Critical Study of Enron with Special Reference to Corporate Governance
Posted: 16 Aug 2009
Date Written: August 15, 2009
Abstract
There were ups and downs in the company in October 2001 when Enron reports its first quarterly loss in four years, $618 million US, and a reduction in shareholder equity of over $1 billion. The Securities and Exchange Commission began an investigation related to investment partnerships led by Fastow. Their investigation later showed that the complex web of partnerships was designed to hide Enron's debt. In November 2001, Enron announces it had overstated its earnings back to 1997 by about $600 million. Its shares plunge to 'junk' status from eighty-five dollars to thirty cents by the end of the month. The devastating results occurred when it was revealed that many of its profits and revenue were the result of deals with special purpose entities. Enron’s failure highlighted uncertainties about credit risk transfer vehicles and underscored two broader issues: Inadequate oversight of financial activities of nonfinancial corporations. Enron was the main dealer, market-maker, and liquidity provider in major segments of the over-the-counter energy derivatives markets and was also active in other derivatives markets, yet these activities were essentially unregulated. It was not required to disclose information either about its risk exposures or about market prices or conditions, nor was it required to set aside prudential capital. Because its trading unit’s capital was not segregated from the parent company’s capital, banks lost confidence in the parent company and withdrew their credit lines, which, in turn, contributed to the collapse of the trading operation. This was due to Ineffective private market discipline, disclosure, corporate governance, and auditing. Enron’s financial difficulties and vulnerabilities, including those associated with its extensive offbalance-sheet transactions, seemed to have gone undetected by analysts, shareholders, and creditors until it was on the brink of bankruptcy. In part, this may have been due to inadequate accounting rules and standards as well as to errors by its auditors, who failed to uncover related-party transactions and did not require Enron to properly consolidate its numerous, complex off-balance-sheet special purpose vehicles in its financial statements. Enron’s collapse raises the issue of how to reinforce directors’ capability and will to challenge questionable dealings by corporate managers. The Enron scandal shows the absolute requirement for boards of directors, executives and everyone else in the business world to accept the moral responsibility for honesty. While maximizing return for shareholders is the foundation of our economic system and provides for generally efficient capitalism, the system can be easily corrupted by the immorality and greed of a few.
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