failui;s e>[

v
COMPARATIVE CORPORATE GOVERNANCE AND FINANCIAL GOALS CHAPTER 1 23
The tragic consequencesof the related-party transactions and accounting errors
were the result offailures at many levels and by many people:a ]la'wed idea, self-
enrich ment by employees,inadequately designed controls, poor implementation,
inattentive
'oversight,'simple (and not so simple) accounting mistaes, and overreaching in a cul
ture that appears to have encouraged pushing the limits! "ur review indicates that
many of these consequencescould and should have been avoided,
"Report ofInvestigation: Special Investigative Committee of the
Board of Directors of Enron Corporation," Board of Directors, Enron, Fer!ar" #,2$$2, pp% 2&'2(%
)n Decemer 2, 2$$#, Enron Corporation filed of the specialpurpose entities *S+Es, and off'al
for an-r!ptc" protection !nder Chapter ##% ance sheet partnerships carr"ing this det either
Enron failed as a res!lt of a comple. comination /ere fo!nd to have een misclassified to egin
of !siness and governance fail!res% 0s noted in /ith or /ere reconsolidated /ith the compan" as
the previo!s 1!otation from the oard report, a res!lt of their e1!it": falling in val!e *Enron
the fail!res involved organi2ations and individ!' shares,% 3hich leads!siac- to the eginning'
%als oth inside 4and o!tside of Enron% B!t o!tside /h" did Enron4s5shar'"5pgce t!rnle in 2$$#6 3as
of the to!rt7d%ncl sensational prdt4the %1!estion it simpl"ta: nat!ral%n88tlt,:(fafailing9!siness, or
% 55:remain::8s t15li8354%the9S":tetn all;,/ed it8t<hap' had Enron4s rep4=i5t8 %%%% rospective earnings,
~1~~~~~r~p~4%45~iil8!t~5g>88th%?8845"f8i888@ in S6+58matioh#84 #$%,
& 2t~fipanCial%:pealth, %
%% not4%A%;"%#%$Be$ e 8%9,%B"~%%"%& &#
4one%&B'sB&~&,%&:%4:%t:&%li%,89%r8%"% %pB,5%%8%5%%5,%%%858#e%$%(B," $%~ :%%%,%aBri%d%%%8vald8ted6
catcg,%8t6+59 =r:54p4f8venithe Enron6 B%%B ,,' %% C 9c9 %% @
" )i*$ ','(1:\":"" ,,'t ,!,#(!,' FaiiOre +f "C+*,+*a-e G./e*~a!0e at
Enron
E!*+!$s;~+lla,se" Enr)ll4s senior84"n#aD8gement team, primaril"
to 4 former:" Enron4 @CE)9 $Ieffre" CE) Eenneth 4pa",8445irid45C)) 7effre" S-illing
eca!se of a "r!n on the *later F,% 4"41' & the form!la'
is 4proal"%technicall" cor'
cr%edit %, 4/as"do/n'
Govemer
2H CHAPTER 1 COMPARATIVE CORPORATE GOVERNANCE AND FINANCIAL GOALS
lo/ed generall" accepted acco!nting prac
tices in the, statements of its financial
res!lts %% 0ndersen,4, li2e au a!ditors, /as
hired and paid "Enron itself% 0ndersen
also provided a large variet" of cons!lting
activities for Enron, the s!m of /hich /as a
m!ch larger line of !siness than the asic
a!dit practice itself%
2. Iegal co!nsel% Enron4s legal co!nsel, pri
maril" the Jo!ston firm Kinson 3
El-ins, also hired " the firm, /as
responsile for providing legal
opinions9 on the man" strategies,
str!ct!res, and general legalit" of m!ch of
/hat Enron did% 0s /as also the case /ith
0rth!r 0ndersen, /hen 1!es tioned later
as to /h" it did not oppose cer tain ideas%
or practices, the compan" e.plained
thatvi hasL not een f!ll"
illfo48medf ill4ic Mtails"'and cornple.i'
% % o/nership of
Nhe GOSE did no firsthand verification of
compliance on its o/n%
Beca!se the Enron shares /ere fol
lo/ed " a m!ltit!de of investment an-
ing firms, anal"sts for these firms /ere
responsile for follo/ing, anal"2ing, and
eval!ating Enron4s res!lts on a constant
asis% Enion4s relationships /ith its invest
ment an-ers involved fre1!ent "tit'for
tat" ehavior, in /hich those firms that
cooperated /ith Enron and s!pported its
performance stories /ere re/arded /ith
ne/ !siness and ne/ mandates for other
investment an-ing activities that /ere
profitale to the firms%
li-e all
gf588i88:8,1i%1,8iR,88,88lsahrle8eet in
spe
is considerale
the credit4
and -no/'
COMPARATIVE CORPORATE GOVERNANCE AND FINANCIAL GOALS CHAPTER 1 2?
