Reputational risk is damage to the value of a company’s brand name caused by negative public opinion. It can happen for a number of reasons such as directors maximize self interest which have a debilitating effect on shareholder wealth and value of the company (Wise Geek). Large companies always have a strong concern on establishing and maintaining its good name. Hundreds of millions of dollars have spent on “image advertising”. When a company got a positive reputation, it may come up with many ways to protect it.
Reputational risk management plays an important role in a company’s good corporate governance modal. Not managing reputation properly can have a significant impact on a long term and devastating consequences for a business (Billington,2004). For example, a company’s unethical behaviour in its business activities will bring about poor market perception which lead to a decrease in customer confident and trust, quantities on sales become fewer and this in turn has a negative effect on its share price. Arthur Andersen was one of the world’s five largest accountancy and auditing firms since 1990s. At that time, Enron was the most important client of Andersen.
The firm acted as auditors and financial advisers to Enron for many years. “The collapsed of Enron due to a number of questionable and illegal financial practices, and Arthur Andersen was subsequently convicted of obstruction of justice for its part in the scandal”( Giles, 2012). The reputation damage for both companies were immediate and catastrophic, and its clients fled in droves. Problems on business strategies can also caused reputational risk as Enron’s willingness to take risks on innovations such as Enron Online and hiring top professional staff are results to be failure.
Risk Theme Discussion
Enron’s innovation process Enron increased its profits by introducing a number of innovations(Fox, 2003). In 1989 it launched Gas Bank, which allowed gas producers gas producers and wholesale buyers to purchase firm gas supplies and hedge the price risk at the same time. Enron used derivatives to reduce risks associated with future gas price. The company took advantage of the derivatives revolution that had already begun in the finance area, but it was new to the natural gas industry.
This provided the executives opportunity to bring risks into the company and those risks were easily ignored by the risk committee as there are lack of principle or treatment. However, most of Enron’s trading involved customized contracts used outside of exchanges, which meant that there was no exchange regulating these deals (Fox, 2003). This initial success prompted Enron to extrapolate its business model to other markets. Since the high debt levels would lower the investment grade and trigger banks to recall money, Enron need to find a way to hide the debt, therefore the company became the pioneer in using the Special Purpose Entities. An SPE is simply a trust created by a company to hold some of the company’s assets.
As it contains some assets but none of the company’s existing debt, it is a risky borrower and can borrow money at lower rates(Curral and Epstein, 2003). So, basically, Enron was making a sale to itself, showing a profit on its book, and hiding the corresponding loss in the SPE which can brought in financial risk and operational risk into the company. Another innovation at the same time was the initiation of EnronCredit.com, which bought and sold credit risk to help companies manage the risk incurred in trading transaction (Fox, 2003). Therefore, we can see that Enron’s willingness to take risks on innovation makes its reputation as an innovator. This gives the company an competitive advantage but also put reputational risk on the desk. Appropriate risk management process should have here in order to prevent disaster happening.
Enron’s corporate culture
A corporate culture may be loosely defined as “the way we do things around here.” corporate culture is a product of formal rules and unspoken dicta, fables and heroes, and the behaviors that are rewarded and punished (Bader, S). Through the rise and fall of Enron, the company has been known as having a culture of arrogance. This particular culture made people believe that the company could manage a wide variety of risks without taking any danger. Enron’s corporate culture has failed to promote the values of honesty and integrity.
These values were undermined through the company’s emphasis on decentralization, its employee performance appraisals, and its compensation program(Weiss, 2009). Enron has divided its business activities and business unit into different parts and there are all separate from the others. As a result very few people in the organization had a general perspective of the company’s operations. This is where operational risk happened among the different department and thus caused losing reputation of outsider of poor performance of the units in the “cobweb”. Jeff Skilling was a major player in setting the expectations high at Enron and made it clear that his type of people were extreme risk takers and thrill seekers(Graarrg .2010). He implemented a very rigorous and threatening performance evaluation process for all Enron employees.
