Table of ContentsThe Rise of Enron:The Collapse of EnronConclusions and Recommendations:Recommendations:References:This The report was written, prepared and analyzed jointly by the two members of the group. .Say no to plagiarism. Get a tailor-made essay on “Why Violent Video Games Should Not Be Banned”? Get the original essaySummary From the 1990s until the fall of 2001, Enron was famous in the business world and was known as an innovator, a technological powerhouse, and a fearless company. Enron's sudden collapse in late 2001 shook up not only the business world, but also the lives of its employees and all those who believed their rise to greatness was genuine. Their collapse was followed by a series of revelations about how they had manipulated their success. Introduction Enron shocked the world, going from being "America's most innovative company" to the largest American corporate failure of its time. At its peak, Enron was the seventh largest American company. Enron gave the illusion that it was a stable company with good revenues, but this was not the case, a large portion of Enron's profits were paper. This was made possible by masterfully designed accounting and morally questionable actions on the part of traders and managers. Deep debt and the emergence of information about hiding losses brought big problems to the company, and at the end of 2001 Enron declared bankruptcy under Chapter 11 of the United States Bankruptcy Code . Many factors affected Enron's rise and sudden fall. In this report, we will discuss and present what we believe to be the main reasons for their rise and fall. Ken Lay and Enron Corporation: Although a group of characters were involved in Enron's passion game, one person stands out as the thread that ties everyone else together throughout the rise and fall. fall of Enron: Kenneth L. Lay. A small-town Missouri boy who wanted to make it, Lay earned his bachelor's and master's degrees in economics from the University of Missouri. After brief stints at Humble Oil in Houston and in the U.S. Navy, where he found his way to the Pentagon, Lay returned to Houston where he earned his doctorate in economics in the evenings at the University of Houston. He then returned to government service, first at the Federal Energy Regulatory Commission (FERC) and then at the Department of the Interior. Throughout his time in Washington, Lay focused on what he believed to be the inevitable movement toward deregulation of the American energy sector. And he vehemently believed in its rightness. Ethical Dilemma: One of the first tests for corporate leadership occurred in 1987 at Enron's crude oil trading operations located in Valhalla, New York.3 After it was discovered that several of the traders were booking and paid for falsified tickets. professions, Ken Lay reorganized the unit and modified its hierarchical structure. Rich Kinder wanted it closed, but Lay didn't. Within months, traders were out of control again and losses approached $150 million. Two of them were eventually convicted of fraud, and Enron managed to reduce the loss to just $80 million. Outside influence: Ken Lay hired McKinsey Consulting immediately after Enron's founding to evaluate the company's strategy. The head of the McKinsey team was Jeffrey Skilling, a graduate of the Faculty of Engineering at Southern Methodist University and Harvard Business School(MBA 1979), and by all accounts before and after, the smartest man in the room. McKinsey Consulting was widely considered the best and brightest of the time, and among its many talents, Skilling stood out. Few people had risen more quickly at McKinsey, where Skilling rose to partner in five years and director in ten.4 In 1989, Jeff Skilling was leading McKinsey's global energy practice and needed a new challenge. Jeff Skilling's insistence on using an accounting technique would create ripples within Enron in the years to come.common in financial services, but unknown in mark-to-market (MTM) accounting ) in the energy sector. MTM would allow Enron to record sales and profits from transactions today, even though most of the actual sales, profits, and cash flows would only occur in the future. Skilling actually told Ken Lay that he wouldn't join Enron if he couldn't use MTM. Skilling was able to convince Ken Lay and Rich Kinder, then Enron's COO, that MTM made sense if they wanted to start a business venture. After some delays and deliberations, the Securities and Exchange Commission (SEC) approved the application in January 1992. Enron's Rise to the Top: From Energy to Commerce: Kenneth Lay was a leading spokesperson in on energy market deregulation, largely because of his personal ties to the Bush family. In the early 1990s, the U.S. Congress approved a law deregulating the sale of natural gas. Shortly before, Lay was one of the initiators who made it possible to sell electricity on the open market. This major deregulation of the energy market gave Enron the ability to sell its energy at higher prices, leading to increased revenue. This was the beginning of Enron's journey from an energy company to a trading company. The focus has shifted from energy markets to finding new ways to make money. Significant investments have been made around the world to expand its activities and open up to new markets. Enron has been named America's most innovative company six years in a row by Fortune's Most Admired Companies survey. This made the company attractive to top graduates from America's best universities, which gave the