po/er proPects *s!ch as Enron did in India,,
electrical po/er trading, and even ne/ trading
vent!res s!ch as the trading in /ater rights and
roadand, /er8, in the /ord of one former
e.ec!tive, hideous! Nhe salaries, on!ses,
start!p costs, and general lac- of control over
all operating costs dro/ned /hatever profits
arose from the ne/ vent!res%" Even the more
S!ccessf!l trading lines, incl!ding electricit", did
not generate the margins the mar-etplace had
come to e.pect from Enron and its older port
folio of !sinesses *primaril", nat!ral gas trad
ing,% 0s ill!strated in the follo/ing E.hiit 0,
the act!al operating income *IBIN, or income
efore interest and ta.es, " !siness line /as
not gro/ing in line4 /ith reven!es%
Nhe gro/ing deficit in corporate cash
flo/s also led to a more f!ndamental financial
management prolem for Enron: th*gro/ing
% 0ltho!gh 7eff S-illing had first emplo"ed
the concept of a f!nd of capital to e created to
s!pport !siness development /ithin Enron
/ith the creation of the )actus *und in #==#,
0ndre/ Fasto/ too- the concept to a /hole ne/
level% Fasto/4s e.perience in an-ing, specificall"
in the !se of special p!rpose entities *S+Es,, a
common tool i! financial services, /as his tic-et
!p the corporate ladder at Enron% Je event!all"
rose to the position of Chief Financial )fficer%
+any of the transactions involve an
accounting structure nown as a $special
purpose entity, 01' $special purpose vehicle$
(referred to as an ))-..)in this -ummary
and in the /eport)! % company that does
business with an -.0 may treat that -.0
as if it were an independent) outside entity
!for accounting purposes if two conditions
need for %4 4,4
'$1!a,re
2!
:(3) an !o,wn#: in:d#4,e,n##r5##6ehe
#,company must mae'a, s'l7'b8tan(tt#e!eqtf#ty
'" investment of at least 45 of the '-.0)9(# , $
, ! ##':wts) and that ';9fq(mus#e9rnainl#35ii#o"6';"';$7"8
;#~#~"
,)...-., -" -' .~,ff'.~#""''" * 9 " "#: 7 ) $;;#; ';il#"i~ 4%# B 8F8:,54:'4 l8%8"
, flthroughout the:tt:dn,sacti#'n(((#t:d:<(#=#t7g'#,:(e##:!(:#l>:5?'
7!l'
':independent owner' must e@ercisefo#ttol of: '
!:A:th-e.0! Bn those circumstnces5l#l3eC'io7ft:,(,,,
,#,pany may record gains and losses!on
trans $ actions with the -.0) and the '! - !
,5iabilities of the -lD# d!re not H$ E(5,l$'Et((:E &!~'7J,
'fthe company)s balance sheet)'
''$lthe company and: $-.0
Bt was
2< CHAPTER 1 COMPARATIVE CORPORATE GOVERNANCE AND FINANCIAL GOALS
freed additional room on :'the alance sheet to
f!nd ne/ investment opport!nities% Secondl",
the sale of the tro!led investments to the part
nerships generated income that Enron co!ld
then !se to ma-e its 1!arterl" earnings com
mitments to 3all Street%
Nhe prolem /ith this sol!tion /as that it
/as only temporar"% Nhe S+Es /ere largel"
f!nded from three so!rces: %,*17 e1!it" in the
form of treas!r" shares5 <=7 e1!it" in the form
of a minim!m 45 of assets " an !nrelated third
part" *in principle, altho!gh this /as later
fo!nd to e !ntr!e in a n!mer of cases,5 and
<47 large 1!antities of det from maPor an-s%
Nhis capital ase made !p the righthand side of
the S+Es4 alance sheet% )n the lefthand side,
the capital /as !sed to p!rchase a variet" of
assets from Enron% Fasto/%sold %these partner
ship deals% to the an-s 84+,n5:"the476remisethat
eca!se he /as % " 5 4% 4 , , 4
the
CF) ofEriro): a!#Ci the
S+8, he co!ld
The trouble was) the /aptors, lie the restA',#:
of F5+=) had become something of a
dumping ground for bad properties! Bn an
effort to mae quarterly earnings (and) 0/<
course) annual bonuses) 0nron! oriqina- ~#'~";#
tors were hooed on maing deals with *a##:
tow instead of outside third parties-who :$
would have ased a lot of questions, slowed: $ '
down! the process) and) in many cases) ,
illed deals! %gain) none of this mattered :#
to most people at 0nron, as long as the
stoc ept rising,ll
The Failure of People
As it t!rns o!t, m!ch of /hat Enron reported
as earnings /ere not, Q!ch of the det raised
" the compan" via the partnerships that /as
not disclosed in corporate financial $C;@C4'>"F>44444
sho!ld have een, Sim!ltaneo!s /ith the
reporting of profits and the
4det, /as the massive compensation
and on!ses earned " corporate"
ho/ co!ld Lhis,#,appen6
B It: ap8edRs ~~fthe 8.ec!tive4o"--$ icers2
firm /ere s!ccessf!l illshepherding
of Directors to/ard rrianagement484,oSvn
Qanagement had moved the compan",
n!mer of ne/ mar-ets in /hich the
fered s!stantial losses",r4es!lting i*4#4"lS'
>,K
attempts on their part to Lr12:fi88::":
the 4
",
f

COMPARATIVE CORPORATE GOVERNANCE AND FINANCIAL GOALS CHAPTER 1 2&