Corporate Governance @ Finance - Enron Corporation, USA
A
derivative is an instrument whose value is “derived” from the underlying value
of something else, such as a stock, a bond, or in the case of Enron’s
derivatives, a unit of electricity. Derivatives are useful because they enable
an investor to hedge against a decline in value. Example: Enron, USA could enter a contract with a purchaser of
electricity, such as a utility, guaranteeing that the purchaser would pay a
certain price for a certain amount of electricity at a certain date in the future.
Whistle
blowers are people who reveal generally harmful or very unfair activities,
often of which they have become aware because of their employment position
within their employer's organization and, or their access to otherwise
unavailable communications from within the organization.
SPE-
Acronym for Special Purpose Entities. SPE’s reflect a common financing
technique for companies. Companies can cut their risk by moving assets into
separate partnerships that can be sold to outside investors. In Enron’s case,
assets that were losing money were sold to partnerships. Enron listed the sales
of these assets as earnings. However, to be legitimate, accounting rules
require that an SPE be legally isolated from the company that created it.
In
Enron’s case this was not true. The SPE’s relied upon Enron managers for
leadership and Enron stock for capital. When outside auditors told Enron to
treat some of the 4,000 SPE’s it had created as part of Enron, the company had
to take the $1-billion charge against earnings.
Energy
companies lobbied congress in the 1980s for deregulation of the energy business.
Throughout all of this, Enron and its key members were making political
contributions to the white house and congress. Kenneth Lay donated $100,000 to
President Bush in 2000, and in 2001 Bush invited Lay to become an advisor to
his transition team. In the year 2000, Kenneth Lay met three times with Dick
Cheney to discuss energy policy review. When the review was published in May
2001, it was very favorable to the Enron and the energy sector. He quit as CEO in February 2001.Energy policy
was changed and Washington lifted controls on who could produce energy and how
it was sold
By
the late 1990s Enron controlled some 25 percent of all electricity and natural
gas contracts traded worldwide and were considered the best in the business.
This success led Enron to act as a market middleman for other commodities as
diverse as lumber and Internet bandwidth (the rate at
which data can be delivered over the Internet).
Jeff
Skilling took and aggressive approach to expand Enron by trading futures in gas
contracts. He was Enron's chief executive in the first half of 2001. Since
joining the company in 1990, Skilling helped transform Enron from a natural-gas
pipeline company into an energy-trading powerhouse.
Under
Skilling’s new plan Enron bet against future movements in the price of
gas-generated energy. “Enron bought and sold tomorrow’s gas at a fixed price
today”. With every trade, Enron took a cut for transaction costs
Using
the internet to promote trading, Enron became the most successful player in the
futures game; 90% of Enron’s income came from trades. Enron took advantage of
the dot.com boom and traded internet bandwidth. The value of Enron’s online
transactions was huge ($880 billion). The problem was Enron wasn’t making money
on many of their online trades because they made the market very efficient.
Enron began tweaking the numbers in their financial statements with accounting
techniques to hide their losses
Jeffrey
Skilling, Enron's chief executive in the first half of 2001. Since joining the
company in 1990, Skilling helped transform Enron from a natural-gas pipeline
company into an energy-trading powerhouse.
The company had a strong code of corporate ethics, written up
in a 61-page booklet and centring on Enron’s guiding principles of RICE
(Respect, Integrity, Communication,
Excellence). These were prominently displayed on
wall-posters, key rings, mouse
mats and T-shirts and all employees had to sign
a certificate of compliance. In
practice, however, the unrelenting emphasis on
profit growth and individual
initiative tipped the culture from one that
awarded aggressive strategy to one
that increasingly relied on unethical
corner-cutting. The corporate ethics were
in place, but they were rarely policed and
frequently ignored if they stood in
the way of the more ‘important’ business. Enron
employees were easily identifiable by their swagger. The rewards for those who
performed well were high: bonus day at Enron became known in the city as car
day.
