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Enron Case Study Answers: A Classic Corporate Governance Case– 2000 Words – This Enron case study presents our own analysis of the spectacular rise and fall of Enron. The Case Analysis of the Scandal of Enron. Get accomplished critical Case Study Assignment Help with financial, Corporate Financial Report, Analysis, Report, checklist within significant Enron Case Study Report writing.

The merger of Houston Natural Gas and InterNorth in 1985 created a new Texas energy company called Enron. In 1989, Enron began trading in commodities—buying and selling wholesale contracts in energy. By 2000, turnover was growing at a fantastic rate, from US$40 billion in 1999 to US$101 billion in 2000, with the increased revenues coming from the broking of energy commodities. The rapid rate of growth suggested a dynamic company and Enron’s share price rocketed. Top executives reaped large rewards from their share options. The company’s bankers, who received substantial fees from the company, also employed analysts who encouraged others to invest in Enron. But the cash flow statement included an unusual item: ‘other operating activities $1.1 billion’. The accounts for 2000 were the last Enron was to publish.

 Case Study Answers on Enron: A Classic Corporate Governance Case

The chief executive of Enron, Jeffrey Skilling, believed that old asset-based businesses would be dominated by trading enterprises such as Enron  making markets for their output. Enron was credited with ‘aggressive earnings management’. To support its growth, hundreds of special purpose entities (SPEs) were created. These were separate partnerships that traded with Enron, with names such as Cayman, Condor and Raptor, Jedi and Chewco, often based in tax havens. Enron marked long-term energy supply contracts with these SPEs at market prices, taking the profit in its own accounts immediately. The SPEs also provided lucrative fees for Enron top executives. Further, they gave the appearance that Enron had hedged its financial exposures with third parties, whereas the third parties were, in fact, contingent liabilities on Enron. The contemporary American GAAP did not require such SPEs to be consolidated with partners’ group accounts, so billions of dollars were kept off Enron’s balance sheet.

In 2000, Enron had US$100 billion in annual revenues and was valued by the stock market at nearly US$80 billion. It was ranked seventh in Fortune’s list  of the largest US firms. Enron then had three principal divisions, with over 3,500 subsidiaries: Enron Global Services, owning physical assets such as power stations and pipelines; Enron Energy Services, providing management and outsourcing services; and Enron Wholesale Services, the commodities and trading business. Enron was the largest trader in the energy market created by the deregulation of energy in the USA.

Case Study Analysis Answers on Enron: A Classic Corporate Governance Case

The company had many admirers. As the authors of the book The War for Talent (Harvard Business School Press, 2001) wrote, ‘few companies will be able to achieve the excitement extravaganza that Enron has in its remarkable business transformation, but many could apply some of the principles’.

Enron’s auditor was Arthur Andersen, whose audit and  consultancy  fees from Enron were running around US$52 million a year. Enron also employed several former Andersen partners as senior financial executives. In February 2001, partners of Andersen discussed dropping their client because of Enron’s accounting policies, including accounting for the SPEs and the apparent conflicts of interest of Enron’s chief financial officer, Andrew  Fastow, who had set up and was benefiting from the SPEs.

In August 2001, Skilling resigned ‘for personal reasons’. Kenneth Lay, the chairman, took over executive control. Lay was a close friend of US  President George W. Bush and was his adviser on energy matters. His name had been mentioned as a future US Energy Secretary. In 2000, Lay made £123 million from the exercise of share options in Enron.

A week after Skilling resigned, Chung Wu, a broker with UBS Paine Webber US (a subsidiary of Swiss bank UBS), emailed his clients advising them to sell Enron. He was sacked and escorted out of his office. The same day Lay sold US$4 million worth of his own Enron shares, while telling employees of the high priority he placed on restoring investor confidence, which ‘should result in a higher share price’. Other UBS analysts were still recommending a ‘strong buy’ on Enron. UBS Paine Webber received substantial brokerage fees from administering the Enron employee stock option programme. Lord Wakeham, a former UK cabinet minister, was a director of Enron and chair of its nominating committee. Wakeham, who was also a chartered accountant and chair of the British Press Complaints Council, was paid an annual consultancy fee of US$50,000 by Enron, plus a US$4,600 monthly retainer and US$1,250 attendance fee for each meeting.

