Ethical failures and corporate culture in the Enron collapse

Enron & Ethics

Enron Ethical Lessons

The collapse of Enron in 2001 was an incredibly negative event in the business world of the U.S., and it sent shock waves through corporate hallways everywhere. It also sent laid-off employees scurrying for comfort and it sent many stakeholders into the poorhouse as 401K investments melted away like butter in a blast furnace.

And even though there have been numerous corporate meltdowns since then, especially in the past year due to the recession and bank failures, the Enron case stands out as one of the darkest moments in the economic history of the United States. And the one simple word with complex meanings is at the root of Enron's stunning collapse: ethics.

Indeed, the appalling ethical breaches that occurred at Enron before and leading up to its demise are the subjects of countless lectures in universities, books, scholarly articles, and no doubt the lessons of Enron are shared in many HR training sessions as well.

What happened? Basically there were many causes for the Enron collapse, according to Kirk Hanson, executive director of the Markkula Center for Applied Ethics. Santa Clara University sponsored an interview between Hanson and Japanese journalist Atsushi Nakayama (with Nikkei, a major Japanese newspaper). Hanson said for one thing, the conflict of interest between the dual roles place by auditor Arthur Anderson led to a deceitful corporate accounting. For another, members of the Enron board of directors did not pay close attention to what was happening with the "off-books financial entities with which Enron did business" (Hanson, 2002). A third reason that led to the collapse of Enron was the "lack of truthfulness" on the part of management as to the financial health of the company.

But all those reasons notwithstanding, Hanson hits the nail on the head when he explains that "...the culture of Enron was the primary cause of the collapse" (Hanson, 2002).

Introduction

The Congressional Research Service of the United States Congress published a report for members of Congress looking in to the Enron failure (Jickling, 2002) in February 2002, which offered "An Overview of Financial Issues" relative to the Enron collapse. Enron began in 1985 from a merger of Houston Natural Gas and Internorth; soon Enron was the "first nationwide gas pipeline network" in the U.S., Jickling writes. In time, Enron's focus moved away from the regulated transportation of natural gas around the country to "unregulated energy trading markets" (Jickling, CRS 1). The Enron philosophy was working on the notion that there was more money to be earned "buying and selling financial contracts linked to the value of energy assets (and to other economic variables) than in actual ownership of physical assets" (Jickling, CRS-1).

To all intents and purposes, and to most observers from the financial world and Wall Street, the Enron transformation from ownership of energy assets to buying and selling contracts was an "outstanding success," Jickling continues. In fact Enron reported annual revenues that were impressive; in the early 1990s Enron was reporting annual earnings of $10 billion, but by 2000 Enron reported annual earnings of $101 billion.

The "unraveling" of Enron began in August 2001, Jickling explains, when the CEO, Jeffrey Skilling, suddenly quit his post for "undisclosed reasons"; and shortly thereafter, on October 16, 2001, Enron reported its first quarterly loss in four years (Jickling, CRS-1). Things began to spiral downward for Enron; on November 8, 2001, the company announced in a filing with the SEC that it was "restating its earnings since 1997 - reducing them by $586 million" (Jickling, CRS-2). On November 28, the "coup-de-grace" came down on Enron as their bond rating was downgraded to "below-investment-grade, or junk bond status" (Jickling, CRS-2). Shortly thereafter, on December 2, 2001, the giant and successful energy company filed for Chapter 11 bankruptcy.

Looking Deeper into Ethical Standards and Conduct

Craig Edward Johnson is the author of the book Meeting the Ethical Challenges of Leadership: Casting Light on Shadow (Johnson, 2008). Anyone even remotely familiar with the Enron mess knows that there were some shadowy activities within the executive ranks at Enron. But Johnson makes a case that everyone has a "shadow side." On page 4 of his book Johnson notes that psychotherapist Carl Jung was the first social scientist to identify the side of the human personality called the "shadow side." Jung was alluding to and studying the subconscious in this context, and looking into both positive element ("creative," and "the desire for achievement") in the subconscious and the negative, or dark element ("greed, fear, and hatred") (Johnson, p. 4). Other psychologists equate the shadow with "destruction," Johnson writes, but most psychologists agree on this point: "If we want to manage or master the dark forces inside us, we must first acknowledge that they exist" (Johnson, p. 4).