company more skills and a great desire to move forward. The forward effort was the same as the goal of increasing the stock price. Enron employees were partly paid in stock, so increasing the stock price became a major interest. Mark-to-Market Accounting: In 1990, Jeffery Skilling joined Enron Corporation and in 1997, he was named CEO of the company. Skills were needed to change Enron's accounting system from a simple type of accounting in which Enron had listed the actual revenues and costs of supplying and selling gas into the valuation accounting system. walk. The mark to market method requires estimates of future income when signing a long-term contract. These estimates were based on the future net value of cash flows, as contract costs are often difficult to predict. This means that the estimated revenues from the projects were included in Enron's accounting even though the money has not yet been received and that if there were any changes such as additional revenues or losses, they would appear in later periods. Investors received misleading information due to the discrepancy in estimates. Enron was the first non-financial corporation touse the market value method. The United States Securities and Exchange Commission gave Enron approval to use this method on January 30, 1992. (Smartest Guy in the Room, 2004) Special Purpose Entity: Special purpose entities are legal entities created solely to carry out a specific activity or temporary task. The objectives are to manage assets either by financing or by risk management. A sponsor creates the entities but the funding comes from investors. Financial reporting has many rules indicating whether the entity is separate from the sponsor. In the case of Enron, special purpose entities were not only used to circumvent traditional accounting conventions, but also to hide debts. The entities allowed Enron to understate and hide its debts and overstate its equity. A new strategy: In 1992 Enron was the largest seller of natural gas in North America, its earnings before interest and taxes amounted to 122 million dollars. To continue its growth, Enron followed a differentiation strategy based on the fact that the company owned and operated a variety of assets, pipelines, broadband services, paper plants, water plants, and power plants. . Enron not only made money on its assets, it also actively negotiated contracts for the products and services it provided, generating additional revenue. This made Enron a favorite among investors and between 1990 and the end of 1998, Enron's stock price increased 311%. The increase did not stop there: in 1999 it increased by 56% and in 2000 it increased by another 87%. The market index in the same two years was +20% and -10%. Enron's stock price was $83.13 and its market value was just over $60 billion on December 31, 2000. (The Fall of Enron, 2003)The Commodity Futures Modernization Act of 2000 , which ensured the deregulation of over-the-counter derivatives, helped Enron with its derivatives business. One example was the California electricity crisis (2000-2001), where they manipulated the California energy market and drove up electricity prices by a factor of at least eight. At that time, the price of natural gas was trading as high as $60 per thousand cubic feet in California (up from about $3 per thousand cubic feet previously). This type of manipulation caused Enron's stock price and earnings to increase. But this not-so-clever manipulation of Enron became a political target and accelerated the ruin of their finances. The company's aggressive accounting had corrupted Enron's accounting records and allowed the company to be far too optimistic in its assumptions about future profits. Cash is a necessity for any business and Enron had primarily paper revenue. In mid-2001, they came to the conclusion that the cash crisis had hit them. The Culture of Enron: At Enron, bonuses and incentives in the form of cash or stock options were offered in bundles, only if you were good enough and were considered one of the money generators. This mentality made Enron a very competitive place to work. Everyone was in a hurry to close deals (good or bad) because right after a deal was closed, they received their bonuses regardless of the outcome of the deal. This became a problem because there were many projects underway but no follow-up. No one wanted to be responsible for a closed deal, they just wanted to close it and get their bonus. The performance evaluation committeewas also a factor why Enron employees were so aggressive. This created a culture within Enron that replaced cooperation with competition. The committee gave scores from 1 to 5, with 1 being the highest and at Enron, a score of 1 meant you would get a good amount of bonus. If you were in the bottom 5 to 6 percent of this ranking, it meant that you were not good enough to stay at Enron and that you should pack your bags because you will soon lose your job. Financial Focus: The financial philosophy that emerged at Enron in the 1990s was aimed almost exclusively at Wall Street. All other things ignored, it was all about revenue. Both Ken Lay and Jeff Skilling believed that the market rewarded earnings growth over all others, including cash flow and earnings quality. In the first half of the 1990s, when Enron's business results still came primarily from operating gas pipelines, profits and cash flow were largely aligned. When profits were recognized (recorded as incurred), they were realized (appearing as cash flows). Table 1 illustrates this relative balance, as Enron's net cash flows (cash flows from operating activities minus cash flows engaged in investing activities) remained either slightly positive or balanced . Profits increased throughout the period from 1991 to 1996, and the Enron story gained momentum in the market. But with the growth of Skilling's gas bank and associated businesses, the company's net cash flow became radically loss-making. Mark-to-market accounting has been used to an increasingly large extent to reflect upfront all the profits associated with a transaction or transaction. As Enron's activities transformed into energy. 