Enron Case Study

Submitted To:- Submitted by:-

Mr.
Mazhar Javaid Group#.(06 ) MBA (B3)-B
Sakhawat Hussain(G.L) 58
Muhammad Shahid Sharif 68
Zain Sharif 18
Uzair-ul-Hassan 48
M.Aurangzaib 74

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History of Enron
Enron traces its roots to the Northern Natural Gas Company, which was formed in 1932 in Omaha,
Nebraska. It was reorganized in 1979 as the leading subsidiary of a holding company, InterNorth. In
1985, it bought the smaller and less diversified Houston Natural Gas.
The separate company initially named itself "HNG/InterNorth Inc.", even though InterNorth was the
nominal survivor. It built a large headquarters complex in Omaha. However, the departure of ex-
InterNorth and first CEO of Enron Corp Samuel Segnar six months after the merger allowed former
HNG CEO Kenneth Lay to become the next CEO of the newly merged company. Lay soon moved
Enron's headquarters to Houston after swearing to keep it in Omaha and began to thoroughly re-brand
the business. Lay and his secretary, Nancy McNeil, originally selected the name "Enteron" (possibly
spelled in camelcase as "EnterOn"); but when it was pointed out that the term approximated a Greek
word referring to the intestines, it was quickly shortened to "Enron". The final name was decided
upon only after business cards, stationery, and other items had been printed reading Enteron. Enron's
"crooked E" logo was designed in the mid-1990s by the late American graphic designer Paul Rand.
Enron was originally involved in transmitting and distributing electricity and natural gas throughout
the United States. The company developed, built, and operated power plants and pipelines while
dealing with rules of law and other infrastructures worldwide. Enron owned a large network of natural
gas pipelines which stretched ocean to ocean and border to border including Northern Natural Gas,
Florida Gas Transmission, Transwestern Pipeline company and a partnership in Northern Border
Pipeline from Canada. In 1998, Enron moved into the water sector, creating the Azurix Corporation,
which it part-floated on the New York Stock Exchange in June 1999. Azurix failed to break into the
water utility market, and one of its major concessions, in Buenos Aires, was a large-scale money-
loser. After the move to Houston, many analysts criticized the Enron management as swimming in
debt. The Enron management pursued aggressive retribution against its critics, setting the pattern for
dealing with accountants, lawyers and the financial media.
Enron was created by a merge between Houston Natural Gas and Internorth. Houston's Natural Gas's
CEO Kenneth Lay headed the merger of the two companies. Kenneth Lay became the CEO of Enron.
Enron was originally solely involved with the distribution and transmission of electricity and gas in
the United States. In the merger, Enron incurred a large amount of debt, and as a result of
deregulation, no longer had exclusive rights to its pipelines. The company had to find a way to
generate profits and cash flow. Kenneth Lay hired Jeffrey Skilling to work for Enron as an
accountant. Skilling suggested the practice of buying gas from a network of suppliers and selling it to
consumers at a fixed price with a contract. Enron was interested in the expansion, building, and
operation of pipelines, power plants, and other infrastructure worldwide. After just a year of operation

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Enron merged with a company called Spectrum Seven, a company whose chairman and CEO is the
former president of the United States, George W. Bush. In 1999, Enron tried to expand their company
by creating the Azurix Corporation, a water utility company. Overall the Azurix Corporation proved
unsuccessful financially. The Azurix Corporation, due to their failure to make an entrance into the
market, went under. By 2001, Enron announced plans to dissemble Azurix and liquidize the assets of
the corporation.
Enron allegedly became successful, trading over eight hundred different products worldwide. Enron
was named "America's Most Innovative Company" by Fortune magazine from 1996 to 2001. Enron
was on Fortune's "100 Best Companies to work for In America" in 2000. The company's future
appeared to be bright and promising continued success.
Enron faced many accusations of building links to political power. The company's connection to
George W. Bush, and Houston's local politics has received much attention in the recent past. In 1986,
Enron was involved with Bush's company in joint drilling for oil. There are reports that Kenneth Lay
and George W. Bush even shared friendship. The Enron Corporation was the largest financial
supporter of Bush's presidential campaign. Kenneth Lay has employed politicians who have worked
under George W. Bush. Bush also signed off on a law that deregulated Texas's electrical markets,
which coincidentally resulted in large profits for Enron.
The company also had political links that reached outside of the United States. Enron created a
massive and highly expensive power plant in India, even though many Indian citizens and the World
Bank strenuously objected. Allegedly protesters in India were beaten and arrested. The United States
ambassador to India, who opposed the plant eventually, joined the board of Enron Oil and Gas.
The screws came loose in August 2001, when Jeffrey Skilling, the CEO resigned from office for
unknown reasons. By October 2001, Enron experienced its first quarter where they did not report a
profit. On November 8th, 2001 Enron told the SEC it was restating its earnings since 1997, reducing
income by $586 million dollars.
In December 2001, Enron filed for chapter 11 bankruptcy. This was the biggest bankruptcy protection
case in United States history. It appears that Enron's problems were not in its energy operations, but
from "dot com" investments and in some foreign subsidiaries. The accounting system practices in
placed failed to provide a clear picture of the corporation's financial status. Enron used accounting
techniques involving hiding debts to give the illusion of high profits. When the accounting practices
were revealed virtually all profit since 2000 had disappeared and the company plummeted.
Like many other companies Enron offered a retirement plan to its employees, in which they could
substitute earnings for stocks in Enron. The benefits to this were that the employees were able to buy
the stock on a tax-deferred portion of their pay. When the company closed in December 2001, sixty-
two percent of the company's 401 k plan was held in Enron stock. The stock, which once traded at
eighty dollars a share, went for less then seventy cents a share when Enron folded.

