The Enron scandal and bankrupcy

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The world was shocked by the emergence of Enron Corporation as the worst corporate bankruptcy of its time in U S. at its peak, Enron was the most innovative company in America and was the seven largest corporation in the U S. The scandal was revealed in spite of its illusive financial steadiness with good revenue by traders and executives through well designed accounting act. Although this acts were morally questionable, it brought to the surface information on deep debts and hidden losses of the company. In 2001, the company went bankrupt. The fall of Enron is a nightmare to its current and former creditors, auditors and accounting regulators. The following academic paper analyzes the reasons behind the rise and fall of Enron.
The Rise of Enron to the Top
Kenneth Lay was the principal spokesperson in the deregulation of the energy market. The U.S Congress enacted legislation to deregulate the sale of natural gas. Lay became one of the initiators who made the sale of electricity possible on the free market. Enron gained an opportunity to sell their energy at relatively higher prices due to the significant energy market deregulation leading to greater revenue. Enron's journey from being an energy company to be a trading company began. The company diverted its focus from the energy market to inventing better ways of earning more money. To expand its business to open itself to new markets, Enron made large investments all over the world. After six years, Enron was named the most innovative company in America in a survey conducted by the Fortune's Most Admired Companies. The achievement motivates the company to be more competitive and increase their stock prices. Enron paid its employees partly through the stocks, so the increment in the stock prices became the company's main interest.
Jeffery Skilling joined Enron in 1990 and was appointed as the Chief Executive Officer seven years later. Skilling authorized the changing of Enron’s accounting system to the market-to-market accounting system. The initial accounting system was forthright since Enron listed its actual revenue along with the supply cost and sales of the gas. The proposed market-to-market required Enron to list their estimations for the future incomes in case of a long-term contract (Ailon, 257). The estimations were entirely based on the cash flow's net value in the future making the prediction of contract costs hard. Enron ‘s accounting included the money from the estimated income projects even before the money was received, and any changes such as loss were presented in the consequent periods. The information presented to the investors was wrong due to the deviations in the company's estimations. Enroll became the first non-financial company in the U.S to use the market-to-market accounting system. On 30th January 1992, the Securities and Exchange Commission in the U.S gave Enron the endorsement to use the method. Special purpose entities are created only to execute specific and temporary tasks since they are legal entities. The main objective of the entities is to handle asset through risk management or funding. Although the sponsor is responsible for the creation of the entities, the investors carry out the actual funding. In case the entity is separated from the sponsor, there exist several financial reporting rules to be followed. Enron used the special purpose entities to dodge the traditional conventions that governed accounting and also to conceal their debts. Through the estimates, Enron was able to hide and underestimate its debts along with overestimating the equities without arousing any suspicion.
In 1992, Enron was the largest natural gas seller in North America and their earnings before the taxes and interest amounted to $122 million. Enron adopted a differentiation strategy to grow further. The strategy was centered on the company's ownership and operation of various assets, paper plants, pipelines, electricity plants, broadband services along with water plants. Enron not only made money on its assets but also engaged in active trade with the contrasts of both the products and services it provided, generating more revenue. Enron emerged as the favorite among the investors due to the success, and their stock prices increase tremendously by almost 311% between 1990 and 1998. Further, the company recorded an increase 56% in 1999 and 87% in 2000. By December 31, 2000, the stock price of Enron was $83.3 while its market value was slightly over $60 billion (Adams, 35). Additionally, the 2000 Act of the Commodity Futures Modernization which was responsible for the deregulation of derivatives such as over-the-counter assisted Enron with their derivative dealings. For instance, during the California electricity crisis between 2000 and 2001, they manipulated the energy market in California leading to a surge in the electricity prices. At that time, the price of natural gas was selling at $60 per 1000 cubic feet that was previously trading at $3. The manipulation increased the stock prices and revenues of Enron. However, the manipulation exposed Enron to political attack and hastened their financial ruin.
The Collapse of Enron