7 The Dabhol project in India is analyzed in depth in Enron and the Dahbol Power Company, by Andrew Inkpen, Thunderbird Case A07-02-0008. 6 TB0123 trading, broadband and other market making activities, the gap between reported profits and cash flows has widened. Special purpose entity: in order to hide losses and manufacture profits, Andrew Fastow created several SPEs. Some SPEs are Chewco, LJM1, LJM2 and Raptor. When news of the debt cover-up surfaced, Enron's stock began to fall and several SPEs began to collapse due to Enron's stock price falling. For an SPE to be legal, it must meet 3 requirements: (1) At least 3% of the equity must come from outside investors (i.e. not belonging to Enron)(2) L The entity cannot be controlled by Enron, and(3) Enron was not responsible for any loans or other liabilities. (Bryce, 2002) An internal investigation into the SPEs showed that they were not independent since they were run by Enron employees (i.e. LJM was run by Andy Fastow while ChewCo was led by Kopper). Therefore, they had to be disclosed in Enron's financial statements, which significantly reduced profits and debt levels. Key Players: Enron was housed by brilliant, talented employees and everyone thinks they are so smart or smarter than everyone else that they think they could always get away with "crime". “Jeffrey Skilling was the lead implementer of mark-to-market accounting at Enron. Under his leadership, Enron launched Enron Online, an Internet service for trading commodity contractsenergy with Enron. Ultimately, Enron was unable to cover the capital costs of their transactions, which is also one of the reasons that led the company to bankruptcy. Andrew Fastow was the CFO of Enron who was the mastermind behind special purpose entities like LJM1, LJM2, etc. at Enron. He created complex financial structures so Enron could hide its losses and debts. Rebecca Mark was the head of Enron's failed businesses, namely Enron International and Azurix. Some of these projects included the $3 billion power plant in Dabhol, India, and the costly acquisition of Wessex Water. She also used the Enron Jet during her travels around the world. One executive even mentioned that every time Mark attends a meeting, it costs the company at least $60,000 (this would cover his transportation alone). Of course, who could forget Enron Chairman and CEO Kenneth Lay's contribution regarding Enron's bankruptcy. In addition to walking away from the company because he was too busy socializing, he and his family misused the company's assets. At one point, they used all of the company's jets for personal travel. He was also involved in conspiracies and fraud within the company in order to hide his downfall. Consequences of the Enron bankruptcy: The bankruptcy affected at least all 21,000 Enron employees. In the four years preceding the bankruptcy declaration, during which shareholders lost $74 billion, approximately $40 to $45 billion could be attributed to fraud (Wikipedia, 2012). In May 2004, 20,000 former employees won a lawsuit against Enron for $85 million. This represented compensation for almost $2 billion in lost pension funds (Doran, 2004). It's not all about money, many people have lost their regular income, their security to feed their families and many people's future has been shattered due to the loss of their pension. The Sarbanes-Oxley Act is an American federal law adopted after the Enron scandal. The law contains a set of standards that regulate the boards of directors of public companies, management and accounting firms. Some of the main regulations are that all companies must have a majority of independent directors, the nomination and remuneration committee must have independent directors and the audit committee must consist of members with a financial background and one of members must be an expert (Wikipedia, 2012). On January 14, 2004, Andy Fastow and his wife Lea both pleaded guilty and were sentenced in a very unusual crime. Andy was sentenced to 10 years in prison without parole in exchange for his testimony against Lay, Skilling and other former Enron executives. Prosecutors were so impressed with his performance that his final sentence was reduced to 6 years. The jury in the Lay and Skilling trial returned its verdict on May 25, 2006. Lay was found guilty of all 6 counts he faced (securities and wire fraud) and faced a maximum sentence of 45 years in prison . Forty-one days later, Ken Lay died in Aspen of a heart attack; this was even before his sentence was set. On the other hand, Skilling was convicted of nineteen of twenty-eight counts, including securities fraud and wire fraud. On October 23, 2006, Skilling was sentenced to 24 years and 4 months in prison. Conclusions and Recommendations: Conclusions: Executives and traders committed morally questionable acts. One thing that is inevitable is that employees ?.