Enron Corporation was formed in 1985 from a merger between

Houston Natural Gas Company and Omaha-based InterNorth

Incorporated. Enron was once the seventh-largest corporation in
America and was named the ‘America’s Most Innovative Company’
by Fortune for 6 years consistently. The corporation that took 10
years to build up to 60 billion dollars in value took less than a
month to go bankrupt. Enron had accumulated approximately
$598 million in losses, $628 million in debt. (ColdFusion, 2019),
billions of dollars stolen, thousands of jobs lost, dozens of
convictions, one suicide and a public display of corporate greed.

It was headed by Kenneth Lay as the CEO and Chairman of the

corporation. Lay appointed Jeffrey Skilling to lead the
organization and Andrew Stuart “Andy” Fastow as the CFO.

Role Of Financial Instruments In Downfall Of Enron.

In order to finance their corporation and subsidiaries, Enron was

able to attract investors and trading partners through offering
their reputation as the most innovative company, credit, expertise
in energy, political backup and praise because of its expansion and
ambitious projects. (Company Man, 2017).

Enron knew as long as the company met or exceeded its endless

expectations their stock price would keep rising. Enron’s executive
management committee, therefore, violated the accounting
regulations under Generally Accepted Accounting Principles
(GAAP) to hide losses and debt (Lemus, 2014) in order to cover up
the true value of their corporation.

This is how;

1. Off-Balance Sheet

Enron understood that the information delivered to the market

participants has a direct effect on the returns that can be made.
They used of special purpose vehicle (SPV) known as a special
purpose entity (SPE) to hide large debts and toxic assets from
creditors and investors. They set up side companies in which they
pushed their debt over to them hence solving the ‘debt problem’.

They also colluded with JPMorgan Chase, Citigroup bank which

helped report loans as cash flow from operations for the period
1992–2001 (B. Aven, 2015). Also, Arthur Andersen who audited
their financial statements.

2. Mark-To-Market

MTM is based on ‘fair value’ not the ‘actual value’ so it can be

manipulated by allowing organizations to log estimated profits as
actual profits as in the case of Enron.

An example is the case of the partnership of Enron broadband

services and Blockbuster where they entered or logged expected
earnings based on the expected growth of the VOD market. Or in
the case of the Indian power plant where immediately after
building the power plant, Enron claimed the profits in its books
even when the company had not even made a dime.

3. Futures Speculation

Enron’s executives believed that their stock would continue to

appreciate. Enron being the counterparty and in total control of
their assets and trading enabled them to manipulate the prices of
their stocks to fit their desire.

4. Manipulation of Derivatives

Enron did this by hiding the losses in the derivative section (loans
were presented in the form of prepaid commodity swaps) (Konar,
2018).

Some reasons why fraudulent transactions happened:

1. Gas and electricity market deregulation.

2. Absence of accounting standards for prepaid commodity swaps.

(Konar, 2018)

3. Political ties to the then president of America George W. Bush

Market Effects Due To The Rise And Fall Of Enron.

1. Positive.
a. Stricter regulations were set to govern the market and auditors
now have a stricter independence role

b. Sarbanes-Oxley reforms that make sure that CEOs and CFOs

have to specify the signatures on their financial statements so that
they can not deny they ever saw them. (Goodell, 2018)

2. Negative

a. Thousands of employees lost their jobs.

b. Shareholders saw their investments shrink to a fraction of the

previous value. (Leg, 2020)

c. Auditors who survive by reputation like Arthur Anderson did

not survive the scandal. This means investors avoid companies
audited by them, which is bad for business.

Risk Mitigation Techniques To Minimize Enron Risk Profile

1. Strengthen Rules And Regulations Governing The Board.

This can be done by adopting key aspects of the private-equity

governance model to ensure that they fulfil their oversight
responsibilities. (Lagace, 2002).

In private-equity governance, boards are “proprietors or

representatives that means they have a strong sense of ownership,
clear shared expectations of risk-return and the timeline that
frames their investment” (O’Brien, 2008).

2. Up-to-date accounting standards. (Konar, 2018)

For example, adopting International Financial Reporting

Standards (IFRS) instead of the US GAAP. IFRS has set rules so
that financial statements can be consistent, transparent and
comparable around the world.

3. Compulsory Disclosure Of Financial Statement

This is to promote openness and transparency during the entire

reporting period while promoting information aggregation and
coordination. This will also allow investors and creditors to make
informed decisions.

4. Implementation of Fraud Detection Systems

These will basically help reduce misinformation from the

corporations.

Conclusion

Enron downfall and collapse led to a more regulated and open

financial market with information being key to good investments
around the world.

In financial markets, risk is unavoidable but can be reduced or

managed or mitigated. Ways in which the investors, creditors and
the corporation could have mitigated their risks which came with
the fall and collapse of Enron have been mentioned above.

References

Lemus, Edel. The Financial Collapse Of The Enron Corporation

And Its Impact In The United States Capital Market. Global
Journal Of Management And Business Research., 2014,

Goodell, Robert. “What Was The Broader Market Effects

Resulting From The Rise And Fall Of Enron?”. Quora , 2018.

Legese, Alem. “The Role Financial Instruments Played In The

Downfall Of Enron”. Studocu,2020.

Konar A. The Role of Financial Markets in the Case of Enron .

Bulletin of the South Ural State University. Ser. Economics and
Management, 2018, vol. 12, no. 4, pp. 41–44.
DOI:10.14529/em180405

ColdFusion. Enron — The Biggest Fraud In History . 2019.

Company Man. The Enron Scandal — A Simple Overview . 2017.

Lagace, Martha. “Innovation Corrupted: How Managers Can

Avoid Another Enron”. HBS Working Knowledge , 2008.
Aven, B. L. (2015). The paradox of corrupt networks: An analysis
of organizational crime at Enron. Organization Science, 26(4),
980–996.