Building a Smart Organisation 13.

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DISCUSSION QUESTIONS

1. Give some examples of bad decisions caused by psychological biases.

2. Discuss the four key challenges in building a psychologically smart organisation.
3. What is a balance sheet? What are its contents?
4. What is a statement of profit and loss? Discuss its contents.
5. Discuss the following facets of business performance: profitability, growth, and risk.
6. What are the drivers of return on equity?
7. Discuss the important measures of growth.
8. Discuss the important measures of risk.
9. Discuss the important measures of value.
10. What are percentage financial statements? What kinds of questions do they help in answering?
11. What is planning fallacy? What can be done to mitigate planning fallacy?
12. What are the objectives of executive compensation policy, according to Stephen O’ Bryne?
13. Discuss the guidelines for designing a good incentive compensation plan.
14. What are the reasons for group errors?
15. How can groupthink be countered?
16. Discuss the technique of premortem.
17. What questions should be asked to assess the quality of recommendations, according to Daniel
Kahneman, Dan Lovallo, and Oliver Sibony?
18. Discuss the suggestions for improving the quality of decisions.

MINI CASE

ENRON

Rated by Fortune magazine as ‘The Most Innovative Company in America’ for six consecutive years,
from 1995 to 2000, Enron was the darling of investors in the 1990s. From December 1990 through
December 2000, Enron’s market capitalisation grew 25 times when S&P 500 advanced only 5 times. A
year later, to the shock of its investors and others, Enron filed for bankruptcy and its market capitalisation
was decimated.
Buoyed by its success in the natural gas business in the early 1990s, Enron management sought to
replicate that performance in markets where it lacked expertise, such as broadband, retail energy, water,
steel mills, and electric power generation. It invested over $10 billion in several ventures that generated
a near-zero return.
13.24 Behavioural Finance

To improve its earnings, Enron’s management presented to the board the use of special-purpose
entities organised as partnerships. Masterminded by Enron’s CFO Andrew Fastow, these partnerships
were artificial devices to boost earnings. By the way one of these partnerships was set up by Fastow and
he named it LJM2, after the initials corresponding to the first name of his wife and two sons. LJM2 was
meant to enrich Fastow and his aide Michael Kopper. In 2002, Fastow and Kopper pleaded guilty. Fastow
was sentenced to a 10-year prison charge.
Enron sold assets at inflated prices to these entities (many of them being fictitious entities created by
Enron’s CFO Andrew Fastow), along with a promise to repurchase those assets at a higher price in future.
While Enron recorded the profits from the sale of those assets, it cleverly hid the promises to buy them
back in various ways. Much of Enron’s growth in revenues and profits in the late 1990s stemmed from
such manipulation. For example, in 2000, 96 per cent of reported earnings were the result of accounting
jugglery.

Enron’s Board
Enron’s board approved the creation of partnerships as they were presented as a tool for improving
Enron’s earnings. It even waived Enron’s code of ethics for Fastow.
Enron’s directors asked very few questions and readily accepted the answers provided by the
management. They did not cast any dissenting views. Nor did they examine the partnership prospectus
material to identify the conflict of interest.
All this was surprising because the majority of Enron’s board was made up of independent directors
and the board had an independent nominations committee.
Moreover, the audit committee of the board was headed by Robert Jaedicke, a professor of
accounting and former Dean of the Stanford Business School. Notwithstanding Jaedicke’s expertise,
Enron’s board and managers were seemingly focused on earnings rather than cash flow.
Discussion Question
1. Identify the reasons for the collapse of Enron.