Why Enron Failed
BACKGROUND
Enron started humbly enough in 1985 from the merger
of two natural gas pipeline companies. The rise of Enron over the
next 15 years was meteoric. As a result of pipeline deregulation, Enron emerged
as an energy trader – matching buyers and sellers while making huge profits as
a broker. Enron also expanded into other business areas, including water, fiber
optics, newsprint, and telecommunications. Annual revenues rose from about $9
billion in 1995 to over $100 billion in 2000. Enron was listed as the 6th
largest company in the world, by revenues, in 2001. Enron was a major political
contributor, with nearly $6 million in campaign contributions since 1990.
President George W. Bush referred to Enron CEO ken lay as
“Kenny Boy.” Enron frequently appeared on lists of the “best companies to work
for” and “most innovative companies.”
PROBLEM
The Enron bubble burst over a period of a few months
in late 2001. Enron’s stock price had already been sliding for months, from $80
per share in February to around $30 in early October. Enron had been using its
stock value as collateral to obtain loans from complicated “partnerships.”
These partnerships allowed Enron, using questionable accounting techniques, to
exclude this debt from its annual reports and thus inflate its apparent
profits. On October 16, 2001, Enron third-quarter report indicated a $638
million loss along with an unexplained reduction in shareholder equity of $1.2
billion related to these partnerships.
After this announcement, things unraveled quickly.
The Securities and Exchange Commission announced an investigation the next
week. By early November, Enron’s stock price had fallen to less than $10 per
share, forcing it to borrow billions of dollars in an attempt to save the company.
Enron’s accounting firm, Arthur Anderson, was accused of shredding documents
and complicity in the deception. Enron’s stock was downgraded to “junk” status
and hit $0.70 per share on Nov. 28. On December 2, Enron filed for bankruptcy.
Investors lost about $60 billion in the Enron
collapse. Among the hardest hit were Enron employees who had most of their
401(k) retirement value in Enron stock. Many of these employees saw their
retirement savings completely depleted. By early 2004, 14 former Enron executives
had been indicted under a federal investigation (seven had pleaded guilty).
THEORY
Prescriptive Approaches to Ethics at Enron
Enron was a global energy firm that filed for
bankruptcy protection in 2001. The firm’s senior managers had engaged in fraud
for an extended period through a scheme in which partnerships owned by the
managers could receive payment for goods and services never provided to Enron.
In addition, the firm’s external auditing firm, Arthur Andersen, was complicit
in the fraud by knowingly certifying false financial statements as accurate.
Arthur Anderson participated in the fraud because the firm did not want to risk
losing lucrative consulting contracts from Enron, which created a conflict of
interest situation (Miller, 2004). The events leading to the collapse of Enron
can be analyzed using the ethical frameworks suggested by consequentialist
theory, deontological theory, and virtue ethics. Such an analysis can provide
an explanation of the failure of Enron’s directors, mangers, and auditors to
adhere to their ethical duties to the shareholders, employees, customers and
suppliers of the firm. Consequentialist theory suggests that an act is ethically
wrong if it results in consequences deemed wrong or harmful by the majority of
people in a society (Hooker, 2002). The consequentialist theory requires
assessing the actual consequences of the act, which includes both direct and
indirect consequences. It also requires using some type of evaluative norm for
determining whether the consequence is beneficial or harmful. The theory is
prescriptive because the evaluative norms are used to guide whether individuals
should perform or avoid an act. To apply the theory, there must be general
agreement in a society as to the nature of the evaluative norms. The theory
also suggests that the ethics of each situation should be determined according
to the specific circumstances without reference to an absolute legalistic or
moralistic standard.
CONCLUSION
Enron’s collapse was devastating in many regards.
Thousands of people lost their retirement savings, and the energy industry was
greatly affected. But perhaps the greatest damage was to people’s trust in
businesses and their leaders. The study of Enron shows that a company’s leaders
are not always positive influencers who lead the company to do the best good
for its stakeholders. The collapse of Enron highlights the importance of
analyzing an organization’s behaviors to detect potential unethical acts. The
actions of the company executives, the culture established, the employee
motivations employed, and the company structure can all provide signals
regarding whether a company is ethically sound.
