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Facts on the Enron Meltdown

By Edited Nov 13, 2013 0 0

Enron: Analysis and Lessons

What They Did and Why

Financial Games of Enron

  
  The Enron Corporation grew from a small Houston energy startup business into one of the world’s most powerful companies, and then imploded in a massive collapse that shook the entire financial world. This huge collapse was directly due to financial accounting abuse by its executives and auditors. 


 As a result of financial mismanagement, the Enron Corporation fell from being a huge powerhouse of Wall Street to just an encyclopedia entry. Along the way, thousands lost millions, people were sent to prison, collateral damage ensued, and new laws were enacted. (LePatner, Corn, and Chan, 2007).

  Enron was started from a merger of two natural gas companies in Houston, Texas in 1986. As Enron grew, it branched out into any field in which it saw profit potential. It was best known as a cutting-edge energy broker. Company president Kenneth Lay propelled it to a $90 stock price and Fortune 500 status by apparent genuine innovation.   As a result of energy deregulation by Congress in the 1990’s, Enron’s revenue swelled to epic proportions, on paper. Stock analysts were convinced the company was only going to keep growing. What the public and the analysts did not know was that Enron kept costs and debts off the financial statements when business did not
go as well as planned. This is the reason for the collapse. There were other exacerbating factors, such as executive dastardliness, a double-dipping accounting firm, and just bad timing in the economy, but the main cause that gave grounding for everything else was the fact that Enron did not play fair with financial statements. 

  To gain a better understanding of the firm’s implosion, we have to start with a timeline of selected key events. Looking at these events chronologically will paint a picture of the rise and fall of this firm that transformed into an icon of corporate financial mismanagement for not only the United States but for the whole world. 

June 1994        Enron trades its first unit of electricity.

Feb 2001         Jeff Skilling takes over as Chief Executive Officer (CEO).

Aug 14, 2001  Jeff Skilling resigns as CEO.

Oct 12, 2001   Accounting firm Arthur Anderson sends incriminating email about document-destruction policy.

Oct 16, 2001   Enron declares $618 million third-quarter loss and writedowns. Aims blame on Chief Financial Officer (CFO) Andrew Fastow.

Oct 17, 2001   SEC requests an explanation for huge third-quarter loss.

Oct 22, 2001   Enron reveals it is the target of an inquiry by the SEC.

Oct 24, 2001   Enron fires CFO Andrew Fastow.

Oct 31, 2001   Enron announces the SEC inquiry has turned into an SEC investigation.

Nov 8, 2001    Arthur Anderson receives a federal subpoena for Enron documents.

Nov 8, 2001    Enron files revised financial statements with $586 million in losses for the previous five years.

Nov 8, 2001    Enron begins attempt to sell itself to another energy company, Dynergy.

Nov 9, 2001    Enron issues another admission of overstated earnings by $567 million. Executive firings begin.

Nov 19, 2001  Enron attempts to restructure a $650 million matured debt obligation.

Nov 28, 2001  Enron’s credit rating dwindles to junk-bond status. Dynegy backs out of take-over bid.

Dec 2, 2001     Enron files Chapter 11 bankruptcy.

Dec 12, 2001   Arthur Anderson executive testifies to Congress that Enron violated securities laws.

Jan 10, 2002    The Justice Departments announces it is launching a criminal investigation into the company’s collapse.

Jan 22, 2002    Incriminating employee testimony indicates document shredding at Enron.

Jan 23, 2002    Ken Lay resigns as Enron’s CEO.

Jan 24, 2002    Congressional hearings begin.

Jan 25, 2002    An Enron executive commits suicide.

Jan 31, 2002    Evidence comes to light incriminating the board of directors.

Feb 4, 2002     A report from Enron’s investigative committee implicates Ken Lay for the accounting shenanigans.

Feb 2002         Enron executives plead the fifth and/or give contradictory testimony when questioned by Congress.

Mar - Apr, 2002          A string of legislation passes in Congress to tighten up corporate accounting practice.

May 7, 2002    Documents appear revealing Enron’s causative role in the California energy crisis. (Enron manipulated the energy flow causing a huge supply and demand unbalance, resulting in huge profit margins for Enron.)

Aug 21, 2002  Michael Kopper becomes the first Enron executive convicted.

Sep 10, 2002   Ben Glisan Jr. becomes the first Enron executive to go to prison.

Sep 21, 2004   First criminal trial of Enron executives begin.

May 2006        Jeff Skilling convicted on 19 federal charges. Ken Lay’s conviction followed, but he
died while awaiting sentencing.

(Timeline information compiled from Akhigbe,  Madura,  Martin, 2005 and  Washington Post Online article, 2004.)

  The company first got into trouble in the 1990’s when it started expanding. When its capital investment projects did not return what was projected or incurred more costs than estimated, Enron executives decided the best thing to do was to hide the bad and show the good. Special purpose
entities (SPE’s) were created to act as shell companies to eat the losses. Through a complicated corporate shell game, Enron would move the losses it created into its SPE’s and just show profits on its balance sheet. In addition to hiding the losses, it would inflate revenue estimates by overstating energy reserves. As a result of these two tricks, Enron on paper looked like a highly
profitable, innovative money machine. In actuality, Enron was losing money hand over fist.