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Former Management and Corporate Governance

Central Management
Kenneth Lay: Founder, Chairman, and Chief Executive Officer
Jeffrey Skilling: President, Chief Operating Officer, and CEO (February-August 2001)
Andrew Fastow: Chief Financial Officer
Rick Causey: Chief Accounting Officer
Rebecca Mark-Jusbasche: CEO of Enron International and Azurix
Lou Pai: CEO of Enron Energy Services
Forest Hoglund: CEO of Enron Oil and Gas
Richard Gallagher: Head of Enron Wholesale Global International Group
Kenneth "Ken" Rice: CEO of Enron Wholesale and Enron Broadband Services
Clifford Baxter: CEO of Enron North America
Sherron Watkins: Head of Enron Global Finance
Jim Derrick: Enron General Counsel
Mark Koenig: Head of Enron Investor Relations
Cindy Olson: Head of Enron Human Resources
Greg Whally: President and COO of Enron (August 2001- Bankruptcy)
Jeff McMahon: CFO of Enron (October 2001-Bankruptcy)

Board Of Directors
Robert A. Belfer: Chairman, Belco Oil and Gas Corp
Norman P. Blake Jr.: Chairman, President and CEO, Comdisco, Inc.
Ronnie C. Chan: Chairman, Hang Lung Group
John H. Duncan: Former Chairman of The Executive Gulf and Western Industries Inc.
Wendy L. Gramm: Former Chairman of US Commodity Futures Trading Commission
Ken L. Harrison: Former Chairman and CEO of Portland General Electric
Robert K. Jaedicke: Professor of Accounting at Emeritus
Charles A. LeMaistre: President Emeritus, University of Texas M.D. Anderson Cancer
Center
John Mendelsohn: President, University of Texas M.D. Anderson Cancer Center
Jerome J. Meyer: Chairman, Tektronix
Paulo V. Ferraz Pereira: Executive Vice President if Group Bozano
Frank Savage: Chairman: Alliance Capital Management
John A. Urquhart: Senior Advisor to the Chairman of Enron
John Wakeham: Former U.K. Secretary of State for Energy
Herbert S. Winokur Jr.: President of Winokur Holdings Inc.

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Products
Enron traded in more than 30 different products, including the following:
Products traded on EnronOnline
Petrochemicals
Plastics
Power
Pulp and paper
Steel
Weather Risk Management
Oil & LNG Transportation
Broadband
Principal Investments
Risk Management for Commodities
Shipping / Freight
Streaming Media
Water & Wastewater

It was also an extensive futures trader, including sugar, coffee, grains, hog, and other meat futures. At
the time of its bankruptcy filing in December 2001, Enron structured into seven distinct business
units.

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Question No.1
Do you think that Enron management behave in an unethical manner if so do you think that a
better system of corporate governance check and balance would have detected their unethical
behavior before it was too late & avoided the company collapse ?

Answer:
I think that Enron’s management behaved in an unethical manner and they adopted some unethical
activities. These activities become the cause of failure of Enron.
Following are the unethical activities
Enron’s unethical employment policy
Enron had adopted a policy of ‘hire and fire’ in which loyal employees who could not perform as per
the company yardstick were fired while those including unethical practices were able to make a fast
jump. In the performance appraisal of employees bottom 10 % in the performance were dismissed
while they have very good score.
Heavy donation to political parties:
Lay president of Enron involved in state level political campaign and spent about $ 2 million of
Enron’s money on 700 candidates in 28 states. The company and top executive used every power they
could gather to bring about energy deregulation that brought them great profit.
Poor project implementation
Due to the wrong implementation of project planning and it started lot of many projects at once.
However many of them were poorly conceived and theoretical. Its failure revealed that many such
projects could not be funded by Enron s capital.
Accountants, Analysts and Lawyers roles:
The accountants and analysts are certainly making the case for Enron dishonesty but “if the truth is
not expected to be spoken” which certainly is the case, than it is their job to cut the cover. No
potential client thinks otherwise. The role of accountants and analysts is to serve shareholders and
potential shareholders in rectifying the information asymmetries that exist when shareholders deal
directly with the company but they did not fulfill the requirements of the shareholders and they
behaved in unethical manner.

