Enron: the story of a symbolic financial scandal

Résumé du document

The death of Kenneth Lay last spring and the recent 24-year sentence of Jeffrey Skilling have put an end to the darkest story of modern finance: the Enron case. Actually, this firm turned from a success model into a paradigm of all the problems of finance capitalism. With the giving up of the exploitation natural gas in order to focus on becoming a market maker, Enron increased its reported annual revenues from under $10 billion to $139 billion during times ruled by the dot-com bubble and electricity deregulation. But these results hid another reality: accounting fraud, nepotism, overstatement of profits.

The end of Enron Corp. was very sudden: division by 350 of the market value, mass redundancies, pension loss… and after that, Enron became emblematic of all that went wrong in the financial system. This scandal along with the WorldCom case and others has lead to a complete reform of corporate governance via the promulgation of the Sarbanes-Oxley Act.

In this article, we'll try to show how Enron's collapse has been a catalyst for a recasting of the financial regulation. First and foremost we'll have an overview of Enron's activities and explain what made this disaster possible. Then we'll look at the consequences of the scandal for people as well as for corporate governance.

Enron Corporation was formed in 1985 from a merger of Houston Natural Gas and Internorth, two natural gas pipeline companies. Originally, it was involved in the transmission and distribution of electricity and gas, and in the construction of power plants and pipeline throughout the United States. At this time, its reported annual revenues were under $10 billion.

But Enron decided to focus on unregulated energy trading market and became a financial trader and market maker in electricity and in other sectors following a strategy of diversification (it managed more than 30 product including natural gas, petrochemicals, steel, paper, water, plastics, credit derivatives, weather risk management). Moreover, Enron has launched EronOnline, the first web-based transaction site which allows users to buy, sell and trade commodities and finance tools. It can be considered as the first successful e-commerce website.

This transformation was seen as a real success: its reported annual revenues were of $139 billion in 2001 (fifth on the Fortune 500), its stock increased by 56% in 1999 and 87% in 2000, it was named "America's Most Innovative Company" by Fortune magazine for six consecutive years (from 1996 to 2001). Until late 2001, Enron was the model of the new America firm. But behind this success, reality was much grimmer.

Tags: Enron, unregulated energy trading market ,corporate accounting scandal

Extraits

[...] We can dwell on a symbolic rate: the Return on Equity (ROE). It's a measure of corporation profitability that reveals how much profit a company generates with the money shareholders have invested net income / shareholder's equity). A common concern is that firms have to do 15% of ROE whatever the economic conditions are. This requirement has many negative consequences: imitative comportments from the firms, non- productive activities (like buying its own stocks to increase shares), a short-term focus and mostly serious: illegal business like Enron did. [...]

[...] This transformation was seen as a real success: its reported annual revenues were of $139 billion in 2001 (fifth on the Fortune 500), its stock increased by 56% in 1999 and 87% in 2000, it was named "America's Most Innovative Company" by Fortune magazine for six consecutive years (from 1996 to 2001). Until late 2001, Enron was the model of the new America firm. But behind this success, reality was much grimmer. Accounting tricks Enron inflated its profits by using various accounting and reporting tricks to deceive their investors. Four categories of accounting techniques can be identified. Wash and roundtrip trades: this is a transaction made without counterpart. [...]

[...] The goal of the SOX is to restore public confidence in financial reporting and improve the accountability of managers to shareholders. The Act contains a lot of sections so we will only study the most significant ones. The first and more important part of the Act creates the Public Company Accounting Oversight Board (PCAOB) which is charged with regulating independent accounting firms of publicly traded companies. Before the creation of the PCAOB, the audit sector was essentially self- regulated by means of the Public Oversight Board private organization whose members were selected by the audit industry). [...]

[...] But during this time, Enron had earned lots of money by trading electricity in this state. Through this example we can see that the deregulation of natural monopolies could be profitable for a little number of companies but was surely disastrous for consumers. Crony capitalism Electricity deregulation is one example of the political power of Enron. In fact Enron had invested time and money in developing relations with government officials (before they were into office, while they were there and even after they left). [...]

[...] So it suddenly had to repay $650 million in obligations. When Enron could not come up with the money due it filled for Chapter 11 bankruptcy protection on December In January 2002, the Justice Department began criminal investigation. Enron has pulled many people in one's fall: employees with the loss of large part of their retirement plan through their 401(k) and with many layoffs (4,000 immediately), investors with the collapse of the share price from around $95 to under some executives (fired and / or sentenced by court) and the dissolution of a major accounting firm (Arthur Andersen). [...]