate failures in the future. The Corporate Law Economic Reform Program was established in Australia which was considered as equivalent to SOX (Sarbanes-Oxley Act of America). This system revamped the entire corporate governance system in Australia and was done to institutionalize the ethical behavior and to promote a vibrant economy. CLERP was very similar to SOX and it made sure that in future corporate failures like Enron will not occur again by making the role of Auditors in Public Limited Company more independent. It also set up frameworks for corporate fund raising to make sure that nothing is omitted from the books of accounts. It also increased the harshness of criminal liabilities for any director or executive found to have tampered the books of accounting in order to mislead the shareholders. It can be clearly seen that CLERP and SOX are two separate systems, but they have the same purpose. Both of these systems have increased the independence of shareholder. It was done to make sure that the owners and shareholders get the true picture of the state of affairs of the company. These systems will increase the truthfulness of the financial statement for the owners. These systems were implemented to make sure that people, directors and executives are forced to act in an ethical way and to provide the truthful information to the public and the shareholders. Enron was also accused of insider trading. The CEO of the company lied and told his employees that the share prices of Enron are going to increase. However, he did not hold on to his own stock and sold it off. Later it was found that the share stock price declined heavily. This showed the world that the CEO knew that the Enron bubble is about to burst and he told people that the share prices are going to rise because he did not want create panic in the market and did not want the share to lose its price until he has sold all his stock. This again comes under the head of misleading people. It is also insider trading because the CEO of the company is making money from the information that is disclosed to him to perform his day to day activities. There are two ethical issues in this scenario. This first problem in this scenario is open betrayal and failure to give the accurate information to the public. He used this information for this own advantage at the expense of others. The second problem in this scenario was that on insider trading. Although SOX and CLERP try to address the problem, but the problem has not been completely eliminated as no harsh laws implemented against these issues. The CEO of Enron did act in a manner that was completely unethical and used the information for his own financial gains which is completely wrong. (Banerjee, 2001) The Laws that were legislated in response to the corporate failure were a fair attempt to institutionalize the ethical behavior. The harsh laws were implemented for executives trying to fool their real owners or to mislead using wrong or far-fetched financial figures. It also increased the terms jail sentences for executives that were found to have been involved in any abuse of their power or to indulge in insider trading. This solved the problem, but did not completely eliminate it. People who work in the company are first one to know of any fraud or any wrong doing. This information reaches the people working in the company faster than people outside the company. SOX and CLERP have crafted new laws in order to make sure that any fraud is disclosed to the public as soon as it is discovered by making tough conditions for firing people on the preset of whist blowing (Astrid and Ibarguen, 2006). It also made it impossible for the companies to stop the pay or any benefits of the whistle blower, but instead it gave them right of any compensatory damages that the whistle blower considers necessary (Healy, 2003). This was done to increase or erect an additional layer of transparency on the Board of Directors and people working in the higher level of managements. In the Enron case, the whistle blower was faced with an ethical dilemma. Since the whistle blower was also the senior vice-president of the company, he was equally involved in fraudulent activities as any other person. The dilemma was to either to accept the blame by whistle blowing or refrain from whistle blowing and let the things run the way they are. . The organizations should seek to protect the whistle blowers at all costs. There are two reasons for this. The first reason for this is the fact that freedom of speech is the basic human right. Everyone is allowed to say what he wants to and the organization cannot stop him from saying what he think is right. The second reason for this is the fact that it increases the internal control against fraud of any organization. This is because that those people who are doing something wrong with the organization will know that their wrong doings are going to be revealed to the public and hence this will become a controlling factor that would stop people from indulging in unethical and behavior and will guide them to stay away from such behavior or face the consequences that can be in terms of a jail sentence and that person may also lose the job. They can protect the whistle blowers by not disclosing their identities to the public. The media should be under the government injunction of not disclosing the name of whistle blower in order to make sure that the whistle blower does not suffer the consequences for being brave. (Gerth and Richard, 2001) The collapse of Enron presented the social scientists, media and business professionals with several other ethical issues that are prevailing in the business world. The collapse of Enron meant that many employees who were working really hard would also lose their job. The investors or the owners of the company were faced with the ethical dilemma of whether to hold on to the stock and lose their money or to support the company for the sake of hardworking employees who had nothing to do with these frauds (Bumgardener, 2003). The increase in power of auditors was another source of concern. Auditors can now blackmail the accountants or people working in finance and abuse their power. This will lead to further problem for the companies and create further ethical issues. Both of these issues are related to truthfulness. The employees who are being fair in their work are losing their job despite being truthful and that is something iron. Similarly, auditors require to be truthful the shareholder and the committee that oversees their work. If they are loyal to them then no ethical issues will occur from the increase in power of auditors. 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