Hypocrisy pervaded the corridors of Enron

There was a lot of hypocrisy in Enron and wide difference in the manner in which they promulgated
policies and the way in they were implemented. There were dichotomy between percepts and
practices. There are four core values of Enron
Communication

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Respect
Integrity and
Excellence
But in fact these were all opposite by their names. If any employee adopted them was dismissed by
the management of Enron.
Recommendations:
I think that a better system of good corporate governance through check and balances to avoid another
Enron collapse I recommend following measures.
Implementation of code of ethics
Management will be assigned responsibility for the code of ethics to promote the importance of
corporate morality and ethical standards. This will also put management in a leadership role rather
than in the cop’s role it currently plays in internal control systems.
Continuous attention by each group will rebalance corporate power, guarantee accurate financial
reporting, stop management fraud, and encourage good corporate behavior. Under the concept of
empowered or reengineered organizations as the cornerstone of this comprehensive governance
structure, all three goals are shared visions and shared responsibilities.
Whistleblowers:
Enron had a committee of whistleblowers but the power of these was used by other like CEO and
BOD. But with the passage of time one of them was fired by the Top management on this reason why
he started the investigation of other case without permission of certain body.
Participation of Regulatory body:
Mostly in developed and developing countries Government plays its vital role to regulate the good
practices of Corporate Governance in these days. Regulatory authority must check and balance the all
ethical practices regarding Code of Governance to avoid another Enron. Government should make a
committee for specially public sectors organization who will check the all unethical and other factors.
Recognizing the Role of Employees
The recognition of the role of employees as key participants in the corporate process signifies a move
toward an progressive view of employees in general, which will promote a cooperative relationship
among shareholders, top management, and employees in the corporate environment.
The psychological impact on labor, individually and collectively, will be of historic magnitude, and
perhaps may be understood only sometime in the future. In the near term, however, the new self-
esteem of employees will probably lead to dramatic gains in productivity.

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Question No.2:
Do you think that the role of non-executive directors, auditors, internal audit committee and the
board of directors are equally important as mechanism of good corporate governance? If not
which mechanism do you consider is the most important?

Answer:
Corporate governance has become an increasingly topical issue in recent years. This has been fuelled
by such corporate collapses as Enron, Worldcom, Parmalat and One.Tel. The role and responsibility
of the board and directors has emerged as an important issue in examining the cause of these
collapses. This has created much debate on what the role of the directors is in 'directing', 'monitoring'
or 'advising' a company. Research indicates that investors are prepared to a pay a premium for good
governance. This raises a number of questions. What is governance? How do we determine what is
good governance? What role do directors have in this? Does the company's performance improve by
adopting good governance practices? There are numerous approaches to examining what makes a
good board. Quantitative techniques have included the use of such measurable concepts as the number
of executive and non-executive directors, directors' skill base (for example, accountancy, marketing
etc) and frequency of meetings attended. Researchers have also attempted to measure board
performance and effectiveness by using indicators such as share values and shareholder returns. There
is a lack of qualitative research in board behavior and effectiveness. This exploratory study adopts a
qualitative approach in order to provide richer data. It uses interviews to evaluate directors' views on
some aspects of corporate governance, specifically in relation to the executive and non-executive
director debate. The interviews were conducted with 11 directors from a variety of organizations in
the for-profit and not-for-profit sectors. Two major themes have emerged from the analysis of the
interviews. Firstly, directors are traditionally considered to be responsible for maximizing shareholder
wealth. However, directors are now expected to broaden their responsibilities to include other
stakeholders and to consider social and environmental issues in making their decisions. The findings
indicate that it is now more demanding to be a director due to increased workloads arising from the
regulatory and legal requirements. This has also impacted on director and board evaluations, multiple
directorships and directors remuneration levels. The second major theme that emerged from this study
is that directors' personal experiences did not necessarily concur with governance principles and
guidelines. For example, the widely recommended method of achieving 'best practice' by having a
majority of non-executive directors on a board is considered too simplistic. Further studies are
required on the behavioral and personality traits, technical skills of the directors, board structure,
composition and type of organization which make the best contribution to achieving boardroom
effectiveness.