Johnson goes to great lengths to examine the shadow side of executives and leaders in a number of instances, including Jim Jones (People's Temple) who led a mass suicide in Ghana a few years ago. But the focus on Enron is particularly effective in terms of a reader attempting to understand what went wrong in the minds of those who committed the illegal and contemptible actions that led to Enron's downslide and eventual demise. The more power we have, Johnson goes on, "...the more likely others are to comply with our wishes" (Johnson, p. 7). The author discusses the "five power bases" in an attempt to explain how power can become corrupted.

Coercive power" is a system based on "penalties or punishments" like salary reductions, suspensions of students in high school or college, "physical force" or "embargoes against national enemies" (Johnson, p. 7). "Reward power" comes in the form of praise, cooperation, trust, "bonuses, health insurance" or grades, while "legitimate power" comes with the position, not the person (examples include judges, cops, parents and supervisors) (Johnson, p. 7). "Expert power" is based on the knowledge of the individual, the skill level, certification and education of the person, Johnson continues on page 7. And the fifth kind of power is "referent (role model) power," which rests "on the admiration one person has for another" (Johnson, p. 7). Johnson explains that leaders most often draw on more than one power source, and in the case of Enron one can certainly deduce that "coercive power" and "reward power" played significant roles.

Meantime, Johnson (p. 29) asserts that Enron's executives "cast shadows" in several ways, in terms of ethics. Those executives certainly exhibited an "abuse of power," and the story of their abuse of ethics can be capsulated through the activities of Jeffrey Skilling (Lay's replacement who didn't stay long). Skilling "wielded power ruthlessly," Johnson explains. Skilling frequently intimidated subordinates while Lay simply "demoted" underlings who disagreed with him. Another shadow cast by Enron leaders vis-a-vis ethics was through "excess privilege"; the executives simply spent wildly with money that truthfully did not belong to them. Lay told a friend, "I don't want to be rich; I want to be world-class rich" (Johnson, p. 29). Even as the 401K accounts of their employees were being "wiped out" Lay and his colleagues were unloading their shares and profiting by multiple millions of dollars.

A third "shadow" that was cast by Enron executives was "mismanaged information" - which Johnson (p. 29) says is a process that deceived the public and the board members. They set up partnerships "off-the-books" which is an illegal way to manage corporate books. A fourth shadow mentioned by Johnson was "Inconsistent Treatment of Internal and External Constituencies"; this breach of the company's own code of ethics amounted to Lay and his executive colleagues giving five hundred Enron officials "retention bonuses" of over $55 million while lower-level employees were being laid off with tiny little severance paychecks (Johnson, p. 29). The fifth breach of ethics from Johnson's perspective was "Misplaced and Broken Loyalties" which occurred because Lay and his cohorts placed loyalty within themselves and were thoroughly disloyal to stockholders, business partners, local communities, ratepayers and even foreign governments.

Author Johnson, who is professor of leadership studies (Ph.D) at the University of Denver and director of the Doctor of Management program at George Fox University, also lists "irresponsibility" as one of the shadows cast by Enron's top people. The last shadow needs no further enumeration. The Enron executives who led their company down the path to darkness and scandal had ethical lapses, for sure, but they also had "warped minds," Johnson asserts on page 37 of his book. He plucks "warped minds" from a survey of corporate psychologists - found in USA Today - a survey that concluded "insatiable desires of out-of-control CEOs have less to do with money and more to do with the following: "poor self-image" (they try to make up for feelings of "inadequacy" by constructing "monuments to themselves"); "The 'I Deserve it' Myth" (executives believe sometimes they deserve all the credit); "Unchecked Fantasies" (they can live out their fantasy by spending and exerting power with unchecked enthusiasm); "Society's Blessing" (as long as they produce results, some executives believe the public allows they to do whatever they want to do); "Competitiveness Gone Awry" (out of control egos strive to out-do their competition in a fanatical way); "Lonesome Soldier Syndrome" (expensive things take the place of friends; high-powered executives find it hard to make friends because they fear the "friend" just wants to be close to power); "Boredom" (at the top of their games, many executives invent "new challenges" that end up being illegal); and "Power Corrupts" (some CEOs "lose the sense of what is rightfully theirs and what isn't...treating others like peasants and claiming all that they see" (Johnson, p 37).

