Professional Documents
Culture Documents
Hervé Stolowy
HEC School of Management, Paris
Department of Accounting and Management Control
78351 - Jouy-en-Josas – France
Telephone: +33 1 39 67 94 42
Fax: +33 1 39 67 70 86
E-mail: stolowy@hec.fr
Abstract
This case about the Enron Group offers an opportunity to explore many accounting and
reporting issues such as accounting information and communication, “quality” and
independence of external auditors as well as many aspects of corporate governance. In
addition it creates opportunities to discuss ethical issues in business, sociological aspects of
business culture and the interaction between business behavior and political circles.
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1. Background information
1.1 Enron
Before its demise into bankruptcy in December 2001, Enron was a global supplier, broker and
market maker of energy and related services. Its share of the energy market in the United
States and Europe was about 25%. Enron was also developing its activities in any newly
deregulated markets such as South America, India and Japan). Although not integrated or
balanced, Enron was active at all phases of the energy supply chain: sales of energy
(electricity) and, to a lesser extent, sales of energy raw materials (natural gas and oil),
construction and management of oil and gas exploration infrastructures, energy production
facilities, transport and distribution networks as well as financial and risk management
services (helping customers manage expected and unexpected fluctuations in price, supply,
and demand of any energy or bandwidth capacity).
The year 2000 annual report list the following business segments (exploration and production
was discontinued in 2000):
Enron’s diversification within the broad energy field had been quite rapid in the previous ten
years. For the years 1996 to 1998, over 60% of the group’s income came from activities
developed only in the previous ten years. In 1998, Enron had diversified its portfolio of
activities beyond energy through the acquisition of fiber optics networks (for broadband
telecommunication and to support its development of Enron Online, its electronic market
place) and the purchase of Azurix Corp. specialized in the distribution of water and waste-
water management, mainly in South America).
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1.2 Chronology of key events
- October 16, 2001: the results of the third quarter 2001 reflect an after tax impact of $544
millions of unexpected expenses. During the ensuing conference call with the financial
community, Chairman Kenneth Lay reveals that Enron also recorded during the third
quarter a reduction in capital of $1.2 Billion. These two accounting adjustments are linked
to, so far unconsolidated, “ad hoc entities”.
- October 22, 2001: the SEC (Securities and Exchange Commission) requests additional
information about transactions carried by Enron with certain entities.
- October 28, 2001: the Enron Executive Committee (EC) appoints a Special Committee,
headed by William Powers, with the mission to prepare a report to the EC.
- November 8, 2001: Enron files form 8-K that reveals additional information about the
previously announced expenses and off balance sheet transactions and indicates it will
restate its published income and financial statements for the years 1997 to 2001.
- November 19, 2001: Enron files form 10-Q with the SEC (quarterly report).
- November 28, 2001: rating agencies downgrade Enron’s debt to the “below investment”
grade.
- December 2, 2001: Enron and some of its key subsidiaries file voluntary petitions with the
U.S. Bankruptcy Court for the Southern District of New York for reorganization under
Chapter 11 of the US Bankruptcy law. As part of the reorganization process, Enron also
filed suit against Dynegy Inc. (NYSE: DYN) in the same court, alleging breach of
contract in connection with Dynegy’s wrongful termination of its proposed merger with
Enron and seeking damages of at least $10 billion.
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2. Questions
The Annual Reports can be found either http://studies.hec.fr/web/stolowy - Enron subsection, (The login and
password are provided by e-mail to those registered in the course) or on the World Wide Web for example at
http://www.enron.com/corp/investors/annuals/ and http://www.enron.com/corp/investors/sec/ .
On the basis of information in the 8-K form filed on November 8, 2001, evaluate the impact
of the restatements for the period 1997-June 2001. Comment specifically on the impact of
these restatements on net income, balance sheet totals and on the debt to equity ratio.
Irregularities have been shown to significantly taint the process of financial and accounting
reporting at Enron. Through your analysis of available information (particularly the 8-K filing
on November 8, 2001 and the Powers report dated February 1, 2002), prepare an analytical
presentation of the following accounting issues:
- Rhythms NetConnections
- Non consolidation of Chewco
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- Non consolidation of Jedi
- Non consolidation of LJM
- Error on the recording of the capital increase of the four “Raptors” SPE (special Purpose
Entities).
In your presentations, the following key questions can (for example) be addressed:
Prepare a synthetic report on the role the external auditors played in the Enron debacle.
- What risks are associated with the lack of independence of the external auditors?
- What have been the consequences of Enron’s bankruptcy on its external auditors and on
the accounting profession in general?
Analyze the impact of conflicts of interest on the managerial behavior and financial reporting
that led to Enron’s bankruptcy. Is any generalization possible?
Analyze the role played by the Executive Committee, the Board of Directors and the internal
control function on the demise of Enron. Are these committees and function able to
effectively promote and protect the interests of shareholders?
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2.4.4 Role of regulatory agencies
What is the role of the SEC and of the FASB in the prevention and control of accounting
irregularities?
- To what extent can one state that the Enron bankruptcy is a political problem?
- What has been, if any, the role of financial analysts in the creation of the Enron debacle?
3.1 Transparencies
Financial statement analysis (text).xls: income statements, balance sheet, key figures and
statements of flows of cash for the period 1997 to 2001.
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3.4 Powers report to the Special Committee, February 1, 2002): 218 pages
- “Enron: Business Culture and Economic Activity”», Kevin Farley (HEC MBA, January
2002), June 2002 (11 slides)
- “Through the SPE looking glass”, Deloitte & Touche, For The Record n°3, April/May
2002 (3 pages)
- “Enron: What Happened & The Implications”, KPMG, January 25, 2002 (10 slides).
- “Written testimony of the staff of the Joint Committee on Taxation on the report of
investigation of Enron corporation and related entities regarding federal tax and
compensation issues, and policy recommendations”, Joint Committee on Taxation,
February 13, 2003 (36 pages)
- “The reform of corporate reporting and auditing”, Baruch Lev, Professor at NYU’s Stern
School of Business, February 6, 2002 (11 pages)
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- “Testimony concerning recent events relating to Enron Corporation”, Robert K. Herdman,
Chief Accountant, U.S. Securities and Exchange Commission, December 12, 2001 (14
pages)
- “Excerpts from speeches by the staff of the Office of the Chief Accountant through
December 6, 2001”, SEC, December 6, 2001 (31 pages).
- “Governance and intermediation problems in capital markets: evidence from the fall of
Enron”, P.M. Healy and K. Palepu, Harvard Research Paper, August 2002 (51 pages)
- “Enron and the dark side of shareholder value”, W.W. Bratton, George Washington
University Law School, May 2002 (79 pages)
- “Winners and losers in multiple failures at Enron and some policy changes”, H.D. Vinod,
Fordham University NY, April 9, 2002 (11 pages)
- “The inevitability of Enron and the impossibility of "Auditor independence" under the
current audit system”, S. M. O'Connor, University of Pittsburg School of Law, March 1,
2002 (73 pages)
- “Essay: Some thoughts on the Enron bankruptcy”, S.L. Schwartcz, Duke University
School of Law, 2002 (9 pages)
- “What Enron means for the management and control of the modern business corporation:
some initial reflections”, J.N. Gordon, Columbia Law School, 2002 (18 pages)
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- “Financial engineering, corporate governance, and the collapse of Enron”, S.L. Gillan and
J.D. Martin, University of Delaware, 2002 (59 pages).