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Non-Executive Director:
The term “non-executive director”, focuses on what they are not rather than what they are. Other
terms have been suggested. “Outside director” is a term used in the US and elsewhere but it is not
widely recognized in the UK. The term “independent director” is given a particular meaning in this
Review, and by no means all non-executive directors could, or need to, meet it.
Role of Non-Executive Director:
The Code of Corporate Governance emphasizes the role of Non-executive directors in the Board of
Directors.
Strategy:
Non-executive directors should constructively challenge and contribute to the development of
strategy.
Performance:
Non-executive directors should scrutinize the performance of management in meeting agreed goals
and objectives and monitor the reporting of performance.
Risk:
Non-executive directors should satisfy themselves that financial information is accurate and that
financial controls and systems of risk management are robust and defensible.
People:
Non-executive directors are responsible for determining appropriate levels of remuneration of
executive directors and have a prime role in appointing, and where necessary removing, senior
management and in succession planning.
The non-executive director role is complex and demanding and requires skills, experience, integrity,
and particular behaviors and personal attributes.
Non-executive directors need to be sound in judgment and to have an inquiring mind. They should
question intelligently, debate constructively, challenge rigorously and decide dispassionately. And
they should listen sensitively to the views of others, inside and outside the board.
The role of the non-executive director is frequently described as having two principal components:
monitoring executive activity and contributing to the development of strategy.
A number of consultation responses identified the personal attributes required of the effective non-
executive director. They are founded on:
Integrity and high ethical standards;
Sound judgments;
The ability and willingness to challenge and probe; and
Strong interpersonal skills.
It is important to establish a spirit of partnership and mutual respect on the unitary board. This
requires the non-executive director to build recognition by executives of their contribution in order to

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promote openness and trust. Only then can non-executive directors contribute effectively. The key to
non-executive director effectiveness lies as much in behaviors and relationships as in structures and
processes.
Executive and non-executive directors have the same general legal duties to the company. However,
as the non-executive directors do not report to the chief executive and are not involved in the day-to-
day running of the business, they can bring fresh perspective and contribute more objectively in
supporting, as well as constructively challenging and monitoring, the management team.
Non-executive directors must constantly seek to establish and maintain their own confidence in the
conduct of the company, in the performance of the management team, the development of strategy,
the adequacy of financial controls and risk management, the appropriateness of remuneration and the
appointment and replacement of key personnel and plans for management development and
succession. The role of the non-executive director is therefore both to support executives in their
leadership of the business and to monitor and supervise their conduct.
In practice, non-executive directors will pursue some of their activities through their role on board
committees. In smaller companies, non-executive directors may also often provide specific expertise
or experience to complement that of the executive team which may be valuable in coaching and
supporting management.

Role of Audit Committee:

According to the Code, the Board of Directors of every listed company shall establish an Audit
Committee, which shall comprise not less than three members, including the chairman. Majority of
the members of the Committee shall be from among the non-executive directors of the listed company
and the chairman of the Audit Committee shall preferably be a non-executive director. The Audit
Committee of a listed company shall meet at least once every quarter of the financial year. These
meetings shall be held prior to the approval of interim results of the listed company by its Board of
Directors and before and after completion of external audit. The CFO, the head of internal audit and a
representative of the external auditors shall attend meetings of the Audit Committee at which issues
relating to accounts and audit are discussed. The audit committee will also review quarterly, half-
yearly and annual financial statements of the listed company, prior to their approval by the Board of
Directors. Monitoring compliance with the best practices of corporate governance and identification
of significant violations is also responsibility of this committee.
The Audit Committee shall, among other things, be responsible for recommending to the Board of
Directors the appointment of external auditors by the listed company’s shareholders and shall consider
any questions of resignation or removal of external auditors, audit fees and provision by external
auditors of any service to the listed company in addition to audit of its financial statements. The terms
of reference of the Audit Committee shall also include ascertaining that the internal control system

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including financial and operational controls, accounting system and reporting structure are adequate
and effective.
Audit committees are an increasingly important component of effective accountability and
governance. An audit committee must have three important qualities in order to fulfill its duties:
Independence
Communication
Accountability

Independence:
In the public sector, the structure of entities does not separate the governing authority and oversight
responsibility from the day-to-day management. For example, a public university president may be
both the chief executive officer and a board member. Public sector audit committees should be
independent both in fact and in appearance, and have processes in place to ensure such independence.
Communication:
Communication between a governing body and its finance officers can be difficult at times. For
example, external financial reporting follows standard principles; however, budgets and expressions
of policy are unique to the circumstances of the organization and its jurisdiction. Communication may
be complicated when a governing body approves a budget but not the financial statements. The GAO
has indicated that audit committees can provide assistance if they have the necessary technical skills
in accounting and auditing and are able to communicate with finance officers and auditors on complex
issues.
Accountability:
An audit committee must be independent to contribute to the integrity of the financial reporting
process. An independent audit committee can help reinforce a culture with zero tolerance for fraud.
The combination of independent oversight and the technical expertise of audit committee members
enhance accountability.

Audit Committees and Internal Controls:

Although Government Auditing Standards (2003 Revision) does not include additional internal
control standards for financial statement audits, it emphasizes several aspects of internal controls that
are important for auditors and audit committees. Controls over the safeguarding of assets, controls
over compliance with laws and regulations, and controls over environment and risk assessment are
covered.
Weaknesses in internal controls can cause many problems, including fraudulent activities, errors, and
noncompliance with laws and regulations. An audit committee should understand an entity’s internal
controls and ensure that the five components of internal controls—control environment, risk

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assessment, control activities, information and communication, and monitoring—are present and
operating effectively in the organization. An audit committee’s activities should include the
following:
Understanding how the internal control objectives are achieved within the entity.
Considering whether the control environment and procedures can accomplish their
objectives.
Reviewing the auditor’s reports on internal controls and compliance with laws and
regulations.
Determining whether material weaknesses, reportable conditions, or other findings were
reported.
Reviewing suggested improvements to internal controls and following up to correct the
weaknesses in internal controls.