  As was later revealed, Enron executives were aware of and were actually directing the loss-hiding scheme in order to keep the company afloat. This Enron method of creatively deceptive accounting later became known as “Enronomics”. ( Investopedia, 2007.) Toward the end when the executives saw the proverbial writing on the wall of the company’s demise, they still had the brazenness to openly encourage Enron stockholders and their employee owners of company-stock-based 401Ks, to purchase more Enron stock. (Multinational Monitor, 2002.) (This was happening just after the Internet/Tech Stock bubble burst that shook the whole economy.) At the same time, the execs were selling off their shares to collect millions before the bad news leaked out.  (MSN Encarta Online, 2007.)

   Enron was able to fool the public, their stockholders, and the SEC for so long because they had an unwitting accomplice in a then-venerable, top-five accounting firm: Arthur Anderson. This was an indictment on all Western corporate accounting. (Choudry, Harahap, 2007.) The Arthur Anderson accounting firm had been in business for over eight decades when it crumbled due to its
gross negligence with the books at Enron. As the facts of the case started becoming public, Arthur Anderson’s other customers started jumping ship. Eventually, its association with Enron brought the company to its end.

   In response to the Enron debacle and the thousands of employees that lost their life savings, Congress passed a series of laws in an effort to prevent this type of fiasco from repeating itself. The Public Company Accounting Reform and Investor Protection Act of July 2002 created the Public Company Accounting Oversight Board under the authority of the SEC. The Board had the authority to investigate corporations and their accounting firms. The Act prohibited accounting firms from double-dipping with a corporation by providing accounting and consultation services, which is what Arthur Anderson was doing with Enron. (Grumet, 2007.) Perhaps the most noteworthy stipulation of the Act was for CEO’s and CFO’s. Both now had to certify their corporation’s financial
statements before their release to the public.

   Now that several years have passed since the outing of the ugly facts of the matter, the state of corporate accounting has been strengthened worldwide. (Zumbansen, 2007.) The oversight rules have bolstered the public’s once-shaky confidence in corporate financial statements and assertions. ( Reaz, Hossain, 2007 and Choi, Eldomaity, & Kim, 2007). The legacy of Enron will be one of a very painful road to strength for corporations.

 

 

SOURCES:

Masrur Reaz,  Mohammed Hossain. (2007). Corporate Governance around the World: An Investigation. Journal of American Academy of Business, Cambridge, 11(2), 169-175. 
Retrieved December 22, 2007, from ABI/INFORM Global database. (Document
ID: 1287753391).

Chong Ju Choi,  Tarek Ibrahim Eldomiaty,  Sae Won Kim. (2007). Consumer Trust, Social Marketing and Ethics of Welfare Exchange. Journal of Business Ethics, 74(1), 17-23. 
Retrieved December 22, 2007, from ABI/INFORM Global database. (Document
ID: 1300347701).

Barry B LePatner,  Henry H Korn,  Anthony S Chan. (2007). Sarbanes-Oxley's Wake-Up Call to the Construction Industry. The CPA Journal, 77(12), 6,8-9. 
Retrieved December 22, 2007, from ABI/INFORM Global database. (Document
ID: 1401195171).

Masudul Alam Choudhury,  Sofyan S. Harahap. (2007). Decreasing corporate governance in an ethico-economic general equilibrium model of unity of knowledge. Corporate Governance, 7(5), 599.  Retrieved December 22, 2007, from ABI/INFORM Global database. (Document ID: 1381003211).

Peer Zumbansen (2007). After Enron: Improving Corporate Law and Modernising Securities Regulation in Europe and the US. Banking & Finance Law Review, 23(1), 215-222. 
Retrieved December 22, 2007, from ABI/INFORM Global database. (Document
ID: 1386986461).

Louis Grumet (2007). Rethinking Sarbanes-Oxley. The CPA Journal, 77(11), 7.  Retrieved
December 22, 2007, from ABI/INFORM Global database. (Document ID: 1383856711).

Before the Deluge: Enron's World, 1999. (2002). Multinational Monitor, 23(1/2), 40.  Retrieved
December 22, 2007, from ABI/INFORM Global database. (Document ID: 583500551).

Aigbe Akhigbe,  Jeff Madura,  Anna D Martin. (2005). ACCOUNTING CONTAGION: THE CASE OF ENRON. Journal of Economics and Finance, 29(2), 187-202.  Retrieved
December 22, 2007, from ABI/INFORM Global database. (Document
ID: 923949871).

"Enron Scandal," Microsoft® Encarta® Online Encyclopedia 2007
http://encarta.msn.com © 1997-2007 Microsoft Corporation. All Rights Reserved.

“Timing of Enron’s Collapse,” Washington Post Online, Sep 30, 2004. Sampled Dec 21, 2007. http://www.washingtonpost.com/wp-dyn/articles/A25624-2002Jan10.html

“Enronomics Article”, Investopedia Online. Sampled 21 December 2007. http://www.investopedia.com/terms/e/enronomics.asp

 


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