Reference no: EM13846178

The Enron Story

The Background

US company Enron was formed in 1986 from the merger of natural gas pipeline companies Houston Natural Gas and Internorth, and in the following 15 years diversified to provide products and services related to natural gas, electricity and communications. Early in 2001the company employed around 22,000 staff. Ken Lay was Chairman of the Board and Jeff Skilling was CEO.

Enron failed when the market lost confidence in it following major profit and asset write- downs in the third quarter of 2001. This caused loans to become due as stock market collateral collapsed making new borrowings impossible. Enron suffered the usual fate of a failed business; it simply ran out of cash. However, the lost confidence was not the cause of the collapse but merely its latest symptom. Enron failed because in the words of one commentator it was the proverbial `Emperor's New Clothes'. The assets and expected earnings which underpinned its meteoric rise into the Fortune top ten were largely illusory, while the tangled web of related companies and financial deals hid a huge burden of debt. Its aggressive accounting practice and market power ensured that the secret was safe, at least in the short term.

In 1997 the company reported operating results of $515m and profits of $105m as a result of non-recurring charges of $410m that `allow us to clear the decks for future growth' [Enron press release 20 January 1998]. From this point to summer 2001 the published financial results were spectacular, with the company meeting or exceeding rising earnings targets in 20 successive quarters. Operating results were $698m in 1998, $957m in 1999 and $1.266bn in 2000, the last full year reported.

With the help of their accountants and lawyers, top executives created subsidiaries that looked like partnerships and made it possible to sell assets and create false earnings. Offshore entities were used to avoid taxes, inflate assets and profits and hide losses. Conflict of interest rules were relaxed to allow executives to benefit personally from questionable ventures that in most cases were a drain on company funds.

One example of unethical practices was the transfer of energy out of California to create blackouts thus raising the price of electricity. Then the energy was transferred back to California and sold at higher prices, generating billions of dollars in extra profits.

Jeff Skilling, Enron's Chief Executive is quoted as saying that his priority as Chief Executive Officer (CEO) was `to keep the stock price up'. In an interview on 28 March 2001 with FRONTLINE about the California power crisis Jeff Skilling said, `We are the good guys. We are on the side of the angels'. His interviewer asked him, `A general comment that I've heard about Enron, and to a certain extent about you [is] that you're very, very smart, very, aggressive. You'll lay out your argument, ``The rules in California are terrible'', but then once you see what the rules are, you guys push those rules to the edge in an effort to make a buck'.

Skilling replied, `That's probably fair, yes. Once you set the rules to a marketplace, we adhere to the rules. If that's what you're saying, that's what we do.' Interviewer, `But you know what I mean you play the game hard. You take it right down to the . . .'. Skilling, `We adhere to the rules. If they set up the rules, we adhere to them. It's like the tax code. No one expects you to pay more taxes than you owe. And so you're expected to interpret the rules and conduct your business in that fashion . . .'.

Jeff Skilling resigned in August 2001 for ‘personal reasons' and was allowed to sell significant amounts of his own stock at a premium price. When Ken Lay took over as CEO he repeatedly emphasised the need to reinforce the message about the value of the company's shares. He
made appearances to investors and the public telling them that Enron was heading in the right direction, at the same time as top executives were rapidly selling their own shares. By August 15 the stock price was down to $15 but many trusted Ken Lay and continued to hold their stock and buy more of it. Four months later Enron filed for bankruptcy

The Board of Directors

The Board of Directors is responsible to the shareholders for the company's business. They should be the guardians of the ethical code and sufficiently in touch with the business to be effective. Enron's board appear to have fallen short in many respects. They were not fully briefed on the extent of the partnerships, allegedly taking only fifteen minutes to review some of the more dubious transactions underlying the surge in earnings. Subsequently of the 17 Directors, 7 were sued for insider trading and 6 had a trading or sponsorship relationship with Enron thus raising questions of conflicts of interest.

Executives and senior management

It is generally considered that the key determinant of the ethical culture of an organisation is the example set by senior management. Enron is no exception. In principle Enron claimed to subscribe to a morally worthy set of values insofar as Respect, Integrity, Communication and Excellence are at the core of its Mission Statement. Respect is defined as `We treat others as we would like to be treated ourselves. We do not tolerate abusive or disrespectful treatment. Ruthlessness, callousness and arrogance don't belong here.'

The Culture

The company culture of individualism, innovation and unrestrained pursuit of profits eroded the ethical behaviour of many Enron employees. The risk-taking culture of Enron and bonus incentives encouraged staff to manipulate profits estimates. Unethical practices were encouraged and were rife throughout much of the organisation. An employee's appraisal scheme, the Performance Review Committee (known locally as `rank and yank') resulted in promotions and bonuses for the top employees and dismissal for the bottom ones. Each year 15-20% of the employees with the lowest performance were fired and replaced by new employees. One commentator says, `the main factor that discouraged questioning of Enron's business practices was a ruthless and reckless culture that lavished rewards on those who played the game, while persecuting those who raised objections'.

The Performance Review Committee controlled employees and forced them into line. Appraisal was supposed to be based upon how well employees had delivered the core values; in reality appraisal was based upon how much paper profit the employee had generated. By all accounts Enron was an exciting place to work and it undermines those who argue that the macho `greed is good' culture did not survive the late 1980s and early 1990s.

The end

It was the biggest and most complex bankruptcy case in US history and had a devastating effect on thousands of employees and investors. It also led to the dissolution of accountancy firm Arthur Andersen, one of the largest in the world, after employees were found to have destroyed documents relating to the auditing of Enron finances. Anderson was serving as the independent auditor whilst at the same time charging Enron millions of dollars in consultancy fees.

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Adapted from Tonge, A, Greer, L & Lawton, A (2003) ‘The Enron story: you can fool some of the people some of the time....', Business Ethics: A European Review, vol. 12, no. 1, pp4-22 Yukl, G (2013) Leadership in Organizations 8th . ed. Pearson, Harlow, Essex.,

Questions

1. How can what happened at Enron be explained by some of the theories of leadership that you have looked at?

2. In what ways does leadership influence culture?

3. What can be done to reduce the type of unethical behaviour demonstrated in this case? What are your recommendations?