Audit Committees and External Auditors

Generally Accepted Auditing Standards (GAAS) and Government Auditing Standards require an
auditor to test an entity’s internal controls and deliver its report and recommendations to the audit
committee. The external auditor is required to communicate the following:
Its responsibilities for testing internal controls and compliance with laws and regulations.
Possible weaknesses in internal controls that are discovered prior to the audit engagement.
The effect that possible weaknesses in internal controls could have on the accuracy of
financial information or on compliance with laws and regulations, as well as any additional
testing of internal controls required.
The probability that internal control procedures are not sufficient to achieve a relatively low
risk that errors or irregularities would not be detected within a timely period by employees
in the normal course of their assigned functions.
Its knowledge of the risk control areas and the activities needed to address those risks.

Audit Committee Composition and Responsibilities:

Having an audit committee does not relieve governing bodies of responsibility for the matters
considered by the committee. An audit committee should have a charter that states its mission,
objectives, authority, organization, and methodology. In addition, the charter should establish voting
requirements, the liability of members, and their method of appointment.
Audit committees should have three to six members, with some or all of the following qualities:
Good communication skills and the ability to work with others;
Knowledge of the needs, interests, and concerns of the constituency;
Accounting and auditing expertise and experience; and

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A willingness to ask hard questions and deal with controversial matters.

An audit committee may often be empowered by the governing body to select or recommend the
external auditors, which would be formally approved by the governing body. In doing so, the audit
committee should consider the following factors:
Auditor independence;
The firm’s reputation and fees;
The firm’s scope of services and experience with the public sector; and
The firm’s quality-control standards.

The Role of the Board and Management:

The Board represents the interests of the corporation's stockholders, the owners of the corporation, in
optimizing long-term value by providing the corporation guidance and strategic oversight on the
stockholders' behalf. The paramount duty of the Board is to select a well-qualified and ethical Chief
Executive Officer (CEO) and to oversee the CEO and other senior management in the operation of the
corporation. In addition, the Board performs, directly or through its committees, the following specific
functions, among others:
Selects, sets the compensation for the CEO and evaluates the CEO and plans for senior
management succession
Oversees the procedures for the election, retention, evaluation and compensation of senior
management with appropriate qualifications and expertise to operate the corporation's
business
Oversees the key compensation, benefits and skill development programs governing
employees of the corporation
Oversees corporate performance and reviews and approves the corporation's strategic plan,
annual operating plans, and budget
Oversees the corporation's risk policies and procedures (including market, credit and
operational risks)
Advises management on significant issues facing the corporation
Reviews and approves significant corporate actions
Oversees the integrity of the corporation's accounting and financial reporting systems and
processes, including independent audits, systems of internal controls, and the relationship
with the outside auditor
Oversees an independent review, no less frequently than every five years, of the
corporation's organizational, structural, staffing, and control matters

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Oversees the process and adequacy of reporting, disclosures and communications to

stockholders and other investors
Oversees the corporation's legal and regulatory compliance program
Nominates directors and oversees effective corporate governance
At least once annually, reviews, with appropriate professional assistance, the requirements
of laws, rules, regulations, and guidelines that are applicable to the Board's activities and
duties

Members of the Board are expected to perform their responsibilities diligently, prepare for and attend
meetings, and participate fully in the Board's activities.
It is the responsibility of management, in the exercise of their fiduciary duty to the corporation and its
stockholders, to run the corporation's business in an effective and ethical manner. The CEO is the
leader of management and, pursuant to the Bylaws and a Delegation of Authority to the CEO, as may
be amended from time to time, the Board has vested the CEO with the authority to manage and
conduct the business of the corporation except where the Board has reserved authority or the right of
approval as specified in the Bylaws and its Delegation of Authority to the CEO. Officers and
employees (consistent with the provisions of their delegations of authority from the CEO) may retain
outside consultants and advisors, as necessary, to assist them in the performance of their functions.

Conclusion:
In my point of view the role of non-executive directors, auditors, internal audit committee and the
board of directors are equally important as mechanism of good corporate governance. But the
condition is that there should be transparency in each activity of Enron and should be the
independency so that each department does his work without any restriction or any hesitation.
Another thing which is important there should be check and balance of each activity or transaction.
Everyone should be accountable to his higher authority.

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Question # 03
Summarize the corporate governance problems in ENRON. Do you think that they are all of
equal important if not which corporate governance problem do you feel contributed the most to
the company’s downfall ?

