Enron Case Study

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Enron

Companies that do not behave in the ethical manner that society expects will eventually suffer in terms of profit. The temporary gain in profit that companies see because of their unethical behavior is erased one hundred fold if the deception is discovered. Yet, so many CEOs practice this type of behavior. They jockey the financial position of the company to influence share prices. One of the more elaborate situations in recent years involved Enron. The company's executives so badly wanted to leverage debt, that they dumped debt in tailor made limited liability partnerships (LLPs) and skirted all kinds of financial laws.

CEOs make moves everyday to try to affect the price of stock. In a way, these actions are a testament to the growth and power of the stock market.

It can also be said that the influence of the stock market has too much power over CEOs. This is because a large portion of their pay, in the form of stock options, is connected with the performance of their stock.

Their vision, a good indicator of how the stock is perceived, becomes blurred because of their overwhelming concern with the price of stocks. The reason Enron drew public attention on a grand scale was the magnitude of which the trust of the country was violated. Enron violated practically every known ethical rule. There was no end to the deception. Because of this, employees, companies that conducted business with Enron, and the country as a whole suffered huge losses.

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The key to controlling ethics in the workforce is to have a set of internal and external controls in place that are adhered to. If these controls had been enforced in the case of Enron, the bleeding would of have stopped a lot sooner.

I. The Root of Unethical Behavior in the Financial Community

A. Misrepresentation of Financial Information

Case Study on Enron Case Study Assignment

Unethical polices provides a company with unearned cash flow. However, the financial ramifications are devastating when the unethical polices and fraud are discovered. Enron is a classic example of a company that made a fortune through unethical means only to see those fortunes evaporate and criminal charges placed against those involved. As a result, Enron was in a considerably worse financial situation because of its unethical policies. Before we discuss the financial ramifications that Enron suffered and the procedures needed to prevent such an outcome, we must first explain why individuals in positions of power (i.e. CEO, CFO) push the envelope to reach their goals. So, we start with the core of all financial information.

B. Generally Accepted Accounting Principles

The basic objectives of financial reporting are guided by Generally Accepted Accounting Principles (GAAP), which provides information on how economic entities should identify, measure, and communicate financial information to a reasonably knowledgeable user. This information is translated by investors and creditors who make decisions on the viability of the company. Because the standards of GAAP are uniform, each company is measured along the same criteria. If companies skirt the provisions of GAAP to provide fraudulent information, the economic system in which we base our decisions would be based on tricks.

There are well documented cases on what happened when financial reporting was not widely accepted or when the rules governing financial reporting was not adhered to. One of the earliest examples is the stock market crash of 1929. There are many theories on why the market crashed, but one unanimous theory is financial reporting. Companies simply failed to clearly and accurately report their financial condition. People are still talking about the crash decades later. Sadly, the same dishonest reporting still takes place today.

This dishonest reporting is the source of poor ethics in the financial community. The most recent mega example is Enron. This case of Enron was widely reported in news articles about how the company distorted earnings by creating companies to bury debt. The after mess and full extent of the debacle is still unknown. The question becomes, why do CEOs take the risk of reporting dishonest information?

C. The Conflict of CEOs and Stock Option Compensation

The main reason that CEOs behave unethically is the power and growth of the stock market. As the stock market continues to grow, more companies began to tie their CEOs salary to stock options. The conflict of interest is clear. The better the company can portray its stock, the more money the CEO receives. Unethical CEOs accomplish this through tricks of the trade, essentially hiding debt and creating false income. Reporting bogus information causes their stocks to be over valued, which means more money lines their pockets. "Mangers who receive cash compensation may act differently than those who receive long-term incentives (options and shares) because short-term compensation is awarded based on earnings, while long-term compensation is awarded based on long-run performance." (Supanvanij, 2005)

CEO who is receiving a salary and paid an occasional bonus has less incentive to act unethically than a CEO whose earnings are tied to stock options.

The CEO who is concerned with stock options will ensure that the stock price is as high as possible. This can be positive or negative. On the positive side, the CEO will want to do a good job for the company and work really hard for the company. On the negative side, stock options are a hidden evil because they tempt the CEO to act unethically to line their pockets. In the end, it only takes one CEO to behave in an unethical manner; the effect will be far reaching to anyone associated with the company. The trend is continuously moving towards stock options for executive compensation; another alarming thing is the size of the salary which is miniature compared to the amount of stock options (Supanvanij, 2005). The question becomes, is it smart to let executives basically have an open checkbook on how much they can make? In a nut shell, this is basically what Enron did. The temptation is just too great in most instances for CEOs not to devise plans to steal shareholder's money. Now that we know the reason behind unethical policies and fraud, let's take a closer look at how Enron became one of the most powerful companies in the world through fraud.

II. The Death Sentence Lack of Ethics Provided to Enron

A. The Early Years

Enron Corporation began with the merger of Houston Gas and InterNorth in 1985. Ordinarily, this would have been a good merger. Enron would have been able to control most of the natural gas in the area by having tremendous pipelines and other infrastructure. However, Enron could not capitalize on this infrastructure because natural gas was deregulated (Akhigbe, Madura and Martin, 2005). Since natural gas was deregulated, other companies had the opportunity to use Enron's infrastructure. This weakend Enron's potential market advantage.

In 1986, Ken Lay became the CEO of Enron. He had a vision to transform Enron into more than just a natural gas company (Akhighbe, Madura, and Martin, 2005). This vision was brought about mainly because of the problems deregulation motivated Ken Lay to look for additional opportunities. He wanted Enron to become a player in the investment market. To get this vision moving along, Mr. Lay hired the consulting firm of McKinsey & Co. From this company came the young consultant Jeff Skilling. Skilling advised Enron on ways to make the company profitable. The main thing he did was set up a system where Enron could have predictable profits and returns. This was done by making arrangements with outside contractors in the gas business. Mr. Lay was very impressed with Mr. Skilling's work and offered him a job at the newly formed Enron Finance Corporation.

B. The Glory Years

The efforts of Ken Lay and Jeff Skilling propelled Enron into a mega company (Akhigbe, Madura, & Martin, 2005). They surrounded themselves with young, energetic talent. The revenues of the company skyrocketed in the 1990's. The company's stock price quadrupled and it was one of the most envied companies in the world. Jeff Skilling would eventually become Enron's CEO. The transformation that Ken Lay envisioned was coming full circle. The company had become much more than an energy company. It was trading commodities, Internet bandwidth and other items. Enron's profitability was not all it seemed. The mega company was playing with funny money, and doing funny math. Enron is a perfect example of what happens when the highest of ethics are not upheld in companies. In the short run, the company will do well, but when the lies and deception are discovered the company is doomed. As the market was going up in 2001, Enron dropped right to the bottom (Hamilton, 2004). This is the period when Enron's deception was discovered. Enron's stock price was at eighty dollars a share twelve months before the drop.

C. The Fall

In the late 1990's and early 2000, Enron began to fall (Hamilton, 2004). The CEO, Jeff Skilling, resigned and the stock price for the company began to tumble. It seems that… [END OF PREVIEW] . . . READ MORE

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