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Enron Questionable Accounting Leads to Collapse

HomeEnron Questionable Accounting Leads to Collapse
07.08.2019
Category: Essay Samples

Introduction

Despite the fact that Enron was declared bankrupt more than ten years ago, its impact on ethical standards and corporate governments have never faded. Enron rose from an unknown company to become one of the largest energy corporations not only in the United States but also worldwide. It was once ranked on the Fortune 500 as the sixth-largest energy business in the world. The company had assets worth billions of dollars during its heyday. The rise of Enron from a ten billion dollar firm to a sixty billion dollar giant took only sixteen years. However, it took only twenty-four days for the corporation to be declared bankrupt. In August 2000, the company’s stock price peaked at $90. However, revelations of the rampant accounting fraud in the corporation dwindled investor confidence so that by November 2001, Enron stock price was less than $1 (Anon, 2006). This eventually forced the company to file for bankruptcy. Thousands of workers became unemployed while investors lost billions of dollars due to Enron’s collapse. The Enron scandal prompted Congress to pass the Sarbanes-Oxley Act to protect investors’ funds from the negative impacts of corporate greed. Enron’s collapse highlights the fact that ethics and integrity are the cornerstones of the long-term success of any organization.

Ethical Issues

What went wrong at Enron falls into three ethical categories, which include personal, organizational, and systemic ones. People who were involved in the management of the company were vicious and greedy. Enron created several Special Purpose Entities (SPEs) to hide the corporation’s debt burden. SPEs enabled the company to engage in questionable hedging activities while hiding the real economic losses from its income statements. Various employees of the firm earned significant sums of money due to activities of the SPEs. The SPEs enabled the company to undertake transactions that it would not otherwise have been able to complete. Enron’s CFO, Andrew S. Fastow, managed various partnerships that were set up as SPEs. Fastow earned management fees that run into tens of millions of dollars from these SPEs. Chewco SPE, which was managed by Michael Kopper, an employee who reported to Fastow, enabled the company’s workers to earn millions of dollars due to dubious financial transactions (Wilson & Campbell, 2003).

Organizational explanations of ethical failures in Enron seek to determine how group influences made the corporation engage in unethical behaviors. Enron’s employees strived to ensure that they hid the financial problems that the company was facing. Enron’s CEO, Jeffrey Skilling, CFO, the Chief Accounting Officer (CAO), and the Chief Credit Officer (CRO) engaged in questionable activities (Anon, 2006). Their activities made Enron’s employees believe that the firm could take huge risks without jeopardizing its activities.

Systemic explanations also help in defining Enron’s failure. SEC regulations allowed Enron to use companies, such as Arthur Andersen, to provide consulting services and then give audited reports on the financial results of the firms from various consulting activities. This created a conflict of interest. The legal system also allows businesses to hire and pay their own auditors. It provides the auditor with an incentive not to issue unfavorable financial reports on companies that pay them (Wilson & Campbell, 2003).

Enron had a code of conduct that prohibited managers from being involved in other business entities that did business with the corporation. However, these codes of ethics were set aside allowing the company’s CEO to manage various SPEs that did business with Enron. It enabled the CFO and other employees of the firm to have various financial benefits while increasing Enron’s debt burden.

Construction of Possible Options

Partnerships are an efficient means, which businesses use to raise money. Enron used partnerships to create SPEs that enabled it to sell assets and create ‘earnings’ that helped in improving the company’s bottom line. SPEs enabled Enron to exaggerate its earnings due to the sale of assets. Enron should have ensured that it created partnerships that would benefit its stakeholders instead of benefiting a few people in the company. The corporation should have guaranteed that it did not use the partnerships to book earnings before they were realized. This culture caused erosion of the ethical boundaries of the company (Reinstein & Weirich, 2002).

Enron used partnerships that were at “arm’s length.” The company guaranteed the Securities Exchange Commission (SEC) that the partnerships were its subsidiaries. This is due to the fact that classifying partnerships as subsidiaries would have necessitated Enron to provide an in-depth disclosure and use stricter accounting methods. Enron cited a Financial Accounting Standards Board (FASB) rule stating that partnerships were not considered as subsidiaries if 3% of their equity was derived from outside investors, and they had independent management (Reinstein & Weirich, 2002). Enron should have avoided using partnerships to hide its real financial position. It should have simply sought other means of raising funds. This measure may have exposed the company to various risks. However, the risks were short-term. It was wrong for the top management to only consider the short-term impact of the company while neglecting the fact that the partnerships were exposing it to greater risks in the long term.

Technically, Enron’s management was not engaging in any crime when they started participating in shady financial deals. However, it was vital for the management to acknowledge the potential ethical issues before they become legal problems. This would have tackled the roots of the problems that ultimately led to the collapse of the company. Enron’s top management should not have neglected managerial integrity and capacity. This would have enabled them to desist from engaging in activities that were legally permissible but morally questionable. Integrity capacity would have provided Enron with an intangible asset that would have guaranteed future growth and profitability of the company. Most of Enron’s top managers pleaded the Fifth Amendment in congressional hearings, which highlights the fact that they engaged in illegal and immoral activities. It also highlights the impact of individual neglect and organizational integrity capacity of the managers.

Ethical Perspective and Potential Consequences

Poor corporate culture is the major factor that made Enron’s management engage in unethical behavior. Enron’s corporate environment necessitated the management to use normative or prescriptive foundation in the decision-making process. Normative theory strives to determine what people should or should not do. It requires people to acknowledge various ethical alternatives. Events that led to Enron’s ultimate collapse may be explained using two types of normative theories. These include action-centered normative theories and agent-centered normative theories. The theories focus on the values and principles involved in various activities.