Answer.
Every time you turn a stone, another worm creeps out. That seems to be the story of the Enron
disaster. I feel that the following all problems contributed to destroy the Enron.
Chairman and CEO:
It is considered good practice to separate the roles of the Chairman of the Board and that of the CEO.
The Chairman is head of the Board and the CEO heads the management. If the same individual
occupies both the positions, there is too much concentration of power, and the possibility of the board
supervising the management gets diluted.
In Enron, Mr Kenneth Lay was both the Chairman and CEO. For a brief while the two positions were
separated when Mr Jeff Skilling functioned as CEO, and when he resigned in August 2001, Mr Lay
again took on both roles. His recent claim that he did not know too much of the details of the
accounting falsification that was going on is, at best, disingenuous.
Audit Committee:
Boards work through sub-committees and the audit committee is one of the most important. It not
only oversees the work of the auditors but is also expected to independently inquire into the workings
of the organisation and bring lapses to the attention of the full board. The Enron audit committee
failed in this regard.
In the words of the Special Investigating Committee: "The Board assigned the Audit and Compliance
Committee an expanded duty to review the transactions, but the Committee carried out the reviews
only in a cursory way." The Chair of the Audit Committee since 1985 was Mr Robert Jaedicke, a
former accounting professor and Dean of Stanford University Business School. (Normally, it is good
for this position to rotate every three or four years.) He was there because audit committee's are
required to have as its members, persons who are financially literate.
Mr Jaedicke, in addition to not using his expertise to perform his role as Chair of the committee,
seconded the motion in the board to suspend the `Code of Ethics' of the company in order to allow an
employee to set up a special partnership. (Audit committees normally oversee compliance of such a
code.) Setting up that entity amounted to a conflict of interest and was specifically prohibited by the
company code.
Mr Jack Welch, the legendary former Chairman of GE, commented recently in a television
programme that suspension of a code of ethics is unheard of. I would go a step further and say that it

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is the corporate equivalent of the `insanity defense' that we see in criminal cases. Apart from Mr
Jaedicke, the audit committee comprised of five persons, three of whom reside outside the country.
An audit committee is almost a `working' committee and needs to meet more frequently than a full
board. Having non-residents on the committee hampered its functioning. One of the members, Mr
Ronnie Chan, missed 75 per cent of the meetings in 2001.
Independence and conflicts of interest:
Good governance requires that outside directors maintain their independence and do not benefit from
their board membership other than remuneration. Otherwise, it can create conflicts of interest. By
having a majority of outside directors on its Board, Enron followed a good practice. But in the way
they behaved, they compromised their independence. Six of the 14 outside directors suffered from
serious conflicts of interest:
(a) Mr Robert A. Belfer, Chairman of Belfer Management, bought a stake in an energy company from
an Enron partnership, thereby providing funds to start another.
(b) Ms Wendy Gramm (spouse of a Republican Senator) was formerly Chairman of the Commodities
Futures Trading Commission of the federal government. Enron's trading in energy derivatives was
exempt from regulation by the CFTC.
Shortly after that decision, she quit the commission and joined Enron's board. She is presently
Director of Regulatory Studies Program at George Mason University. Enron has donated $50,000 (Rs
24 lakh) to that centre.
(c) Mr John Mendelsohn is the President of the MD Cancer Centre at the University of Texas. Enron
and related entities have donated $1.5 million (Rs 7.2 crore) to the Centre since 1985.
(d) Mr William Powers, who also headed the Special Investigation Committee is the Dean of the
University of Texas Law School. Enron has given $3 million (Rs 14.4 crore) to the University since
he became Dean. The law firm that works for Enron, Vinson and Elkins, has endowed a chair at the
Law School.
(e) Lord John Wakeham, a former Minister for Energy in the UK was paid $72,000 (Rs 34.5 lakh) for
services as a consultant to Enron's European unit. When he was minister, he gave consent to Enron for
building the country's largest power plant at Teeside.
(f) Mr Herbet S. Winokur is also a Director of the Natco Group which is a supplier to Enron and its
subsidiaries. He is also Chairman of the Board's Finance Committee which recommended that the
board suspend the company's ethics code. The involvement of these Directors resulting in other
benefits compromised their independence making one wonder whether they acted in the best interest
of Enron.
Flow of information:
A board needs to be provided with important information in a timely manner to enable it to perform
its roles. A governance guideline of General Motors, for instance, specifically allows directors to

