Why Did Enron Fail?
Posted: Tuesday, April 29, 2008
by Phil Corrado
In 1985, Houston Natural Gas merged with InterNorth, a Nebraskan pipeline company, to form Enron. Enron, however, incurred massive debt as a result of the merger and the recent deregulation of pipelines, and had to come up with a way to generate profits and cash flow. A young consultant named Jeffrey Skilling helped CEO Kenneth Lay by coming up with a innovative idea known as a "gas bank" in which Enron would by gas from a network of suppliers and sell it to a network of consumers, thus guarantying supply and price. The innovative idea allowed Enron to gain market power and dominate the natural gas market with superior prices and profits.
Enron didn't look anything less than spectacular until the latter part of the year 2000. Around that time, their competitive advantage started to crumble. New market's were having continuing success in their field, which forced Enron to squeeze its profit margins further and further to stay on top. Energy prices started falling in 2001, and Enron stopped distinguishing between good deals and bad deals for the company so long as it would yield a positive NPV, or in other words yield some kind of profit. They tried techniques such as reducing hard assets while increasing paper profits to increase their return on assets, thus making them more appealing to investors. This, however, would only dig them deeper into debt.
Enron's shady profit schemes were revealed in 2001 and led to a lack of trust in the companies earnings. Kenneth Lay retired in February 2001. Afterwards the stock fell to $80, $60, and eventually to $30 per share as senior managers sold their stock to make millions and get out. In October 2001 Enron announced its first quarterly losses in four years, and after that billions of dollars worth of losses began to be revealed. The company had a deal with Dynergy, a rival company, to be bought out, but Dynergy pulled out because of Enron's balance sheets that were way off on their actual debt. The stock closed at 26 cents a share in November, and the company filed for bankruptcy on December 2.
Why did Enron become such a failure? Many of the reasons were exposed as the Justice Department began a criminal investigation of Enron right after they filed for bankruptcy. It was revealed that executives were inflating the stock price through numerous techniques and misleading public statements. They described technological achievements of Enron that did not exist. They boasted about the value and financial performance of the company even when it was not true, and described a network far superior then their competitors even though it was not. All of this was done to inflate the stock price and thus the money they would earn. All of this was being done as executives traded Enron securities inside the company while they had non public information about the business, aka insider trading. Five executives alone were revealed to have made a total of $150 million off of these schemes.
Business ethics cannot be talked about enough, and as Enron grew, poor ethics destroyed them. Employees were regularly rated on a scale of 1 to 5, with 5's being the highest based on the companies policy of respect, integrity, communication, and excellence. The funny thing was, however, that 5's were often fired within six months, and the lower rated employees rose in the company. Employees described the feeling that they were only valued on the basis of how much profit they could produce. Everyone in the organization felt pressured to do deals and post earnings. Enron was able to stay on top for so long because their paper work looked great, even though it was really garbage. As they began to lose their competitive edge, however, and the economy went into a recession, they became more desperate to yield profits and thus dug themselves deeper and deeper into debt. Meanwhile, outsiders became more and more suspicious, and the company built on trust crumbled. Trust is everything to investors, and the loss of this, along with poor business ethics and shady practices, is why Enron ultimately failed as a business.
BIBLIOGRAPHY
- Thomas, William. "The Rise and Fall of Enron". Journal of Online Accountancy. April 2002. April 2008. <http://www.aicpa.org/pubs/jofa/apr2002/thomas.htm>.
- The Associated Press. "The Enron Trials: An Enron Chronology". Today. January 2006. April 2008. http://www.usatoday.com/money/industries/energy/2006-01-23-enron-chronology_x.htm.
3. Thomsen, Linda. "Speech by SEC Staff: Regarding Fraud, Insider Trading Charges Relating to Enron's Broadband Subsidiary". U.S. Securities and exchange Commission. May 2003. April 2008. http://www.sec.gov/news/speech/spch050103lct.htm
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Top-level comments on this article: (3 total)yes, it gave me a great insight into the reason's for Enron's collapse, with excellent references.
wow very interesting insight on the collapse this information will be a big help for my essay on enron.thank you highly appreciated.
crisp and concise..one of the best articles iv read on the topic so far..only required information. :)
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