Teleology and deontology are the major types of action-centered normative theories. Teleology theories are also referred to as consequentialism. They help in defining ethical decisions based on their outcomes or consequences. The consequences may be direct or indirect. They may also be helpful or harmful. According to the consequentialism theory, managers of Enron and Arthur Anderson acted unethically since the consequences of their actions benefited only a small number of people while simultaneously inflicting harm on a larger number of employees (Ferrell, Ferrell, & Fraedrich, 2015, p. 492-493).

Whistleblowing may have been wrong since it may have resulted in several negative outcomes that may have outweighed the positive consequences. It may have made more than 21,000 employees of the company lose their jobs. Therefore, whistleblowing may not have led to the ‘greater good,’ which is one of the major conditions of consequentialism. This may be linked with the rationalization of Enron’s management that failure to report fraudulent activities taking place helped in safeguarding the wealth of their stakeholders and that of the company. Consequently, it helped in serving both the self-interest of the management (ethical egoism) and the greater good (utilitarianism) (Ferrell et al., 2015, p. 491-492).

Deontology is different from teleology in that it is not based on social utility. It enables to tackle various flaws in utilitarian theories, which make the majority benefit. In addition, deontological theories do not use the outcomes of various actions to determine the moral decision. Instead, deontological theories claim that people have a moral obligation to perform certain activities in line with their social relationships. According to deontological theories, Jeffrey Skilling and Andrew S. Fastow, Enron’s CEO and CFO respectively, had the duty of ensuring that they conduct activities that do not harm the company. However, the CEO, CFO, and other top managers of the corporation continued engaging in fraudulent activities. In so doing, they breached their fiduciary duty to the organization. Arthur Anderson auditors also breached the fiduciary duty that required them to put the public interest first. They certified fraudulent financial statements, being fully knowledgeable of the nature of the fraudulent statements and their impact (Ferrell et al., 2015, p. 492).

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On the other hand, virtue ethics view actions from an agent-centered dimension. It assumes that people have an inherent set of moral principles that should guide their actions. Virtue ethics is significantly different from deontology since it examines the responses to certain situations based on the principles of the individual in question. Those moral theories may be used to justify a breach of duty depending on the principles of the individual. In contemporary organizations, diversity may lead to a collision of moral values. However, lack of moral diversity may be harmful to an organization. It may lead to group thinking, which may have a negative impact on performance and organizational culture. From the Enron case, it is clear that this company strived to develop group thinking. The top management discouraged employees from questioning the activities of the corporation despite the fact that it was evident that it was involved in fraudulent financial activities. According to standard virtue ethics in contemporary society, it is wrong for anyone to engage in fraudulent activities for private gain and public loss. As such, Enron and Arthur Anderson’s managers engaged in activities that were both unethical and illegal. Enron’s managers intentionally participated in fraudulent financial activities whereas Arthur Anderson certified the fraudulent activities as sound ones. Managers of Arthur Anderson also tried to destroy the documents to hide evidence of fraudulent financial activities (Ferrell et al., 2015, p. 492).

The above-mentioned theories have helped in analyzing different moral dimensions and methodologies that may help in defining Enron’s unethical behaviors. However, the theories have certain similarities. On the one hand, teleological theories defined the negative impact of the exposure of Enron’s fraudulent activities with regard to self-interest and the number of people who would be harmed due to the exposure. On the other hand, deontological theories analyzed the fiduciary duty and the moral obligation of Enron’s top managers and Arthur Anderson. Finally, virtue ethics analyzed the obligation of Enron’s managers and Arthur Anderson auditors due to their social relationship. All theories showed that the companies engaged in unethical activities (Ferrell et al., 2015, p. 494).

Decisions

Accounting fraud is a serious unethical behavior. Enron’s top executives engaged in unethical behavior as they lacked a moral background. They were unaware of the impact of their activities on various stakeholders of the company. Certain employees wished that regulatory authorities would have known the unethical behavior that Enron was engaging in. This is despite the fact that the revelations of the unethical practices would have led to the collapse of the company, making thousands of employees lose their livelihood. The executives may have prevented the collapse of the corporation by ensuring that they put the interests of various stakeholders above their desire for more money. This would have necessitated them to develop strong moral values in order to run the company in an ethical manner (Ferrell et al., 2015, p. 494).

Deontological and virtue ethics are critical to prevent situations, which occurred at Enron. It was vital for Enron’s top executives to have the moral character to engage in activities that lead to desirable results. It is apparent that the lack of moral values makes people engage in activities that have undesirable outcomes as evidenced by the Enron case (Ferrell et al., 2015, p. 487).

The use of deontological ethics would have enabled Enron’s top executives to know their moral obligation in order to ensure that they do not harm various stakeholders of the company due to their social activities with these parties. It was the duty of the top executives not to engage in activities that would lead to the collapse of the business since their social relationship with employees demand that they do not harm them. Moreover, social relationships with investors of the company necessitated them to desist from engaging in activities that would jeopardize the investment of shareholders. From a virtue ethics perspective, Enron’s top executives also had to desist from engaging in fraudulent activities for private gain and public loss (Ferrell et al., 2015, p. 494).

Conclusion

Enron’s collapse highlights the impact of involvement in unethical behavior. A few months prior to its collapse, it seemed unthinkable that a company of such magnitude would go bankrupt within days. Despite the fact that Enron had some of the smartest executives in the market, they could not help the ultimate business breakdown. Deontology, teleology, and virtue ethics has helped in explaining the unethical activities of the top executives of the company. If the top executives of the corporation adhered to strong moral values, they would not have engaged in the activities that would have led to its collapse. This would have helped in safeguarding the interests of employees and investors. However, they chose to make millions while ignoring the plight of their employees, investors, and the public. Some of the top executives of the company are currently serving long prison sentences due to their unethical and illegal conduct.

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