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contact individuals in the management if they feel the need to know more about operations than what
they are being told.
In the Enron situation, the directors are pleading ignorance of the murky deals as a way of excusing
themselves of the liability.
The Special Investigating Committee report says: "The board was denied important information that
might have led it to action, but the Board also did not fully appreciate the significance of some of the
specific information that came before it.' Here is another mea culpa. Moreover, if they did not have
sufficient information, they should have gone seeking it. Reports suggest that Enron operated about
3,500 Special Purpose Entities, that is, partnerships that shifted debt and losses off Enron's balance-
sheet. If the directors did not understand what was being reported to them, it was their job to educate
themselves more about it by asking the right questions and getting more information. This they failed
to do.
Too many directorships:
Being a director of a company takes time and effort. Although a board might meet only four or five
times a year, the director needs to have the time to read and reflect over all the material provided and
make informed decisions. Good governance, therefore, suggests that an individual sitting on too many
boards looks upon it only as a sinecure for he or she will not have the time to do a good job. Mr
Raymond Troubh, one of the directors, is a Director of 11 public companies.
Many successful companies suffer from one or more of the faults described above. When the
company performance is satisfactory, we tend to overlook these drawbacks. In Enron's case too many
of their faults came together at the same time to cause the company to implode.
The corporate governance model being followed was too weak to prevent the problems from
escalating. And this should be a lesson for all of us. Next time we receive a proxy statement from a
company in which we hold shares, we must read it carefully.
If we are unhappy with the directors being proposed for election, we must voice our complaint to the
company and vote against the slate being offered. If we are suspicious of the company's governance
structure, we should report to the stock exchange where the company's shares are traded. As a final
resort, we can exit the situation by disposing the stock.

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Question No.4
What extent do you agree that, "When an apple is rotten there is no cure, but at least the rotten
apple can be removed before the contagion spreads and infects the whole basket? This is really
what corporate governance is all about. Discuss your views.

Answer:
An apple is not rotten in a very short period of time. It always takes time to rotten because it is a
natural phenomenon that every thing takes time to being existence in its proper form. And when this
rotten apple puts in basket then it start to damage others.
Here key point is to identify this rotten apple before its damage to other once.
Now when we narrate this scenario with ENRON when it starts its controversial business practices no
one identifies them on major platforms and it continues to doing business in its own way. And it’s
exactly a time when ANRON leads towards a rotten apple.
This exactly happened with ENRON that when (rotten apple) not identify and puts it’s into a large
basket and its damage whole system. And all stakeholders effected badly by one rotten apple.
So the best time to counter any controversy is when its start to arise and handle it on that particular
time. Other wise its come forwarded us in a shape of ENRON.

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Q.No05
Recalling the code of Corporate Governance What are the shortcomings and loopholes you
observes in Enron Case and also come up with practical recommendation to avoid an other
Enron?.

Answer:
The Enron scandal is the most significant corporate collapse in the United States since the failure of
many savings and loan banks during the 1980s. This scandal demonstrates the need for significant
reforms in accounting and corporate governance in the United States, as well as for a close look at the
ethical quality of the culture of business generally and of business corporations in the United States.
Shortcomings in Enron
What makes the company an interesting case is its sudden demise from operations in2001 owing to
improper financial performance and bankruptcy. Whereas the main reason was financial
embezzlement and inaccurate financial disclosure, it was later revealed that there are many underlying
causes behind its downfall, most important of which wassailed corporate governance by top
management and board of directors who didn’t act to secure shareholder interest. Some of the key
attributable reasons are briefly discussed here:
Unbridle growth and expression
To begin with, Enron’s business concept was flawed. It was venturing into many divergent businesses
areas such as water and broadband services, without having the relevant technical expertise and know
how about industry dynamics. Furthermore it was pledging beyond its capacity. Since the energy and
trading business is highly susceptible to speculation, and is extremely interlinked, hence collapse
through ripple effect was witnessed. Enron guaranteed supplies and uplifting in case if third party
partner companies fell back on their pledge. When many trading groups who were financially
unsecured fell back on their professional commitment, Enron had to bear financial losses for their
actions.
Financial reasons
Enron had accrual basis of accounting in vogue. Meaning thereby, revenues were realized when they
were earned. The previous CEO, Rich Kinder who was an expert on financial matters, always focused
cash flow from operations. All project managers were under scrutiny to meet cash generating targets
of the company. Hence the company had strong financials, and especially cash position was solid. The
company had the ability to have controlled growth.
Since revenues were sky high, hence management turned a blind eye to cash flow issues. The
company lacked the capacity to realize that the revenues reported were not actually earned. Whereas
profits were high, actual cash position was declining sharply. The company squandered resources, in