The accounting scandals at Enron and ethical attitudes in general are the subject of an article in Social Science Quarterly (Conroy, et al., 2006) titled "Changing Ethical Attitudes: The Case of the Enron and ImClone Scandals." In other words, how did the Enron disaster affect the way Americans feel about ethics? The authors note at the outset of the piece that while "ethical attitudes do appear to change over time," previous research has not been able to exactly identify the "stimulus for such change" (Conroy, p. 396). When there are legal consequences associated with a corporate scandal, and it becomes a major media event night after night on television and in the newspapers, society also suffers, as society did with the Enron collapse, Conroy explains. As to the American public's response - in ethical terms - to Enron's messy aftermath, the degree to which the public rejected the corruption was "...driven by the realization that such actions cause significant harm to innocents" (Conroy, p. 397).

The article presents surveys of public attitudes tapped into during and following the Enron scandal. The Pew Research Center tested public opinion, according to Conroy, in December 2001, and asked Americans if they had been following news of the Enron collapse "very closely" or "fairly closely." The response was that 34% in December 2001 admitted to listening "very closely" or "fairly closely" but by January 2002 that percentage went up to 43%; in February, 2002, the news media was swarming all over the Enron story and as a result 61% of those polled admitted to following the scandal.

Japanese reporter Atsushi Nakayama asked the executive director of the Markkula Center for Applied Ethics Kirk Hanson, who was referenced earlier in this paper, what he meant when he claimed that the Enron debacle will become the "morality play of the new economy" (Hanson, 2002). Hansen replied that the "most important ethics lessons" to be learned from Enron are the following five lessons: One, money is to be made the old fashioned way - by "providing goods or services that have real value"; two, cleverness in financial dealings is not a substitute for "a good corporate strategy"; three, investors should see a "red flag" whenever corporate executives exhibit "arrogance" and present themselves as the "best and brightest"; four, paying executives too much money makes them believe that they are above the rules and they can make up their own ethical standards; and five, government should not relax rules but rather government should regulate and update rules for the "new economy."

Hanson's belief that additional regulations were needed came to fruition thanks to the U.S. Congress in 2002. Called the Sarbanes-Oxley Act of 2002 (SOX) was put into law due not only to the Enron collapse, but also as a result of the scandals at WorldCom, Peregrine Systems, Tyco International and Adelphia. These disasters all contributed to the need for Congress to beef up the credibility and the framework of publicly held companies through legislation.

Democrat Senator Paul Sarbanes of Maryland along with Republican Representative Michael G. Oxley of Ohio authored the bipartisan SOX law. The bill, signed into law by President George W. Bush on July 30, 2002, provides new or greatly enhanced standards for all U.S. public companies in terms of their boards, their management, and the public accounting firms that are linked to their management and services, according to www.soxlaw.com.Thereare 11 titles to the act, and the PDF that provides the entire specifics of the act is 66 pages long. It was obviously the work of lawyers meticulously working through many legal and corporate issues, trying to come up with legislation that would assure the American public that something positive was being done to prevent further Enron-like financial scandals.

The 11 titles embrace tough corporate board responsibilities, which can lead to criminal penalties. The titles also established a new quasi-public agency, called the Public Company Accounting oversight Board (PCAOB) which has the job now of regulating, inspecting and handling oversight for accounting firms, the www.sox.law.comsiteexplains. When Enron crashed, one of the most glaring trouble spots in that review was the accounting firms that seemed to go along with the corruption and lawless manipulating of money, hence the PCAOB.

The benefits of the SOX bill could definitely be helpful to the management of corporations because for one reason, investors will have more faith that their money will be used wisely, and the public that makes purchases from that corporation will have a feeling that it is conducting its business within the law. SOX will also improve corporate management because any executive going into a corporate position now knows that he or she is under specific guidelines that call for still penalties if those guidelines are broken or breached in any way.

Conclusion / Recommendation:

The idea that corporate management needed strict federal laws to force it to live up to legitimate guidelines is a reflection on the fact that some companies have been out of control with huge amounts of power and money (Enron, WorldCom, et al.). Beyond Enron, we can look around today and see powerful banks and lending firms abusing the public once again, by taking government "bail-out" money (taxpayer money) and then handing out multi-million dollar bonuses to top executives. One wonders if there will ever been enough regulation of the corporate and banking world to keep executives from deceiving their stakeholders and the American public. Too much regulation has proven to be stifling, and too little regulation leads to the Enron scandal and the current meltdown of Wall Street. Is there a middle ground?