Enron's Collapse: Reasons, Corporate Governance Reforms, and Impact

This report provides an overview of the Enron collapse, beginning with a brief description of the company and the factors that led to its downfall. The report highlights the lack of transparency as the primary reason for Enron's collapse, detailing accounting and auditing issues, pension problems, corp...Read More

Running head: CORPORATE GOVERNANCE
Corporate Governance
Name of the Student:
Name of the University:
Author Note:

1CORPORATE GOVERNANCE
Executive Summary:
The assignment is an overview on collapse of Enron. There are two questions that have been
answered in the assignment. The answer to the first question focuses on the main reasons for
the collapse of Enron while the second question provides an answer to necessity of the
reforms in corporate governance after Enron’s collapse. This is followed by a conclusion.
Table of Contents

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Introduction......................................................................................................................................3
1. a. Reason for Collapse of Enron..................................................................................................3
1. b. Corporate Governance Reform after Enron.............................................................................6
Conclusion.......................................................................................................................................7
References........................................................................................................................................7
Introduction:

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The assignment is a discussion on collapse of Enron. The assignment begins with a
brief description of the company along with the mention of the main causes that led to the
collapse of the company. Through the assignment one will be able to find that the lack of
transparency in all its activities was the sole reason for its collapse. There is also a second
part to the assignment that deals that talk about the necessity of corporate governance reform
on a worldwide basis
1. a. Reason for Collapse of Enron
The company Enron formed in the year 1985 due to the merger of Houston Natural
Gas and Internorth and was the first nationwide pipeline for natural gas (Benston &
Hartgaves, 2002). With time, the business focus of the firm shifted from transportation of
regulated natural gas to energy trading markets that were unregulated. The guiding principle
for this was the greed for more money through buying and selling of financial contracts
linked to the value received from energy assets than being the actual owner of the assets.
Enron’s problems arose not because of its energy operations but its other ventures like
the investments in the Internet and high tech communications (Healy & Palepu, 2003). Enron
saw a flourishing future in the internet therefore during late 1990s it purchased the service
providers and online marketers, constructed a communication network based on fiber optic
and thereby created a market that traded communications capacity based on broadband. The
company entered these markets during boom and paid higher prices thereby initiating a heavy
load of debt for financing its purchase. The crash of the internet industry in 2000 dried up
revenues from the investments thereby keeping the debts constant. The company also
recorded for losses in certain foreign operations where it expected to make profit in the new
markets that remained deregulated. However, due to local politics there was a blockage in the
sharp increase in price as anticipated by Enron.

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The company’s response to the problems was the main reason behind Enron’s major
financial scandal. Rather than disclosing its actual condition to the public investors, the
company issued false accounts (Ailon, 2012). Moreover, Enron tried to disguise its bank
loans as derivatives of energy trades for concealing the extent of indebtedness of the
company. However, when the actual figures came to the forefront more than 80% of its
profits vanished thereby resulting in collapse of the company.
Thus, the major issues responsible for Enron’s collapse are as follows:
Accounting and Auditing Issues
The auditor of Enron, Authur Anderson, turned blind eye towards the accounting
practice that was improper but got actively involved in forming a financial structure that was
complex and transactions that led to deception.
Issues Related to Pension
Enron sponsored for its employees a retirement plan where they contributed a portion of their
payment. Therefore, in December 31, 2000, around 62% of assets against the company’s
retirement plan comprised of Enron stocks held by many employees. This led to an increase
in the share prices of about 80$/shares in the year 2001 and a sudden drop to 70 cents in
January 2002. This led the company to wipe out some of the existing retirement plan that led
to questioning of the regulation and laws that governs such plans.
Issues Related to Corporate Governance
The top management of Enron indulged in selling shares of the company worth
billions of dollars but tried to keep its financial problems under wraps so that it does not get
revealed to the public (Crowther & Aras, 2013).

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Issues Related to Securities Analyst
The securities analyst of a company does research and make recommendations for
buying, selling or holding which is followed by most public investors. Enron required the
support of such analyst due to the continuous infusion of funds from the financial markets.
Their decision of selling Enron shares after its sudden fall also remained responsible for its
collapse.
Issues Related to Banking
Enron had banking issues with some of the prominent banking companies like J.P.
Morgam and City group which also contributed partly to its fallout.
Issues Related To Energy Derivatives
Enron involved in dealing with derivative contracts that were based on the oil, gas amd
electricity as a part of its energy business (Pavel & Encontro, 2012). The contracts allowed
the buyers in avoiding or hedging risk involved with increase or decrease of energy prices.
The unregulated markets that Enron traded in without any reporting requirements left scope
for little information about the profitability of the company from the energy derivatives.
Thus, involving in trading of derivates also contributed to the company’s collapse.
1. b. Corporate Governance Reform after Enron
After the Enron Collapse measures reforms in corporate governance took place for
ensuring greater transparency of the existing accounting and auditing firms between the
investors or owners and the management (Kim & Lu, 2013).The reform in the corporate
governance was necessary for ensuring precision in the responsibilities undertaken by the
companies towards the employees, customers, employees, shareholders, business partners
and communities where they operate.

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The meltdown of the company resulted in the initiation of Sarbanes Oxley Act 2002.
The act was move towards right direction but it fell short in addressable of certain critical
reforms that were advocated by corporate accountability group like the enhanced
independence of the board, abolishment of the staggered boards, increased disclosure of
environmental and social issues and staggered board abolishment. However, this was
overcome by the formulation of new rules for strict disclosure practice and corporate
governance put forward by National Stock Exchange (NASDAQ) and Securities Exchange
Commission (SEC). The NASDAQ also put forward that the listed companies should have
board committees and board directors who are independent in addition to the rules imposed
by the Sarbanes-Oxley Act on non audit service and accounting firms.
However, the controlled companies are exempted from the requirement of an
independent board. Such companies are the ones where another company or a group or
individual holds voting power which is more than 50%. Although such controlled companies
relying on exemption must make it a point in disclosing its annual meeting proxy and the
basis of its determination. The exchanges also make sure that the non management directors
meet at executive sessions that are regularly scheduled but without the presence of
management.
Conclusion:
Thus from the discussion in the assignment it is concluded that giant companies like
Enron that had huge profit margins suffered a major collapse due to its unplanned moves,
lack of foresight and transparent means of actions. The meltdown of Enron has thereby
necessitated reform in the corporate governance worldwide ensuring that companies hold an
accountability of the every move that it takes.

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References:
Ailon, G. (2012). The discursive management of financial risk scandals: The case of Wall
Street Journal commentaries on LTCM and Enron. Qualitative Sociology, 35(3), 251-270.
Benston, G.J. & Hartgaves, A.L. (2002), Enron: what happened and what can we learn from
it, Journal of Accounting and Public Policy, 21(2): 105-127

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Crowther, D., & Aras, G. (2013). Introduction. In The Governance of Risk (pp. ix-xii).
Emerald Group Publishing Limited.
Healy, P.M. & Palepu, K.G. (2003). The fall of Enron, Journal of Economic Perspectives,
17(2): 3-26.
Kim, E. H., & Lu, Y. (2013). Corporate governance reforms around the world and cross-
border acquisitions. Journal of Corporate Finance, 22, 236-253.
Pavel, T., & Encontro, M. (2012). The Enron scandal. Chalmers University of Technology
Financial Risk, Goteborg.