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maintaining top quality life style for its executives in the form of compensation and fringe benefits. It
also invested heavily in other activities outside its core business, without tangible cash basis. Cash is
lifeblood of a commercial company. When trading business started showing a downturn due to high
volatility of prices, the company realized that it didn’t have sufficient cash to pay back on its pledges.
Furthermore, it needed cash to pay back its day-to-day expenditures, debts and penalties for energy
banking initiatives.99
Creative Accounting
Since the company’s trading business depended substantially in gambling on future prices of energy
products, it required attractive financial statements so that the company could attract suitable business
opportunities, investors and creditors. However, when future guaranteed energy prices showed a
downturn, sending ripple effects on business models, the company was left with a weak cash position
and mounting debt. Hence to hide this debt and potential losses, the company formed new partner
companies, (associated with top executives of the company, thus violating its own ethics of no
personal interest of management in business operations of the company or its partner companies).100
Such partnerships would shift debt of Enron to that of the partner companies’ accounts, thus
improving balance sheet position of Enron Corporation as wellas shifting losses to partner companies’
accounts, showing them as sales for Enron thereby boosting profitability. 101
Failure in light of Agency Theory
The main reason of Enron’s downfall was that the board turned absolutely blind eye, as if they were
just a rubber stamp authority that approved anything that top management suggested to them. This
suggests that they were not fulfilling their responsibilities as true agents of shareholders. Agency
theory clearly suggests that- any business association between agents and the company in terms of
conflict of interest and in terms of lack of professional conduct in protecting shareholder interest- will
lead to corrupt practices and systemic collapse.
Enron down fall in model of corporate governance.
Different forces associated different expectations from Enron. Each actor asserted his own pressure on
the corporation to grow in an unprecedented fashion. The external environment wanted to capitalize
on Enron’s resources, growth and reach. They also wanted to be strategic partners in Enron’s success
and to enter into a win-win relationship. It is to be kept in mind that whereas good corporate
governance is the prime responsibility of the Board, but it is equally imperative for stakeholders that
they help the company in fulfilling its obligations as a good corporate citizen. The internal
environment was a product of strict corporate culture which was marked by cut-throat competition
amongst peers. Since top management didn’t lead by example, hence other employees could not
prevent this disaster from happening. Since other employees also wanted promotions, bonuses and
privileges hence they acted as silent spectators while agents plundered wealth from the corporate

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system and thus violated their own code of ethics. Thus as a whole, the company collapsed because
the system had become self-destructive, owing to principal-agent conflict of interest.

Key lesson from Enron.

Enron had a global vision. To achieve this aim, it had an expansion oriented corporate strategy. Its
strategy was shaped by influence of external and internal stakeholders, with both being connected
through non-transparent, inappropriately disclosed information exchange.
Enron collapsed because its corporate strategy was not equally supported by its corporate
governance mechanism. Once the governance mechanism failed, strategy failed and the firm
collapsed as a whole.
In case of Enron key problem occurred because there was a problem of failed corporate
governance and groupthink. Since Enron was performing high, hence, Board had a blind faith in
the performance of top management and they generally endorsed, whatever the top management
proposed without exploring the tradeoff between risk, returns, and authenticity of information that
was communicated to them by the top management. The element of accountability was
immensely missing at Enron.
Enron’s top management consisted of people who had great industry experience, and the Board
consisted of people who had policy and government background as well as market experience.
The top management consisted of people who were mostly graduates from Ivy League
universities of USA hence there was this element of blind trust in each others judgment and
decisions. Since Enron was like a golden egg laying entity, hence none of them wanted to
question the Chairman, the CEO or performance of top management. Company was excessively
growing hence the Board found no need to turn things around, since the results were coming up
fine, hence the Board was not skeptical as to how this unprecedented growth was taking place.
Recommendations:
Main lesson to be learnt from Enron is that conflict of interest must not arise between principal
and agents. If such a scenario arises, it would be imperative forth agents to subordinate their
interest for the collective benefit of the system as a whole. Agents have a moral obligation to
ensure that principal’s interest is secured in ethical way and that principal is rightly communicated
about developments in the corporate entity.
Furthermore, conflict of interest should never arise amongst the agents i.e. the top management
and the board of directors or it may lead to systemic collapse. They should not have any business
association with the company. In the event of such violations, accountability should be done
speedily.

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Agents must ensure not to set precedents for corporate malpractice. Corruption travels down the
organization in through a trickle down mechanism. External and internal stakeholders must be
vigilant to ensure that the company is acting as a good corporate citizen.
They should not be lured by its growth rates but must be skeptical in wider interest of all
concerned.
The corporate culture of an entity plays a pivotal role in its ethical orientation as well as strategy
implementation. If culture is cut-throat in nature, it will not serve stakeholder interest as a whole.
A key point is that the Board Chairman and the CEO should be separate persons. In this way
appropriate blend of CEO’s aggressive strategies coupled with conservative thinking of the
Chairman board will work in the organizational interest as a whole.
Auditors being valuators of public funds must never connive with agents. Furthermore there
should not be a conflict of interest between the auditors and the organization.
Corporate strategy will only be successful if it is backed by a well-governed corporate system.
Since both these attributes have external and internal implications hence their mutually
complimentary role will serve as a unique competitive advantage for the corporation.

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References:
www.enron.com/
http://www.thehindubusinessline.com
http://hbswk.hbs.edu
http://www.oecd.org/document/
www.oppapers.com/essays/Enron-Its-Shortcomings/
http://ezinearticles.com/?A-History-of-Enron&id=2082701
http://en.wikipedia.org/wiki/Enron
http://fpc.state.gov/documents/organization/9267.pdf

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