The aggressive market-to-market accounting system that had corrupted the books of Enron failed. The accounting system had increased Enron’s optimism in its assumptions of the future profits. Enron experienced a cash crisis in the mid-2001 because instead of cash, it had paper revenue. The Enron culture for rewarding the moneymakers with large bonuses and incentives made it an extremely competitive workplace. The employees were in a hurry to close deals since they would receive bonuses irrespective of the deal's results. Many projects that lacked follow-ups were done, and this was a major problem. Further, the performance review committee aggravated the employees' aggressiveness. Competition replaced Enron's culture of cooperation. The ratings of the committee ranged from 1to 5 for the higher performers while those in the lowest 5-6% of the rankings were sacked.
Andrew Fastow made multiple special purpose entities to conceal the losses and fabricate the earnings. Some of the entities included Raptor, LJM1, AND LJM2 along with Chewco (Ailon, 263). Enron’s stock fell dramatically when the news about the hidden debts surfaced leading to the collapse of several special purpose entities decreasing the stock prices. The special purpose entities had to fulfill certain requirements to be legal such as 3% of the equity had to be from external investors, Enron could not have any control over the entities, and the company had no liabilities. An internal investigation of Enron's special purpose entities revealed that they were not independent since the employees controlled them. For example, Andy Fastow-runs the LJM while Kopper runs Chewco. The special purpose entities were revealed in the financial statements of Enron and this severely depressed the earnings as well as the debt levels.
The key players in the downfall of Enron included its most talented employees. Jeffrey Skilling was responsible for the implementation of the market-to-market accounting system. Under his administration, Enron launched an internet based platform, EnronOnline where the trading of contracts on energy products could occur. However, the company was unable to cover all the transaction costs sending it to bankruptcy. Andrew Fastow, Enron's Chief Financial Officer, was behind the fabrication of the special purpose entities and other complex financial structures to enable the company to conceal the debts and losses. Rebecca Mark was the head of Azurix and Enron International which collapsed. Among her, numerous projects were the power plants in Dabhol, India that cost Enron $ 3 billion (Lo, 168). During her trips around the world, she used the Enron Jet and used over $60,000 only to cover her transportation. The CEO of Enron, Kenneth Lay misused the company's assets in his adventures with his family. His family even used the company's jets for personal trips. Besides, Lay was involved in fraud along with conspiracy to conceal the company's conspiracy.
The bankruptcy of Enron Corporation affected over 21,000 of its employees. Four years afore the declaration of bankruptcy, the shareholders lost almost $74 billion. The company compensated 20,000 former employees who won a suit against the company with almost $ 85 million for the $2 lost pension funds. Many people lost their source of steady income and the loss of pensions shattered their futures. After the Enron scandal, the Congress created the Sarbanes-Oxley Act to regulate the boards of public companies as well as the management and accounting of public firms (Ailon, 270). The key players of Enron’s bankruptcy were charged in courts of law for conspiracy and fraud among other crimes. On 14th January 2004, Andy Fastow along with his wife Lea pleaded guilty. Andy testified against Skilling, Lay and other former executives of Enron received a jail term of 10 years minus parole. However, after he testified, his jail term changed to six years. Lay faced six charges related to wire fraud and securities attracting a jail term of 45 years. However, Lay died forty-one days later due to heart attack even before the schedule of his sentence. Skilling, who was guilty of wire fraud and security got a jail term of 24 years.
Conclusively, Enron's scandal surfaced due to the morally questionable acts made by the executives and traders. The stocks, bonuses, and incentives motivated the employee at Enron to carry out unethical actions with the aim of raising the stock prices as well as their income. The special purpose entities along with the market-to-market accounting system created a false image of Enron to the shareholders, investors, and debtors. When the information on the actual financial; status of Enron surfaced, the stock prices decreased dramatically. Several factors such as the market-to-market method, the use of special purpose entities along with the extremely competitive working environment caused the bankruptcy of Enron (Lo, 178). Executives such as Skilling, Lay, Mark, and Fastow also played a significant role towards Enron's journey to bankruptcy. The Enron scandal is not only a description of the accounting scandals but also of the personnel who made decisions for their interests without considering the lives of over 21,000 employees but also America at large. 
Works Cited
Adams, Renée Birgit. "Governance and the financial crisis." International Review of Finance 12.1 (2012): 7-38.
Ailon, Galit. "The discursive management of financial risk scandals: The case of Wall Street Journal commentaries on LTCM and Enron." Qualitative Sociology 35.3 (2012): 251-270.
Lo, Andrew W. "Reading about the financial crisis: A twenty-one-book review." Journal of economic literature 50.1 (2012): 151-178

November 11, 2021

Business Economics


Corporations Finance

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Enron Enron Scandal

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