Enron Case Study

Team Members
Abdul Wahid Ibrahim
Raman Narayanan
Suzilawati Norsalizan
Ismarizal Ismayatim
Ismuni Latip
Master of Business Administration
College of Business,
Universiti Utara Malaysia
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Questions

If business operates within the law, does

it operate morally? Why or why not?

Enron Case Study

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Agenda

• Literature Review
• Introduction
• Enron Findings
• Implications
• Lesson Learnt

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Literature Review - Western
Integrity
Comes from individual forms the
culture of organization
Values – transparency,
innovative, customer loyalty,
Busine$$ – Profit$
Business Ethics Corporate
Governance
Rules, standard, moral principles
A set of processes, customs,
right/wrong policies, laws, and institutions
Issues – Accounting fraud, affecting the administration
misconduct, bribery, conflict of Stakeholders – BODs, employee,
interest creditors, customers &
community
1970s – strengthening
governance worldwide
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Literature Review - Islamic
No fraud

No Mutual
monopoly consent

Strict on
Free
weight &
market
measures

No
hoarding

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Introduction
• An energy company established in 1985 led by
Kenneth Lay.
• Grew 311% till 1998, 56% in 1999 and 87% in 2000
• Rated as Fortune’s Most Admired Companies
• Benefited from Free Market System for selling
electricity at market price.
• 2001 – share plunged from USD80 to USD1 and
declared bankruptcy.

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Enron Case Findings
• 1985 – merger - Enron Corp. – massive debt from
the deregulation process.
• Kenneth Lay (CEO) – hired McKinsey & Co. as
consultant – Jeffery Skiling
• Skiling helped Enron create a new product for the
industry – ‘gas bank’ – created a energy chain.
• 1990 – Enron Finance Corp. – Skiling as the P.I.C.
• Hired Andrew Fastow – 1998 - CFO

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Key player – Enron Corp.

• Kenneth Lay Jeffery Skiling Andrew

Fastow

• 3 key-player in Enron (1990 – 2000)

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Skiling Leadership
• PRC (The Performance Review Committee) –
scaled from 1 – 5, with 5s are usually being fired
within 6 months
• 15% of employee turnover
• Recruited the best & brightest from top MBA
schools – pampered with corporate perks, no cap
merit-based bonuses
• Intense internal competition – to justify continued
employment.

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Skiling Leadership..
• Skiling:
> “if you can’t do that, then you have to find a job at
another company or go trade pork bellies.”

1996 – Chief Operation Officer (COO) – convinced Lay that

the ‘gas bank’ concept could be applied in electric energy
as well.
1997 – Acquired Portland General Electric Corp.
Developed Enron Capital and Trade Resources Division
– largest wholesale buyer & seller of natural gas and
electricity in US.

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MISCONDUCT OR BAD INVESTMENT?
• The Dabhol Power Company – India:
Dispute arose after the India’s
Congress Party no longer in
power.

Enron: GE : Bechtel: MESB

65 : 10 : 10 : 15

Enron – manage the project through Enron International

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The Dabhol Power Plant
• Required by contract to pay Enron at Rs. 8/kWh – even no
power was purchased – ‘white elephant’
• New agreement in 1998, Enron agreed to cut the price to
20% - MESB refused to pay.
• Enron has almost $2 billion investment at risk
• Total cost climbs to $3 billion
• Dabhol sits silent

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EnronOnline
• 2000 – a change was made in Commodity Futures
Modernization Act – after intense lobbying
• To exempt energy and metal trading from CFTC oversight
• Allows energy trades to takes place electronically, in
private, with no transperancy, record,audit trail, nor any
oversight to guard fraud and manipulation.
• EnronOnline – began to trade energy bilaterally, and
without being subject to proper
regulatory oversight
• EOL became an overnight success,
handling $335 billion in online
commodity trades in 2000
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“Death-Star” Trading Strategy
• Created by John M. Forney, along with other infamous
strategies: Ricochet, Get Shorty, Fat Boy..
• Death-Star : “get paid for moving energy to relieve
congestion without actually moving energy or relieving any
congestion.”
• “create the appearance of congestion through the deliberate
overstatement of loads’ to drive up prices” – intention and
attempt to manipulate market for profit.
• California Energy Crisis – Enron plays a disturbing role
> Intentionally clogged Path 26 – a key transmission path
connecting Northern and Central California

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“Death-Star” Trading Strategy
• One of the former Enron:
“What we did was overbook the line that we had rights on
during the shortage or in the heat wave. We did this in
June 2000 when the Bay Area was going through a heat
wave and the ISO couldn’t send power to the North. The
ISO has to repay Enron to free up the line in order to
send power to San Francisco to keep the lights on. But,
by the time they agreed to pay us, rolling blackouts had
already hit California and the price for electricity went
through the roof”
Enron made millions by this strategy alone, and helped
California to sign expensive long-term contracts.

