Enron Essay

As Bethany McLean and Peter Elkind portray in The Smartest Guys in the Room: The Amazing Rise and Scandalous Fall of Enron, there was a chain-reaction of events and a hole that dug deeper with time in the life-span of, at one time the world's 7th largest corporation, Enron. The events were formulated by an equation with many factors: arbitrary accounting practices, Wall Street's evolving nature and Enron's lack of successful business plans combined with, what Jeff Skilling, CEO of Enron, believed was the most natural of human characteristics, greed. This formula resulted in fraud, deceit, and ultimately the rise and fall of Enron.

Kenneth Lay created Enron in 1985 as a result of the merger of Houston Natural Gas and Internorth. Within a short time, Enron incurred massive debt and lost exclusive rights to its pipelines. Enron's core business was losing money, so they hired consultant Jeffery Skilling, who would soon create a stock market for natural gas Ð'- transforming energy into financial instruments that could be traded like stocks and bonds. They moved to trading derivatives Ð'- in 2000, Enron's derivatives-related assets increased from $2.2 billion to $12 billion. They had deals in areas such as weather derivatives, water services, metal trading, broadband supply and power plant. Soon enough, Enron had more contracts than any of its competitors and could predict future prices with great accuracy. Enron seemed to always have steady, high profits. Behind the scenes, however, there was much more to it.

Starting with the Vahalla scandal, the board learned that Louis Borget and Tom Mastroeni were gambling beyond their limits, destroying trading reports, keeping two sets of books and manipulating accounting in order to give the appearance that Vahalla was earning steady profits. The board did not fire the Vahalla executives, instead, the message to Borget and Mastroeni was "please keep making us millions," (20). Borget and Mastreoni later ended up on the wrong side of an immense trade, totaling $1 billion in losses. Although Enron executive Mike Muckelroy reduced this loss to $140 million, Enron needed a new source of income Ð'- this is where Skilling came in with his idea for trading energy. To run this energy market, Skilling wanted more than conventional accounting Ð'- "under conventional accounting, you book the revenues and profits that flow from the contract as they come through the door," (39). He wanted to use mark-to-market accounting, where "[they] can book the entire estimated value for all ten years on the day you sign the contract," (39). The SEC approved this accounting style, also known as hypothetical future value accounting, without fully predicting the implications. Under this accounting standard, no matter how much cash came in the door, Enron's profits could be whatever they wanted them to be. This left the door open to unethical behavior, and this is where greed and dishonesty started to come into play. Skilling believed that human nature is steered by greed and competition; it is no wonder why this accounting standard was taken advantage of. Enron had gas operations all over the world that had cost billions to build, and most were performing terribly. However, as soon as they decided on an operation, they could record the future profits of the completed operation in the current time. For example, in India, Enron invested $900 million to building power plants. The problem ended up being that consumers in India were poor, and didn't have money to pay for Enron's services. Despite Enron's loss, they still paid out millions to executives Ð'- "the project team split $20 million," (83). To make up for these phony profits, they had to find other sources of income Ð'- this is where they bought out PGE. They now had control of electricity on the California, which would later lead to even more unethical behavior. Enron then teamed up with Blockbuster for video on demand, and used mark-to-market accounting to show $53 million in profits as soon as they signed the contract with them. By the end of the year 2000, the illusion of the deal was falling, and executives fraudulently sold their stock on the insider information. Next came California's rolling blackouts caused by Enron's traders. By turning the power off and on in California, they could control the price of electricity, essentially stealing people's money. Because they could manipulate the price, they made hefty bets on it, and in turn made over $2 billion dollars for Enron. Just before the fall of Enron, the insiders sold off nearly $1 billion dollars prior to the annunciation of the bankruptcy of Enron. What caused so many executives and employees to behave in such a fraudulent way?

As Skilling put it, the biggest motivator for humans is money. Enron's executives received large quantities of stock options, motivating them to manipulate earnings which would cause an increase in the stock price. The nature of Enron's executives also played a big role in influencing employees to display similar characteristics of aggression, arrogance, greed and dishonesty. Executives at Enron were known to take extreme dirt-biking trips to places like Mexico, where they could dangerously travel 1200 miles of rugged terrain. Stories of broken bones, stitches and flipping jeeps became legendary at Enron, and fed the macho personality of the employees. Top management gave its managers blank orders, to "just do it" (60). In turn, employees attempted to not only crush outsiders, but eachother. Skilling encouraged this behavior, saying "he wanted them to fight," (56). The connection between the culture and fraudulent behavior can be seen, but how did Enron go so long without being exposed?

Andy Fastow, CFO of Enron, used complex financial structures and hundreds of fictitious companies to cover up the fact that Enron was losing money year after year, but showing growing earnings. The fictitious companies covered Enron's debt so that investors could not see it. On the other hand, Fastow used these companies to raise money using Enron's stock as collateral. In other words, the nature of accounting rules, specifically, mark-to-market accounting was causing the financial statements to be manipulated, thus causing the stock to go up. This resulted in giving Fastow collateral for investment banks to recognize, and ultimately persuaded them to invest in Fastow's fictitious companies (SPEs [Special Purpose Entities]). Enron's ultimate goal was to capture the heart and minds of stock analyst and in turn, drive the stock price up for more collateral. It was a vicious cycle. The company had a massive public relations campaign and was fixated on the stock price, so much so that the price was posted in the elevator.