The Rise and Fall of Enron: Ethical Issues

The Rise and Fall of Enron Ethical Issues

Before its collapse in December 2001, Enron was ranked by Fortune as the 7th largest company in the United States and was viewed as one of the most innovative companies in the world. It initially started as a gas and utility company and grew quickly through innovative strategies to a leading trader in energy supply, steel, paper pulp and fiber optic bandwidth.

BACKGROUND

Enron’s rapid expansion required huge investment in assets which was mainly financed through debt. This debt was hidden by means of establishing special partnerships entities to effectively remove any negative effects to the company which may be evident to the stockholders. The company also developed complex financial instruments like futures and swaps which it traded in the financial markets and generated huge profits.

Enron had hired an auditing firm, Arthur Andersen, as the company’s auditors. This firm played a key role towards the eventual collapse of Enron. It was complicit in the use of manipulative and creative accounting policies that were meant to portray the company in good light to investors despite its ailing financial situation.

ANTECEDENTS TO THE CRISIS

An article in the Fortune magazine in March 2001 put doubts on the sources of earnings of the company, questioning the valuation of its stock, which was 55 times of their earnings. The article also reported huge debt, complex transactions and inconsistent cash flow problems. A publicly rude reply to a query regarding the financial reporting by the CEO of the company in April 2001 may have triggered the doubts about the company’s well being and led investors to question the ethics in the corporate governance in the company. Another hint to the company’s ethical malpractices occurred when later that year the CEO resigned and cited the falling performance of the company’s stock at the stock market as one of the reasons for his departure.

The above events may have been the first that made doubtful the corporate well being of the company. However, an investigation to the company’s accounting policies and investment operations by the Securities and Exchange Commission in October 2001may have made it plainly clear that there were ethical malpractices in the company. These events made it evident to parties outside the company that its affairs were not as rosy as they seemed and that there were ethical improprieties in the way the company conducted its operations.

THE ETHICAL DILEMMAS

Enron used the special enterprise entities as a way of hiding its huge amounts of debt from its investors. It is in the best ethical practices to fully disclose the financial situation as correctly as possible to investors even if it reflects a bad financial position. The management of Enron acted in conflict of the financial disclosure standards by deliberately hiding information from investors through the use of the special partnerships.

The use of complex and creative accounting methods by Enron’s management was in conflict of the investor wealth maximization principle. These accounting methods were used to keep the real financial position of the company from investors. This is a conflict since it is expected that a company’s management should not involve itself in activities that may harm the stockholders.

The company’s auditors put their actions in conflict with the expected standards that require them to provide an unbiased opinion regarding the completeness and correctness of the company’s financial statements. By hiding the actual details of the true financial position of the company, the auditing firm actions conflicted with the internationally accepted auditing standard and norms.

The management of the company was more concerned about its pay packages rather than the protection of investors’ funds in the company. Their actions were geared towards earning higher pay and bonuses. This is in conflict with the business expectation that the actions of the management and employees should always be towards the protection and growth of investors’ investments.

Investment analysts continued recommending investment in the securities of the company despite their lack of knowledge about the company’s financial well being. These acts are in conflict with the values that are expected from financial analysts; to give well informed advice on the financial prospects of investment to potential investors.

OUTCOMES

As a result of the financial collapse of Enron, many investors lost their investments. This was the greatest short term effect of the collapse. The fall of the company also resulted in congressional hearing and the subsequent passage of a law that tries to prevent such an occurrence in the future. The Securities and Exchange Commission also developed a new governance policy aimed at protection of investors. It deals with management structures and accounting policies for listed firms.

The chairman and the former CEO of the company, among other employees of the company were tried for fraud, money laundering, and conspiracy among other crimes and were sentenced to different jail terms. The chairman died before he could be convicted.

The reputation of the auditing firm, Arthur Andersen, was badly damaged as a result of the collapse of Enron. It was barred from auditing any public company and lost many of its clients as a result. The firm was later closed and most of its employees lost their jobs.