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“Round-Trip” or “Wash Trades”
• Other competitors following Enron’s lead. - Dynegy, Duke
Energy, El Paso, Williams
• Occur when one firm sells energy to another and then the
second firm simultaneously sells the same amount of
energy back to the first company at exactly the same price
• Sends price signal to the market, and artificially boost
revenue to the company
• Lawyer from JP Morgan Chase admitted: series of “round-
trip” trades from Enron
• Not only done in electricity, but also in broadband

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Azurix Corp.
• June 1998 – acquired Wessex Water Company – UK
owned company – at a premium of 28%
• CEO: Rebecca Mark – Enron
International
• Goal: to use Wessex as a base to
launch worldwide water distribution
and water treatment company.
• After the acquisition, British regulators asked Enron to cut
price by 12% & upgrade aging infrastructure
• Went public at $19 per share in 1999
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Azurix Corp
• End of 2000 - $100 million in profit and $ 2 billion in debt
• In 2000, written down by $326 million
• March 2002 – sold to YTL Corporation for $770 million
cash, after so much pressure to convert it into cash -> ‘fire
sale’
• Re-purchase the Azurix shares after written-down?
• To interpreted bullish signal?

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The Broadband Division
• The dot.com bubble burst in 2000
• Ambitious plan to build a high-speed broadband and traded
it with the same concept as in electricity.
• Enron & Blockbuster : Video on demand deal
• The most controversial SPEs: LJM1 & LJM2 – created to
buy shares of Rhythms NetConnections & The New Power
Company
• LJM – Lea, Jeffery & Micheal – the names of Fastow’s
children & wife. -> to buy Enron’s poorly performing stocks
& bolster Enron’s financial statement
• August 2000 – Enron’s stock hit $90.56/s – most admired &
innovative companies in the world
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The Broadband Division..
• Enron as of 31st December 2000: 
Year Earnings on common stock* Net income*
1998 686 million 703 million
1999 827 million 893 million
2000 896 million 979 million

*Enron’s year 2000 annual report unless otherwise indicated

  Both the $896 and $976 millions earnings for the year 2000
are after a $326 million charge to reflect the decrease in the
value of the Azurix investment. In addition, there is a $39
million gain on The New Power Company (TNPC) stock.

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The Broadband Division..
Enron as of 31st December 2000: 
Income (loss) before interest, minority interest, and income taxes
(PBIT)
Wholesale services $1557 million
Retail energy services $100 million
Broadband Services ($137) million
Transportation and Distribution $335 million
  *Enron’s year 2000 annual report unless otherwise indicated.

Failed to fully disclose the business failure to public – able to

convince credit firm that they are doing well despite the loss
March 2001 – Blockbuster cancelled the deal
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Innovative Accounting Practices
• Collapsed not because it gotten too big -> perceived to be
much bigger than it really was
• Decentralizing -> able to hide huge derivative losses
• Finance Report – carefully crafted using the loopholes in
the State’s Act.
• Losses held off the book.
• Assets stated.

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The Mark-to-Market Accounting
• Refers to accounting for the value of an asset or
liability based on the current market price, or on
assessed “fair value”
• Whenever have outstanding energy-related or other
derivative contract (assets or liabilities) – must
adjust to the fair market value.
• How about future contracts in commodities – no
quoted price -> how to assess value?
• Companies free to develop and use discretionary
valuation models based on their own assumptions
and methods
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Special Purpose Entities (SPE)
• How to lower the company’s debt ratio?
• A company is permitted to increase leverage and ROA
without having to report debt on Balance Sheet.
• Thousands of SPEs created by Enron. The most
controversial is LJM1 & LJM2
• Partnership with CalPERS (California Public Retirement
System) – created Joint Energy Development Investment
fund (JEDI) -> selling speculative assets to the partnership
in IOUs backed by Enron’s stock as collateral
• JEDI – 50:50

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Enron – CalPERS partnership

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Enron – CalPERS partnership..
• In 1997, Skiling asked for separate investment ->
must remove them from JEDI first.
• Don’t want to show any debt in Balance Sheet ->
Fastow created another SPE – Chewco Investment
L.P
• This was the idea....

