Data analytics simulation strategic decision making chegg

Introduction

Once upon a time, there was a gleaming office tower in Houston, Texas. In front of that gleaming tower was a giant “E,” slowly revolving, flashing in the hot Texas sun. But in 2001, the Enron Corporation, which once ranked among the top Fortune 500 companies, would collapse under a mountain of debt that had been concealed through a complex scheme of off-balance-sheet partnerships. Forced to declare bankruptcy, the energy firm laid off 4,000 employees; thousands more lost their retirement savings, which had been invested in Enron stock. The company's shareholders lost tens of billions of dollars after the stock price plummeted. The scandal surrounding Enron's demise engendered a global loss of confidence in corporate integrity that continues to plague markets today, and eventually it triggered tough new scrutiny of financial reporting practices. In an attempt to understand what went wrong, this case will examine the history, culture, and major players in the Enron scandal.

Enron's History

The Enron Corporation was created out of the merger of two major gas pipeline companies in 1985. Through its subsidiaries and numerous affiliates, the company provided goods and services related to natural gas, electricity, and communications for its wholesale and retail customers. Enron transported natural gas through pipelines to customers all over the United States. It generated, transmitted, and distributed electricity to the northwestern United States, and marketed natural gas, electricity, and other commodities globally. It was also involved in the development, construction, and operation of power plants, pipelines, and other energy-related projects all over the world, including the delivery and management of energy to retail customers in both the industrial and commercial business sectors.

Throughout the 1990s, Chairman Ken Lay, CEO Jeffrey Skilling, and CFO Andrew Fastow transformed Enron from an old-style electricity and gas company into a $150 billion energy company and Wall Street favorite that traded power contracts in the investment markets. From 1998 to 2000 alone, Enron's revenues grew from about $31 billion to more than $100 billion, making it the seventh-largest company in the Fortune 500. Enron's wholesale energy income represented about 93 percent of 2000 revenues, with another 4 percent derived from natural gas and electricity. The remaining 3 percent came from broadband services and exploration. However, a bankruptcy examiner later reported that although Enron had claimed a net income of $979 million in that year, it had really earned just $42 million. Moreover, the examiner found that despite Enron's claim of $3 billion in cash flow in 2000, the company actually had a cash flow of negative $154 million.

Enron's Corporate Culture

When describing the corporate culture of Enron, people like to use the word “arrogant,” perhaps justifiably. A large banner in the lobby at corporate headquarters proclaimed Enron “The World's Leading Company,” and Enron executives believed that competitors had no chance against it. Jeffrey Skilling even went so far as to tell utility executives at a conference that he was going to “eat their lunch.” This overwhelming aura of pride was based on a deep-seated belief that Enron's employees could handle increased risk without danger. Enron's corporate culture reportedly encouraged flouting the rules in pursuit of profit. And Enron's executive compensation plans seemed less concerned with generating profits for shareholders than with enriching officer wealth.

Skilling appears to be the executive who created the system whereby Enron's employees were rated every six months, with those ranked in the bottom 20 percent forced out. This “rank and yank” system helped create a fierce environment in which employees competed against rivals not only outside the company but also at the next desk. The “rank and yank” system is still used at other companies. Delivering bad news could result in the “death” of the messenger, so problems in the trading operation, for example, were covered up rather than being communicated to management.

Ken Lay once said that he felt that one of the great successes at Enron was the creation of a corporate culture in which people could reach their full potential. He said that he wanted it to be a highly moral and ethical culture and that he tried to ensure that people honored the values of respect, integrity, and excellence. On his desk was an Enron paperweight with the slogan “Vision and Values.” Despite such good intentions, however, ethical behavior was not put into practice. Instead, integrity was pushed aside at Enron, particularly by top managers. Some employees at the company believed that nearly anything could be turned into a financial product and, with the aid of complex statistical modeling, traded for profit. Short on assets and heavily reliant on intellectual capital, Enron's corporate culture rewarded innovation and punished employees deemed weak.

Enron's Accounting Problems

Enron's bankruptcy in 2001 was the largest in U.S. corporate history at the time. The bankruptcy filing came after a series of revelations that the giant energy trader had been using partnerships, called “special-purpose entities” or SPEs, to conceal losses. In a meeting with Enron's lawyers in August 2001, the company's then-CFO Fastow stated that Enron had established the SPEs to move assets and debt off its balance sheet and to increase cash flow by showing that funds were flowing through its books when it sold assets. Although these practices produced a very favorable financial picture, outside observers believed they constituted fraudulent financial reporting because they did not accurately represent the company's true financial condition. Most of the SPEs were entities in name only, and Enron funded them with its own stock and maintained control over them. When one of these partnerships was unable to meet its obligations, Enron covered the debt with its own stock. This arrangement worked as long as Enron's stock price was high, but when the stock price fell, cash was needed to meet the shortfall.