Giulia Collu

Summary of Enron: The smartest guy in the room

Enron: The smartest guy in the room tells us the story of the rise and fall of Enron, and how its ineffective
corporate governance and perverse corporate culture led to one of the major business scandals in the US history.
Founded in 1985, Enron Corporation was one the biggest and apparently most successful energy trading
companies in the world. Enron was widely regarded as a model to follow to successfully compete in the New
Economy, and its stock was considered blue chip for years. This business fairy tale started to come to an end in
2000/1, following the involvement of Enron in the California energy crisis, and the increasing pressures from
financial analysts in questioning the regularity of Enrons financial statements and stock value. Enrons huge
financial and accounting frauds were eventually uncovered and led the company to file bankruptcy in 2001. As a
result, employees lost pensions funds and their life savings, and shareholders saw the value of their stock
reduced to pennies.
The reasons why the company managed to engage in deceitful and fraudulent practices for years is to be found
first and foremost in the corporate culture instilled by the management. In particular, Jeffrey Skilling, Enrons
charismatic CEO, was the one who mostly shaped a culture of unhealthy narcissism and social Darwinism. He
hired the best talents and nurtured them to believe that they were the smartest guys and that they could achieve
anything. Enrons Appraisal system contributed to strengthen this view. The rank and yank system, where the
15% least performing employees were fired every year, and the top performers could enjoy exorbitant bonuses,
created a fierce competition in the workplace. In such a culture based on personal gain, the interests of the
shareholders (e.g. Californian community during the energy crisis) and stakeholders were completely
disregarded. Finally, Enron considered the companys stock price as the most important success metric, and it
was ready to manipulate accounts and financial statements to meet analysts expectations.
While the companys culture serves as at the background, the documentary showed how Enron managed for
years to hide their debts and losses accumulated with its unsuccessful ventures. In particular, two practices
contributed to the perpetration of Enrons lies. First, Enron was allowed to use mark-to-market accounting, an
accounting method that enabled them to register expected future earnings by current projects as current
earnings, even if there was no certainty that those projects would have been eventually successful. Enron inflated
the future earnings to show profitability, hid the loss of multiple unsuccessful projects, and made its financial
statements very complex in order to escape analysts close scrutiny. The second method used was a fraud
created by the CFO, Andrew Fastow. Fastow created Special Purposed Entities, i.e. companies that had the
purpose to trade with Enron, in order to instill money to the company and to show a lower debt-equity ratio. All
these operations were conducted to bring stratospheric gains to the management directly or through trading
shares.
While the top management had the biggest role in the fraud, more parties are to be blamed. The Board of
Directors and Internal Audit Committee failed their role or purposely stayed quiet. Moreover, Arthur Andersen,
deliberately covered Enrons wrongdoings in name of their own business interests. Finally, many financial
institutions were involved, and probably Bush administration had a stake on it as well. This scandal, among
others, led to the enactment of the SOX law in 2002 to increase financial transparency and protect investors.