Analysis of Enron’s Unethical Entrepreneurial Practices Leading to its Collapse

Seminar Paper, 2018

13 Pages, Grade: 1




Enron – an Admired Company

The Rise and fall of Enron

Failure of Internal and External Check Balances

Continuous Auditing

The Failure of the Board of Directors

Breaches of Accounting and Ethical Conduct

Lessons Learnt from the Enron Case

Alternative Evaluation

Conclusion and Recommendations



Before 2000, Enron was famous in the business world. It was known as an innovative company, a technological powerhouse, and a major corporation with no fear. It was founded in 1985 as a natural gas pipeline company. The company emerged as a pioneer in the deregulated energy market rapidly, and within fifteen years, the enterprise had built various businesses in international energy-asset construction and energy trading (Gore and Murthy, 2011, p.7). From1990 to1998, Enron’s stocks appreciated by three hundred and eleven percent; however, the value of the stocks began to increase rapidly such that, by the end of 2000, Enron stocks were priced at eighty-three dollars, with a market capitalization in excess of sixty billion dollars. The company was rated in the Fortune magazine surveys of the most admired companies as the most innovative company. It, however, surprised many people with its spectacular fall within a year, and its image damaged forever. Its stocks price plummeted almost to zero (Healy & Palepu 2003, p. 3).

Enron – an Admired Company

The Enron Company was started in the early 1980s as an energy distribution company. After deregulation of the sector in mid-1990s, Enron focused on selling energy from the producers rather than making its production (Gore & Murthy 2011, p. 8). The company had a rapid exponential expansion, and the company became very successful. It started to invest in other industries mainly in energy. By the beginning of the millennium, Enron was a diversified, and it appeared indestructible Corporation (Cunningham & Harris 2006, p. 27). However, cracks started forming on the company’s foundation. Apparently, in order to sustain the rapid growth, the enterprise had to borrow money. Since being seen as having excess debts would impact negatively on the price of their stocks, the company kept its debts hidden in partner enterprises. These entities were acquired or started, with the singular mission of hiding the truth about the exposure of the mother company. So the company appeared to stock-investors and the general public as a financially healthy company, and consequently, got voted as the most admired company for six consecutive years.

The Rise and fall of Enron

The rise and fall of Enron can be attributed to several accounting factors. When Andy Fastow was hired as the financial Executive officer at Enron, he hired and developed an accounting staff who, through the use of accounting loopholes and the creation of special purpose entities, coupled with poor financial reporting, managed to hide billions of dollars in debt from unsuccessful projects and deals. For many years, the accounting staffs were able to mislead both the board of directors and audit committee on the high-risk accounting practices (Cunningham & Harris 2006, p. 29). They also pressurized the Certified Public accounting company to ignore the malpractices. These practices managed to help the company maintain a prosperous image to the investing public. The company also encouraged their employees not only to invest in the company’s stock but to put the pension fund in Enron stocks.

Enron operated through a complex business model which involved many products and physical assets that also crossed borders. The sheer size of the enterprise operations may have overwhelmed the accounting systems. Consequently, some unscrupulous executives took advantage of Enron’s accounting limitations in the management of the balance sheet and the earnings to falsely present a healthy picture of the company’s performance (Gore & Murthy, 2011, p. 10). There were two controversial issues. The company business model involved complex long-term contracts. The accounting rules demanded that the company use the present value framework to keep records of these transactions. Hence, the management was expected to make forecasts of future earnings (Healy & Palepu 2003, p. 8). The accounting model, known as mark-to-market accounting, was central to Enron’s income recognition and the management ended up making forecast of prices and interests well into the future. The second factor was that Enron relied heavily on structured finance transactions which called for the setting up of what was called special purpose entities the transactions offered a shared ownership of some particular cash flows and risks with outside lenders and investors. The transactions followed mechanical conventions to maintain records, a practice that created a divergence between what the actual and the accounting numbers (Healy & Palepu 2003, p. 9). The net effect was that Enron managed to present a picture that was far removed from the actual company earnings and, consequently hoodwinked investors to buy their stocks.

Failure of Internal and External Check Balances

The company used Special Purpose Entities (SPEs), either to manage the risks, or to fund specific assets. The special purpose entities are shell companies created by a sponsoring company, but funded by outside debt financiers and equity investors. The special entity, in accounting practices, is supposed to be separate from the sponsoring company. The rules demand that an independent third-party shoulder a substantive equity stake at risk in the entity. The risk was supposed to be three percent of total debt and equity (Gore & Murthy, 2011, p. 19). The third party was also expected to have controlling shareholding of more than fifty percent of the special purpose entity. Enron had hundreds of these special purpose entities which it used to fund its expansion and fund the purchase of the forward contracts it signed with gas producers to supply gas under long-term contracts. These entities were designed to aid in the dubious financial reporting objectives. Consequently, Enron ended up understating its liabilities and overstating the equity and earnings, clearly in violation of the accounting principles, but with the effect of portraying the company as thriving financially. The market response when the accounting irregularities were made public was to halve the price of Enron stocks and increase their borrowing costs. Suffice to say, the practices that allowed the company to succeed were the same that led to the company’s fall. Enron’s attempt to avoid bankruptcy by being bought by a smaller competitor fell apart when the stocks were downgraded to junk status (Healy & Palepu 2003, p. 12).


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Analysis of Enron’s Unethical Entrepreneurial Practices Leading to its Collapse
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Caroline Mutuku (Author), 2018, Analysis of Enron’s Unethical Entrepreneurial Practices Leading to its Collapse, Munich, GRIN Verlag,


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