Corporate Governance case study - Enron

 Corporate Governance

  • corporate governance is a system of policies and procedures that direct how a firm is operated.
  •  Governance checkpoints include adequate transparency and accountability, supervision of senior leaders and risk management policies, deploying reasonable diversity, ensuring board member independence, and representation of required skillsets for the company in question

Enron

  • The company would routinely purchase gas from various vendors and sell it to a network of customers at predetermined prices. 
  • To cover its risk exposure to gas prices, Enron created a new market for energy derivatives. As a result, Fortune magazine named Enron “America’s Most Innovative Company” from 1995 through 2000. At the end of the year 2000, Enron had 20,000 employees and nearly $101 billion in recorded revenue.
  • Reality caught up with Enron in December 2001, which is when it became the largest bankruptcy in U.S. history.
  •  The various failures are listed as follows:
    • Agency risk. Enron’s senior management put self-interest above other stakeholders. 
    • Lack of board oversight. Ken Law was both the chairman of the board and the CEO. The board also allowed Enron’s  (CFO) to operate his own private equity firm as a side business. 
    • Accounting fraud. Enron used special purpose vehicles (SPVs) and other creative accounting tricks to commit outright fraud. It would create fake sales and then move any resulting losses to an SPV to hide them from public scrutiny
    • Revenue recognition practices. The company would routinely construct a physical asset and recognize it as revenue as soon as production was complete (regardless of whether an actual sale occurred). Any losses when an actual sale happened were buried in an off-balance sheet SPV. 
    • Auditor failure. Arthur Anderson was one of the big five accounting firms. It was the sole auditor for Enron. 
  • Enron’s failure was the fuel needed to bring Sarbanes-Oxley (SOX) to life in 2002. This law requires accountability for key corporate officers relative to the reliability of reported financial statements. It also created the Public Company Accounting Oversight Board (PCAOB), which holistically promotes a high standard for corporate governance

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