A warning about the company’s accounting techniques was given to Lay in mid-2001 by Sherron Watkins, an Enron executive, who wrote: ‘I am nervous that we will implode in a wave of accounting scandals.’17 She also advised Andersen of potential problems. In October 2001, a crisis developed, when the company revised its earlier financial statements revealing massive losses attributable to hedging risks taken as energy prices fell, which had wiped out US$600 million of profits. A SEC investigation into this restatement of profits for the past five years revealed massive, complex derivative positions and the transactions between Enron and the SPEs. Debts were understated by US$2.6 billion. Fastow was alleged to have received more than US$30  million for his management of the partnerships. Eventually, he was indicted on 78 counts involving the complex financial schemes that produced  phantom profits, enriched him, and doomed the company.  He claimed that  he did not believe he had committed any crimes.

The FBI began an investigation into possible fraud at Enron three months later, by which time files had been shredded. In a subsequent criminal trial, Andersen was found guilty of destroying key documents, as part of an effort to impede an official inquiry into the energy company’s collapse. Lawsuits against Andersen followed. The Enron employees’ pension fund sued for US$1 billion, plus the return of US$1 million per week fees, seeing the firm  as its best chance of recovering some of the US$80 billion lost in the Enron debacle. Many Enron employees held their retirement plans in Enron stock: some had lost their entire retirement savings. The US Labor Department alleged that Enron had illegally prohibited employees from selling company stock in their ‘401k’ retirement plans as the share price fell. The Andersen firm subsequently collapsed, with partners around the  world  joining other ‘Big Four’ firms.

In November 2001, Fastow was fired. Standard and Poor’s, the credit-rating agency, downgraded Enron stock to junk bond status, triggering interest rate penalties and other clauses. Merger negotiations with Dynergy, which might have saved Enron, failed.

Enron filed for Chapter 11 bankruptcy in December 2001. This was the largest corporate collapse in US history up until then: Worldcom was to exceed it. The NYSE suspended Enron shares. John Clifford Baxter, a vice- chair of Enron until his resignation in May 2001, was found shot dead. He  had been one of the first to see the problems at Enron and had heated arguments about the accounting for off-balance-sheet financing, which he found unacceptable. Two outside directors, Herbert Weinokur and Robert Jaedicke, members of the Enron audit committee, claimed that the board either was not informed or was deceived about deals involving the SPEs.

Early in 2002, Duncan, the former lead partner on Enron’s audit, who had allegedly shredded Enron files and been fired by Andersen, cooperated with the Justice Department’s criminal indictment, becoming a whistle blower and pleading guilty to charges that he had ‘knowingly, intentionally and corruptly persuade[d] and attempt[ed] to persuade Andersen partners and employees to shred documents’.

Why did it happen? Three fundamental reasons can be suggested: Enron switched strategy from energy supplier to energy trader, effectively becoming a financial institution with an increased risk profile; Enron’s financial strategy hid corporate debt and exaggerated performance; US accounting standards permitted the off-balance-sheet treatment of the SPEs.

Enron Case study

What are the implications of the Enron case? First, important questions are raised about corporate governance in the United States, including the roles

of the CEO and board of directors, and the issue of duality;  the independence of outside, non-executive directors; the functions and membership of the audit committee; and the oversight role of institutional shareholders. Second, issues of regulation in American financial markets arise, including the regulation of industrial companies with financial trading arms like Enron, the responsibilities of the independent  credit-rating agencies, the regulation of US pension funds, and the effect on capital markets worldwide. Third, there are implications for accounting standards, particularly the accounting for off-balance-sheet SPEs, the regulation of the US accounting profession, and the convergence of US GAAP with international accounting standards. Last, auditing issues include auditor independence, auditors’ right to undertake non-audit work for audit clients, the rotation of audit partners, audit firms or government involvement in audit, and the need for a cooling-off period before an auditor joins the staff of a client company.

Some British banks were caught in the Enron net. Andrew Fastow, the former CFO, produced an insider account of how the banks had helped to prop up the house of cards. Three British bankers were extradited to the  United States to stand trial, under legislation designed to repatriate terrorists.

Jeffrey Skilling, the former CEO, was sentenced to 24 years’ prison and to pay US$45 million restitution in October 2006. Claiming innocence, he appealed. Kenneth Lay (aged 64) was also found guilty, but died of a heart attack in July 2006, protesting his innocence and believing he would be exonerated.

Although Enron collapsed with such dramatic results, international corporate governance guidelines had in fact been followed, with a separate chair and CEO, an audit committee chaired by a leading independent accounting academic, and a raft of eminent independent non-executive directors. However, the subsequent collapse owes more to abuse of their power by top managers and their ambivalent attitudes towards honest and balanced corporate governance.

Questions

1. Should a company’s bankers, who receive substantial fees from that company, also employ analysts who encourage investment in that company?

2. Enron’s external auditor, Arthur Andersen, earned substantial consultancy fees from the company as well as the audit fee. Enron also employed several former Andersen partners as senior financial executives. Could the external auditors really be considered independent?