Answer the following questions based on the film Enron: The Smartest Guys in the Room (2005).
1. (a) Describe the ownership structure at Enron. (b) How did the ownership structure contribute to the Enron scandal? (15 points) When Enron became a publicly traded company, the employees and executives had more incentive to manipulate earnings and financials. With the shift in structure, there were more external stakeholders to satisfy, which caused the company to focus on short-term results, rather than long-term interests. The company went as far as to trade all sorts of things, including weather and broadband, in order to gain support from investors. Enron got a lot of that support. Investment banks put about $25 million each into the company. With high stakes and image on the line, Enron manipulated earnings to drive stock prices up through mark-to-market accounting to please its stakeholders.
2.(a) Describe the following three leaders: Ken Lay, Jeff Skilling, and Andy Fastow. (b) How did EACH leader contribute to the scandal? (20 points) Ken Lay was a very ambitious man. He was the son of a poor Baptist preacher. Because of Lay’s humble roots, Lay worked several jobs as a kid. He always dreamed about being a businessman one day and making huge wealth for himself. Lay believed he could have a better life with more wealth. He also believed in government deregulation. Lay had a PhD in economics. He aggressively pushed for deregulation of energy markets in Washington. His goal was to liberate businessmen from government’s hold. He took advantage of government letting energy prices float with the market, and started Enron Corporation through a few mergers. Jeffrey Skilling, former CEO of Enron, was said to be “incandescently brilliant” by many at Enron. In reality, he was a risky, danger-seeking gambler. Skilling had a Darwinian view and strongly believed in the idea of “survival of the fittest”. He implemented a group called the Performance Review Committee. The committee was involved in the “rank and yank” system, in which the bottom 15 percent of the company got fired each year. This ultimately led to numerous unethical actions and turning a blind eye to fraud because of employees’ determination for job security.
Skilling was a former nerd, and went on to change himself. He was very admired at Enron. When he got Lasik surgery, everyone else did too. Skilling was responsible for making energy into a tradable entity and for his advocacy of mark-to-market accounting, which was the main tool for Enron’s earnings manipulation. Fastow was a very greedy man. He served as CFO of Enron. He was responsible for running numerous companies that partnered with Enron. He mainly worked to cover up the financial fantasy land that Lay and Skilling had created. He was hired before age 30 by Skilling to join Enron. He always idolized Skilling and wanted to please him. He ended up hiding about $30 billion in debt through his companies. In addition, he skimmed off many of the deals he made, using Enron stocks as collateral. Fastow did not have a strong moral compass, and would play to the greed of the investment banks. He would offer investment banks accounts for their silence. One analyst, John Olsen, started to question the firm, and weeks later, was fired by the investment bank because Fastow paid off the bank with big Enron accounts.
3.(a) Describe the organizational culture at Enron. (b) How did the organizational culture contribute to the Enron scandal? (15 points) The culture at Enron was very cut-throat and filled with greed. Money drove the company and its employees. In fact, even the elevators had displays of the stock prices. The company was overtaken by hubris as well. Everyone was on the bandwagon—the accounting firm, investors, executives, and employees. The entire company thought it was changing the world. Everyone was blinded by arrogance, greed, and money. Enron was always portrayed as a super power in the market. It was said that is someone wanted to be part of the market, they had to go through Enron. In addition, many employees, including Skilling, were former nerds and had something to prove. There was a very macho culture at Enron. Skilling would organize dangerous, macho trips for employees and big clients. The stories from these adventures became legend. One man almost died from a flipped Jeep. Stories like that were legendary in the office. The culture ultimately led Enron to scandal because of the ideas it had put into people’s heads—that money drove everything and cash was king.
4.(a) Describe the performance management/reward system at Enron. (b) How did the performance management/reward system contribute to the Enron scandal? (20 points) The reward systems were big. The executives and employees were all fans of the “pump and dump” system in which the employees drove the stock prices up, and would them sell the stocks off. The company was consumed by stock prices, as stocks were a large part of the compensation structure at Enron. Even the elevators had stock prices posted, so people could be reminded daily that there was more money to be made. The cash bonuses were extravagant too. In fact, a 25-year-old made a $5 million bonus. Executives were given multi million dollar bonuses. In addition, to prevent anyone from raising any flags, Enron played on the greed of the outside accounting firm, Arthur Anderson, as well as law firms. In fact, in 2001, Arthur Anderson got $1 million a week to keep things quiet and go along with everything. The law firm was paid off handsomely as well. Analysts at investment banks would never really look into things because of greed as well. Because of all the bonuses, outsiders turned a blind eye, as did employees, which ultimately gave way to the scandal that ensued.
5.(a) Describe the regulatory/oversight weaknesses for Enron. (b) How did the regulatory/oversight weaknesses contribute to the Enron scandal? (15 points) Enron sought to take advantage of the low level of government regulation and the hyper capitalism created by the reigning consumer culture of the time. The company was run by a group of intelligent individuals who recognized they could take advantage of the government failure of low regulation. Early on while working for Enron, Lay founded many friends within Congress, including the friendship of George H.W. Bush and George W. Bush. The government helped in pork barrel legislation for the company, granting it even more power. In addition, Bush senior helped secure millions of subsidies for Enron and helped promote Ken Lay as ambassador of deregulation at large. In addition, even energy-specific regulators turned a blind eye. Pat Wood, chair of FERC, was recommended by Lay as chair, and would work with Enron in lack of government intervention.
Even the power plants in California were working with Enron at one point. Enron could call someone at a power plant and cause rolling blackouts in parts of California, driving energy prices up. With support from the government and very low regulation and intervention, Enron had a clean path to scandal. 6.Describe three (3) specific ways, which are directly related to the above factors, that Enron-like scandals could be prevented in the future. (15 points)
1. Publically-traded companies should have a strong board of directors that oversees the company and does not have investment in the company. Greed drove Enron to do what it did, but a board of directors who has no stake in the company would be more objective and ethical in decision-making for the company.
2. There should be less compensation tied to stock performance, as that was a large incentive for fraud at Enron. People’s earnings were tied too closely to stock.
3. Analysts should be help more responsible for their actions. The investment banks they worked for got sued, but who’s to say the analysts who turned a blind eye ever got punished? They made the banks lots of money, so they probably kept their jobs and got a slap on the wrist. More consequence in the public eye would deter these actions in the future.