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Enron – CalPERS partnership..

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Enron – CalPERS partnership..
• Received $10 million in guarantee fee & fee based on loan
balance to JEDI
• Total of $25.7 million revenues

• First quarter of 2000 -> increase in price of Enron stock

held by JEDI resulted in $126 million in profits

• CalPERS: paid $175 million & received $171 million -> lost
about $11 million
• Alerted by advisers – resolve to improve accounting &
auditing standards among companies it invests
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Conflict of Interest
• Arthur Andersen LLP
> External & internal audits for years
> Kept permanent assignment at Enron’s office
> Internal accountants, CFOs and Controllers – former AA
> Dismissed as auditor on Jan 2002 – document
destruction & lack of guidance on accounting policy
> Admitted to destroy thousands of documents & electronic
files related according to the ‘firms policy’, before the
SEC issued a subpoena to them
> As at now, not formally dissolved nor bankrupt – ceded
to 4 limited liability corp named Omega Management I
through IV
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Conflict of Interest..
• Stock Transaction & 401(k) Plans:
> Cancellation of Video on Demand (Blockbuster) – shares
dropped to mid $60s. -> senior management started to
sell stock in bull market -> collect hundreds of million
dollar
> Skiling resigned -> ‘personal reasons’ -> shares
continued slide up to below $30.
> 21aug2001, Lay sent email to Enron employees –
optimism to Enron & stock price; and again in
26Sept2001.
> October 17, announced it had changed it plan
administrators for 401(k) plan ->locking their investment
in 30days & preventing workers to sell their shares.
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Implications
1. Social Response
a. External Response – Laws and regulations;
 Laws and rules are constraints on bad choices not formulas for good choices;
 Tend to be reactive – cannot anticipate new circumstances and unexpected
challenge;
 Must achieve a difficult balance which sharply constrain a set of bad behaviour;

b. Internal Response – Professionalism;

 Skills of management are powerful when applied to the resources of organization;
 Ethical behaviour in practice depends not only on knowing what choices are morally
and decision in difficulty circumstances;
 Professional must posses specialised knowledge; must make critical commitments;

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Implications
2. Specialised Knowledge;
 penetrates the root of the matter and gives its possessor an understanding not only how
things are but why they are;
 Obligated to use their knowledge wise and share knowledge only those personally
committed to use it well;

3. Commitment to service;
 stand for something in a public context, to make a public promise to the community;
 commit themselves publicly to use their special knowledge to serve other

4. Autonomy in Decision-Making
 the value of professional s to a community lies precisely in their ability to devise successful
plans for new situation;

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Implications
5. Conflict of Interest;
 Neither new nor avoidable, the important issues how managers managed it;

6. Bad Accounting Practise;

 Audit Committee members often are not independent, they are appointed by senior
management ;
 Demonstrated the need for significant reform in accounting and corporate governance;

7. Failure of Western Capitalism

 The collapsed checks and balances of capitalism is that nobody likes an impersonal story
about monopoly government;
 Western Capitalist is no longer focused on traditional concepts of profit but financially
engineered profit;

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Aftermath
• Shareholders lost USD 74 Billion
• Bankruptcy of Arthur Andersen
• Sarbanes-Oxley Act 2002 (SOX)

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Sarbanes-Oxley Act

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Lesson Learnt
 The Enron scandal is the most significant corporate
collapse in the United States since the failure of many
savings and loan banks during the 1980s.

 This scandal demonstrates the need for significant

reforms in accounting and corporate governance in the
United States, as well as for a close look at the ethical
quality of the culture of business generally and of
business corporations in the United States.

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Lesson Learnt
1. Company and people should make money in the new economy in
the same ways to make money in the old economy - by providing
goods or services that have real value.

2. Financial cleverness is no substitute for a good corporate strategy.

3. The arrogance of corporate executives who claim they are the best
and the brightest, "the most innovative," and who present
themselves as superstars should be a "red flag" for investors,
directors and the public.

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Lesson Learnt … cont
4. Executives who are paid too much can think they are above the
rules and can be tempted to cut ethical corners to retain their wealth
and perquisites.

5. Government regulations and rules need to be updated for the new

economy, not relaxed and eliminated.

6. A responsible and transparent financial planning is very crucial in

ensuring good corporate governance.

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Conclusion
• To be successfully ethical, companies
must go beyond the notion of simple
legal compliance and adopt a value-
based organizational culture.

• A company or an organization is
deemed to be operating morally if it
operates within the law.

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Thank You !

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