Why Enron Failed and How Risk Management Might Have Saved it

Enron and Risk Management Enron is one company that did not practice good risk management following its reinvention of itself as a financial/energy trading giant. This paper will describe what happened to Enron and show how its problems could have been avoided using sound risk management regarding transparency and accountability. Before Ken Lay gave Enron over to the new, "innovative" leaders Jeff Skilling and Andy Fastow, it had been a basic energy provider -- transparent and accountable.

It had nothing to hide because it was doing nothing wrong and therefore it did not need opaque accounting practices. All that changed when Skilling came aboard and opened Lay's eyes to the "possibilities" afforded by mark-to-market accounting. Enron's management team, led by Ken Lay, Jeff Skilling, and Andy Fastow, was a dynamic, powerful force, with a strategy that few understood but which, according to the books, appeared to be making everyone money hand over fist.

The problem was that there was no transparency or accountability in the risk management strategy. Enron was changing as an organization, essentially moving from energy provider to finance, and leadership faced new ethical challenges as a result: how should it portray itself to investors and to employees? Enron's leaders (Lay, Skilling, Fastow) decided to embark on a Ponzi-like scheme which was misleading for investors and employees. Elkind and McLean (2013), for example, analyzed cash-flows and saw that Enron's "financials didn't make sense" (p. 127).

Skilling saw the same thing; his apprentice, Andy Fastow, Enron's CFO, was given the job of covering up these financials as well as the fact that Enron was "$30 billion in debt" (Elkind, McLean, 2013, p. 128). Here was a clear case of fabricating the financials in order to appear clean -- and Skilling and Fastow excelled at appearing fresh and clean; in fact, they were well-known for being "likeable" guys.

Yet, the problem of likeability at Enron was that the definition was not rooted in qualities and attributes that are used to give the term meaning. "Likeability" at Enron had to do with "getting ahead," being the "life of the party," making money, and deceiving anyone and everyone who posed a possible threat to the financial scheme. This was not risk management. This was bad management. Lay should have intervened and terminated Fastow, but Skilling defended Fastow's behavior by explaining it as unorthodox but innovative.

Had Lay insisted on transparency and accountability and listened to those who brought up misgivings about the accounting practices of Fastow, he might have staved off disaster. But Lay feared what the company would look like were it to really come clean. Worse, he feared it could all collapse. Skilling and Fastow prided themselves on their ability to hide and manipulate data rather than on their ability to be transparent, which essentially affected everyone who came into contact with them.

Their policies hurt employees, whose retirement was tied up in the company and lost investors millions. By hiding the reality, Enron ventured into full-blown, outright fraud. By "stashing its debt" in "structure finance" -- hundreds of shell companies used to hide losses -- Enron attempted to fool investors and keep its stock price up (Eichenwald, 2005).

Skilling, Lay and the board knew that they could throw Fastow under the bus should the need arise, which just goes to show how unaccountable they all were: they held no sense of accountability to shareholders or to the public or to their employees. They were more interested in their own immediate advantages. Risk management is not about saving face but about avoiding pitfalls that will cause embarrassment, scandal, and ruin.

Lay should have insisted that operations be defined more clearly, that Enron cease trying to rig the market, and that everyone's cards be laid on the table so that all could see just what was going on. Because the board and Lay were unwilling to deal with reality, they lost their hold on reality. The reality for Enron was that the company was on the verge of total collapse, because its leaders were operating without a "moral compass" (Elkind, McLean, 2013).

It had not adopted a just culture and its workplace environment was undermined by a reckless spirit of unethical practices guided by Fastow. Rather than trusting the fate of the company to the hands of Fastow and then letting Skilling off the hook with simplistic explanations for the huge "profits" that Enron was making (they weren't actually making them, it only looked that way thanks to the unethical accounting practices), Lay.