Enrons Fall

What are the systemic ,corporate ,

and individual issues raised by
this case ?

Systemic Issues
Systemic issue look for causes outside the group
that drive or direct groups or individuals to do
something. The forces include :
1.
2.
3.

Laws and regulations that provide the framework in which

people act ;
Economic and social institution that give meaning and
direction to the public and ;
Culture that shapes the values and perceptions of people
and groups.

Systemic causes of the Enrons fall :

The

U.S. Securities and Exchange Commission allow

Enron to use the mark to market accounting

method.
The

legal and regulatory structure allow firms like

Arthur Anderson to provide both consulting services

and the audited report about the financial results of
these consulting services.

It leads to conflict of interest.

The

legal structure and accounting rules allow Enrons

executives set up Special Purpose Entities which enable

Enron to hide its enormous debt.
The

stock market was shooting upward in the booming

90s. It seems like everyone was making lots of money.

This

boom culture led Enrons managers and executive

to think that anything was fine if the money kept rolling

in .
Most

large companies like Enron are allowed to manage

their own employee pension funds. Companies may use

these funds to advantage the company even when they may
disadvantage employees.

Corporate Issues
Corporate culture
Corporate

culture refers to the prevailing implicit

values, attitudes and ways of doing things in a

company.
It

often reflects the personality, philosophy and the

ethnic-cultural background of the founder or the

leader.

Corporate Culture in Enron

1. A very competitive working environment

Workers were evaluated base on their performance.

Each year, the worst 10% would be fired, while the
top performances would be rewarded lavishly.

2. A culture of deception
(a) They used unjustifiable calculation method to entice
investor to hold the company share.
In assessing the value of its assets (i.e. contracts), traders
were pressured to use
(i) an unrealistically low discount rate and
(ii) an overvalued future cash flows.
This

method enabled the company to record a huge surge

in profit.

This

created an illusion to investors. They were enticed

to buy the companys shares. Among them were the
companys workers, who invested their entire retirements
and life savings into the shares.

(b) They used a deceiving mechanism to cash in the share

value so as to obtain a source of cheap capital from
creditors.

The company was highly geared in debt. In 1987, two

years after its formation, 75% of its stock value was
debt.
Further expansion of the company required more debtraising. This would cause a deterioration in the credit
rating. As the risk of default increases, the creditors
(banks) would charge them a higher interest rate.

To get around the problem, Andrew set up series of

Special Purpose Entities which were invisible from
Enrons balance sheet. Enron shares were then
transferred to these entities. They were then used as
collaterals to obtain cheap capital.

The capital obtained was then channeled to the parent

company in exchange for its debt, failing investment
projects, and realizing the overvalued contracts.

3. A culture of greed and injustice

The relationships between (i) the top management
and the shareholders and (ii) Lay and the
shareholders also reveal the greed and injustice
nature of the corporate culture.
set up of the Special Purpose Entities enabled the
company to cash in on the share value. However, a
large part of the money obtained was not used to
distribute fairly among the shareholders, but went to
reward the top managers who engaged in the deceptive
and illegal practices gave themselves high rewards.

The

 On

knowing the accounting scandals of the company

and the possibility of the collapse of the company, Lay
publicly re-assured the future prospects of the
company, but secretly he off-loaded his possession of
the Enron share in the market.

In

doing so, he took advantage of the privileged

information that was no available to the general
public, and hence was guilty of insider trading.

Ethical problems with Enrons culture

The corporate culture of Enron is featured by its
(1) Harshness
(2) Dishonesty and
(3) Greed
The reward system re-assured this culture by
rewarding these unethical conducts lavishly. We now
turn our attention to explain why this business culture

is unethical.

1. Harshness to the workers

Cons :
i.

Workers tend to be incorporative and compete

with each other. They are less willing to share
resources and information.

ii. No concern with the needs, values, desires and

well-being of the workers.

iii. In Enron, measured by the ability to cheat.

2. Dishonesty
Pros :
The set up of a deceiving mechanism enables the company
to obtain a source of cheap capital from creditors.
It satisfies the utilitarianism requirement at the corporate
level, but not at the social level.

Cons :

Under the negative rights notion, people should have a

right to be freed from injury or fraud. (Failed)
Contractual rights require that everyone also had a
right to be left free and fully informed when contract
are made. (Failed)
Universalizability and Reversibility. (Failed)
1st formation of Categorical Imperative. (Also Failed)

3. Greed
Pros :
It increases the benefits of the top executives. So it
satisfies the utilitarianism requirement in the short run,
but not the long run.

Cons :

Distributive justice requires benefits are distributed

not according to the value of the contribution the
individual makes to a society, task, group, or an
exchange. (Failed)

The difference principle of John Rawls implies that

business institutions should be as efficient in their
use of resources as possible. (Failed)

Individual Issues
Virtues :

Habits of dealing with ones emotions, desires,

and action in a manner that seeks the reasonable
middle ground and avoids unreasonable extremes.
Vices :
Habits of going to the extreme of either excess of
deficiency.

Individual Issues
Virtue Theory :

An action is morally right if in carrying out the

action the agent exercises , exhibits ,or develops a
morally virtuous character, and it is morally
wrong to the extent that by carrying out the
action the agent exercises , exhibits , or develops a
morally vicious character.

Kenneth Lay

Founder, Chairman and CEO of Enron

Kenneth Lay
Dishonest and Lacked Integrity :

Under his leadership, the company managed to conceal its

massive debts through questionable accounting.

Lay and his attorneys decided nothing was amiss although

the special purpose entities might have to be dismantled
eventually if Enrons stock continued to slide.

Publicly , Lay announced to employees ad investors that the

future growth of the company has never been more certain
and urged them to invest in Enron stock.