Enron
created partnerships(SPE), and then passed the assets (losses) to these
partnerships which eliminated the losses from their balance sheets. Andrew
Fastow (Chief Finance Officer) created the partnerships. Condor and Raptor were
two major partnerships named after characters of Starwars and also from Jurasik
park , a science fiction film(1993. By the time
Enron collapsed, it had created as many as 3,000 SPE’s. Enron typically used
the Equity Method of accounting for SPE’s meaning they simply added Enron’s
proportional share in the earnings of each SPE in a single line item on its
income statement without disclosing corresponding balance sheet, cash flow and
other considerations.
Between
January and August 2001 both Skilling and Fastow sold off about $20 million in
Enron stock. They resigned after the close of markets on Aug. 14 2001. On Aug
14, 2001 when Jeff Skilling resigned,
Kenneth Lay became CEO once again. Stock prices began to fall, as investors
were uncertain about the company’s stability.
This started a chain reaction: Enron had hedged against its own stock,
so as long as the stock price was declining, it could not recover its
losses.
Kenneth
Lay , the former CEO of Enron, helped start the company. Enron extended to him
$7.5 million revolving credit line, which he reportedly used and repaid with
Enron stock 15 times within a period of just several months.
When Skilling suddenly quit on Aug. 14, Lay called an
all-employees meeting two days later and asked for comments from workers
beforehand. That's when Watkins finally sat down to write a one-page anonymous
letter on her computer at work. She dropped it in the box at headquarters the
next day.
Kenneth
Lay returned as CEO in August 2001 until
he resigned on Jan. 23, 2002. On Aug. 20 he
exercised options to buy 25,000 shares at $20.78 a share. The next day he
exercised an additional 68,000 shares at $21.56. On both days, the stock closed
around $36, which meant Lay netted nearly $1.5 million before taxes. He
continued to be a huge booster for the stock for another month. As late as
Sept. 26, Lay would try to reassure Enron employees that "our financial
liquidity has never been stronger."
Sherron
Watkins said Lay was "duped" by top executives. The Enron
“Whistleblower”, Sherron Watkins, noticed the fuzzy accounting that had been
used in relationship to the Condor and Raptor partnerships and wrote a letter
to Kenneth Lay and Arthur Anderson warning him that the Enron was unstable. She sent Lay a detailed memo the day after Skilling's
resignation was announced but kept it anonymous until after the company's
all-employee meeting on Aug. 16.
On Oct. 15 Vinson & Elkins, the law firm, issued a nine-page report stating that
Andersen approved of the Condor and Raptor deals and that Enron had done
nothing wrong. On Oct. 16 the company announced a $618 million third-quarter
loss and a $1.2 billion reduction in shareholder equity. On Oct. 31 the SEC
opened a formal inquiry into Enron
December
2001, Enron filed for chapter 11 bankruptcy as it’s share price had collapsed
from about $95 in Jan 2001 to under $1. Companies and large firms that are
facing severe and unmanageable debt may seek to file chapter 11 bankruptcy,
which allows them to re-organize so they can either continue their day-to-day
operations or go out of business entirely. Under chapter 11, a company is
protected from damaging lawsuits and other negative measures, but in exchange
the company is usually required to have all its major business decisions
approved by the bankruptcy court.
Questions
1. Define
a. Derivatives
b. Special Purpose Entity
c. Whistleblower
d. Code of Ethics
e. Insider Trading
f. Window Dressing
2. Name the Stakeholders in the business of Enron, USA
3. Spot the incidences that you feel had conflict of Interest in relationship of stakeholders with reasons
References
1. https://www.econcrises.org/2016/12/07/enron-corporation-2001/
2. https://edition.cnn.com/ALLPOLITICS/time/2002/01/28/know.html
4. https://www.personneltoday.com/hr/did-hr-fuel-the-demise-of-enron/
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