Known as “rank and yank,” the annual process utilized peer evaluations, and each of the company’s divisions was arbitrarily forced to fire the lowest ranking one-fifth of its employees. Employees frequently ranked their peers lower in order to enhance their own positions in the company (Fowler, 2002). As a result, only the “best” and the “brightest” survived this test. This is the time when the employee of Enron starts lost trust with each other from the bottom to the top. Here we could concluded that companies with a healthy corporate culture gain a positive reputation among potential workers, which may attract talented and skilled workers to the organization. A well-regarded business reputation allows the company to charge a higher price for products and services and increases the value of the company in the financial market.
Enron’s reputational risk
Reputation is a dynamic asset, changing as organisation present new services and products in new markets, being held to changing criteria and facing unforeseen challenges. This suggests that there is a role for risk managers both in maintaining and protecting the organisation’s standing with its stakeholders, and in repairing its good name when events conspire to damage it(Economist Intelligence Unit, 2005). As we now know, Enron’s core business involved buying and selling electricity and other forms of energy.
When an electric utility contracts to buy electricity, the managers of the utility want to be completely satisfied that the seller will deliver the electrons exactly as the contract states at the agreed price. This means that the firms with whom Enron was trading electricity needed to be sure that Enron would deliver on its contracted promises. In other words, they had to trust Enron. But in October 2001, when Enron announced that its previous financial statements overstated the firm’s profits, it undermined such trust. As everyone recognizes, the announcement caused investors to lower their valuations of the firm(Karpoff, 2002). However, Enron undermined its reputation.
This is why Enron fallen down so fast as its core businesses relied on the firm’s reputation. When that reputation was wounded, energy traders took their business elsewhere, and the company will face a huge loss in profit. Reputational also concerns Enron’s external auditor, Arthur Andersen. What Arthur Andersen provides as an auditor is certification that its client’s financial statements accurately reveal the client’s business health. Therefore Andersen provide to the public good reputation of Enron. The company pay it audit fees to signal to the investment community that the firms’ books are trustworthy(Nelson, 2008). But we all know that Anderson manipulate the financial report to create a fake image of Enron. Just as Enron collapsed by destroying its reputation and ruining its energy trading business, Andersen’s story is also come to an end.
There should be a healthy corporate culture in a company. We can see Enron’s corporate culture played an important role of its collapse. The senior executives believed Enron had to be the best at everything it did and the shareholders of the board, who were not involved in this scandal, were over optimistic about Enron’s operating conditions. When there existed failures and losses in their company performance, what they did was covering up their losses in order to protect their reputations instead of trying to do something to make it correct. Also, the management should ensure the company develop a reputational risk management process with its risk management program.
Documents some practical cases of corporate reputation failures as a source of management. The directors should oversee the design and implementation of a strategic risk management program where all business events with potential consequences on the firm’s reputation capital are identified and measured. What’s more, it is strongly recommended the company to provide ethics training to enable all stakeholders to recognize, appreciate, and resolve ethical dilemmas. Encourage conversations about ethical and reputational risk and mitigation strategies at multiple opportunities, with all stakeholders.
The Enron case was the biggest in a series of scandals that damaged the reputations of corporations in United States. There are many reasons lead to the collapse of the company. The size of the company, its complexity of business activities and also the greed and collusion of key participants. This essay is focused on the reputational risk the company meet, discuss what happened during its innovation process of which caused damage in the company’s reputation. And the corporate culture within the company that plays an important role in its fallen. From the above analysis, we can find that managing reputation risk have both internal and external challenges. Internal factor requires the management to establish an appropriate vision, values and strategic plan to guide action. External factor requires concern on environment and other stakeholders opinion to ensure it is on the right track in order to get trust and confidence of the stakeholders. Lessons need to be learned or one Enron is not the end.
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9.Karpoff, J. (2002). Why reputation counts more than regulation. Retrieved September 2, from http://faculty.washington.edu/karpoff/FIN%20509/Enron_EBF.pdf
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12.Wise Geek.(n.d.). What is reputation risk. Retrieved September 5, 2013, from http://www.wisegeek.com/what-is-a-reputation-risk.htm
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