Lay and other executives began to quietly sell much of their

Enron stock.

Jeffrey Skilling

President and Chief Operating Officer .

Served as CEO from Feb. Aug.2001

Jeffrey Skilling
Hypocritical ,Irresponsible and
Dishonest :

He insists that his abrupt resignation was motivated by

"personal reasons" and not Enron's impending doom.
He left without a pay-off, saying he wanted to spend
more time with his children and do more charity work. But he
is reported to have sold millions of dollars' worth of company
stock after his departure.
Testifying before Congress, he vehemently denied any
knowledge of the complex web of financial arrangements that
became Enron's downfall.

Andrew Fastow
Chief Financial Officer

Andrew Fastow
Lacked Integrity and Dishonest :
He

was allegedly responsible for creating a web of off-balance

sheet partnership with external companies that allowed him to
hide Enrons very large losses.

He

was also found by an internal Enron investigation to have

secretly made $30m from managing one of the partnerships.

He

is said to have refused to answer questions at a December

meeting with Securities and Exchange Commission officials.

He

tried to fire Sherron Watkins and to seize her computer

when he learned of her attempt to alert superiors of impending
trouble.

Sherron Watkins

Corporate Development Executive

Sherron Watkins
Honest, Responsible ,Courageous
and Integrity :
In August 2001 she wrote a letter to Kenneth Lay warning

of accounting irregularities that could pose a threat to the

company could implode in a wave of financial scandals .
On February 2002, she came before a congressional
committee and publicly revealed everything she knew about
the companys accounting practices. In her testimony, she
cast sacked chief financial officer as the villain of the piece
but claimed that chairman Kenneth Lay was duped.

Table of Summary
Name

Virtues(+)
or Vices(-)
Kenneth
-

Jeffrey

Andrew

Sherron

Morally Right () or
Morally Wrong ()

5 criteria to evaluate whether Enron has

done wrong :
1) Utilitarian perspective
2) Rule-utilitarians view
3) Rights : as the moral standard
4) From the perspective of ethics of virtue
5) From the perspective of corporate social
responsibility

1) Utilitarian :
To bring about the greatest net benefit and the
minimum cost to the greatest number.
A. What Enron has done :
Enron engaged in heavy borrowing in expanding business in
the 1980s in around 1800 different commodities like natural
gas, coal and paper pulp etc.
Benefit :
Facilitated the transaction of vital commodities, paying the

foundation to GDP growth, company growth, rise in asset

value, increase in share price.

There is nothing wrong with borrowing and being in

debt in business world.
Economic growth hinges on growth in nominal in contrast to
real resources.
For example :
A $1 can lead to business of $100, 100 times of real resources.

The problem is :
The percentage of debt (out of asset) : Enrons debt is 75% of
its stock market value. Can the debt be manageable ?

B) Enron engaged itself in commodity transaction :

It stabilized the commodity price against the
background of the US governments deregulating
the energy prices.
Stabilizing the commodity prices is beneficial.
There is nothing wrong with commodity trading
and achieving price stability.

C) Enron inflated the market value of the contracts :

FutureCashFlow
Market value =
DiscountRate
The excess of such market value (discounted net
present value of contracts) over the buying price =
profit ???????
Enron :
Away from the conventional accounting treatment of
profit
Benefit :
Rise in asset value of Enron : rise in share price :
beneficial to shareholders.

D) Enron covered up the debt under the separate

accounting financial statements of the Special

Purpose Entities :
Benefit :
Growth of business : growth of asset value : rise in
Enrons share price : rise to shareholders income.
So long as the share price does not fall, the growth of
business can be tremendous, but such cover-up sows the
seed of hidden disaster as the asset value of business
depends primarily on the investors **confidence &
integrity of CEO & executives.

E) Inflating the market value of Enron : deceiving

investors, shareholders & the US government :

That is why, after Enrons collapse, President

Bush signed into law the Sarbanes-Oxley Act
addressing corporate accountability.

2) Rule-utilitarians perspective :
Decides what is right not in terms of the utility of the
action itself, but in terms of the rule under which the
action falls.

What Enron has done :

A. Engaged in unhealthy heavy borrowing and the dishonest
practice of the CEOs :unacceptable.
B. Deliberately inflating the future cash flow : deceiving the
business partners.
C. By collaborating with the accounting firm, Arthur
Anderson, in providing false financial statements to
shareholders, investors, the public & the US government,
Enron is immoral.

3) Rights : as the moral standard :

Rights :
Enrons shareholders are entitled to have the
dividends and capital gain.
Their income dissipated as a result of the collaboration
between Enron and Arthur Anderson, the cover up of
debt and the lack of integrity of the CEOs.

4) From the perspective of ethics of virtue :

Ethics of virtue :
Ethics is not just concerned with actions, but also
the development & assessment of character.
Enron :

When the interest of CEOs & the business

conflict with limited resources facing Enron, the
executives acted immorally.

5) Corporate Social Responsibility :

Assumptions :
The

Enron share price did not fall.

Enrons

accounting practices were allowed by the

generally accepted accounting rules.

Enron should have taken up the social responsibility

of providing a fair healthy business environment,
benefiting shareholders, investors, government,
pensioners, economic growth & USA as a whole.

Conclusion
The tale of Enron is a story of human weakness, of
hubris and greed and rampant self-delusion : of
ambition run amok ; of a grand experiment in the
deregulated world ; of a business model that didnt
work ; and of smart people who believed their next
gamble would cover their last disaster--and who
couldnt admit they were wrong.
Quoted from Bethany McLean and Peter Elkind :
The Smartest Guys In The Room :The Amazing Rise And Scandalous Fall of
Enron (2004)