THE ENRON

SCANDAL
A case analysis by
ALGIRE, CACHO, CHAN, JORDAN, ORTEGA
SUMMARY
■ Enron was formed in 1985 by Kenneth Lay after merging Houston Natural Gas and InterNorth.
Several years later, when Jeffrey Skilling was hired, he developed a staff of executives that, by the
use of accounting loopholes, special purpose entities, and poor financial reporting, were able to
hide billions of dollars in debt from failed deals and projects. Chief Financial Officer Andrew Fastow
and other executives not only misled Enron's board of directors and audit committee on high-risk
accounting practices, but also pressured Arthur Andersen, the company’s outside auditor to ignore
the issues.
■ One of the infamous topics in the world of business last year 2011 was the failure and bankruptcy
of one of the most innovative companies in America in the late 90’s which was the Enron
Corporation. It was a shock to the public. Enron was cited as the biggest audit failure. It was also
referred as a paragon of corporate responsibility and ethics.
■ The Enron executives engaged in a broad scheme to inflate the company’s earnings, which in turn
increased the company’s stock price. The scheme was aimed at showing that Enron was steadily
growing and meeting analysts’ earnings expectations. In reality, Enron was making bad investments
and recognizing non-existent revenue.
SUMMARY
■ The schemes hid the fact that the company’s cash flow was terrible and did not deserve an
investment-grade credit rating. Ultimately, the manipulation of the financial statements helped
Enron’s stock price to grow from $30 per share in early 1998 to more than $80 per share in early
2001. Even when the stock price started to fall, executives slowed the fall by continuing to
manipulate the financials.
■ Enron shareholders filed a $40 billion lawsuit after the company's stock price. Enron’s stock price
began a dramatic slide, dropping from $90.75 in August 2000 to $0.26 by closing on November
30, 2001. Its credit rating went to junk status, which caused the share price to collapse and banks
refused further finance, suppliers refused to supply and customers stopped buying.
■ The U.S. Securities and Exchange Commission (SEC) began an investigation, and rival Houston
competitor Dynegy offered to purchase the company at a very low price. The deal failed, and on
December 2, 2001, Enron filed for bankruptcy under Chapter 11 of the United States Bankruptcy
Code. Representatives said that the public deserves honesty and integrity by public companies,
and Enron executives mislead analysts and investors. Enron's $63.4 billion in assets made it one of
the largest corporate bankruptcies in U.S. history.
PROBLEMS AND ETHICAL ISSUES
■ Enron’s competitive environment and rigorous performance
evaluation standards caused a culture of deception.
■ This competitive environment contributed to the covering of
the errors and cheating because employees tend to be
uncooperative and seldom communicated with each other.
■ The culture of Enron emphasized too much on the financial
goals.
■ Enron tried to keep its employees and outside parties quiet.
■ Failure of the auditors to maintain their independence and
advocate for the correct accounting treatment.
CONCLUSION
■ ENRON's growth was rapid as there was a sudden boost with their earnings but also
became the biggest corporate bankruptcy to ever hit the financial world. The
company was described as unsinkable by its admirers just like the world's famous
Titanic. Even though known for its enormous power, the recklessness of the people
whose in control brought huge tragedy to its investors, employees as well as their
own company. The greed and love for money of Enron’s executives pulled down the
reputation and name of their company. Because of the severe manipulation of
financials, thousands of people lost their jobs and retirement funds. Investors lost
millions of money. The trust of the investment community and the public at large
was violated.
■ The scandal brought attention to companies to improve their internal control and
accounting systems, to become more aware of collusion or fraud by executives.
Investors and analysts became more prudent and skeptical. On the other hand, the
once very famous and huge company, Enron, will be forever linked with the word
fraud.
RECOMENDATIONS

■ They should use more accurate methods on measuring revenues that is more
suitable for their kind of business like proper accrual method and agen model. This
is for them to record their revenues when earned and cash flows are reasonably
certain. This can also reduce too much assumptions and estimations of revenues.
With this, company can provide confidence to the users of financial information,
most especially the investors.
■ Internal control should be constantly monitored and improve especially for a growing
and booming business. Management should be more active in communicating with
their employees and strictly comply with their policies. Most importantly, spread and
maintain professional ethics , good moral and right conduct.
RECOMENDATIONS

■ Refer to various business consultants and investment advisors to formulate the best
strategies for current and future investments in addition with the company's plans
and ideas to reduce risks and avoid bad investments. This also helps to plan ahead
and make contingencies for the better future of the business and not just for short
term goals and achievements.
■ Lastly, the top management should be the first one to abide the Code of Ethics and
their own business policies for them to achieve their vision. Their intention must
benefit the investors, employees as well as their business health and reputation.
ALTERNATIVE COURSE OF ACTIONS
■ Strong internal control and governance should be
implemented with robust compliance to the principles.
■ Use agent model more than merchant model.
■ MTM should be use in minimal. The estimates for revenues
and costs should be SMART.
■ Compensation and performance management system
should focus on long-term earnings.
■ Give much attention on ROA, ROE, Cash flow and Net Profit
Margin.