This essay discusses the scandal of Enron Corporation. In the first part, main reasons having led to its sudden and scandalous downfall will be explained; in particular accounting and business practices as well as corporate governance will be outlined. Subsequently, in the second part, important parties having been involved will be shown; notably the role of the auditing company Arthur Andersen and their conduct will be analyzed. In a final step, aftermaths for Enron, Arthur Andersen and further involved actors will be outlined. A special focus will be on consequences for the accounting world and how regulations have been changed in order to prevent future accounting violations.
Table of contents
1. Introduction
2. The Enron scandal
2.1 Business and accounting practices
2.2 Corporate governance
2.3 Involved parties
2.4 The downfall of Enron
3. Arthur Andersen as auditor
4. Prevention of the scandal
5. Consequences
5.1 Enron and Andersen
5.2 Sarbanes-Oxley Act
6. Conclusion
7. References
Objectives and Topics
This essay examines the collapse of the Enron Corporation, analyzing the systemic failures in accounting practices, corporate governance, and the role of third-party auditors that led to one of the largest bankruptcies in U.S. history.
- Analysis of questionable accounting methods such as mark-to-market and Special Purpose Entities (SPEs).
- Evaluation of the board of directors and internal corporate culture.
- Examination of the complicity of Arthur Andersen and other involved parties.
- Discussion of the regulatory aftermath and the implementation of the Sarbanes-Oxley Act.
Excerpt from the Book
2.1 Business and accounting practices
On the one hand, Enron established ‘special purpose entities’ (SPE) serving different kinds of needs. The main idea behind those entities was to dispose less productive assets and debt of Enron’s balance sheet; thereby, record less liabilities, higher profits and create cash flows as well as to increase the stock’s value (Johnstone, Gramling & Rittenberg, 2014, pp. 42-43).
Even though a whole network of SPEs was established – and evidently also controlled, by Enron, they did not have to appear on its balance sheet due to the simple fact that there was no accounting standard requiring consolidation in 2001. A company was said to be an independent entity if at least three percent of the capital was provided by external investors. Enron created a group named ‘Friends of Enron’ consisting of several investors, chiefly close related to Enron’s executive employees. For example, a friend of CFO Fastow’s family was one Friend of Enron. When a new entity was to be established one of the Friends provided the necessary three percent outside capital. Later on, Fastow even created a private equity fund for similar purposes (McLean & Elkind, 2003, pp. 166; 197).
By using special purpose entities, such as Chewco, Whitewing or LJM2, naming the most prominent ones, Enron took advantage of accounting rules (Beasley et al., 2009, 79-82). Two examples of how Enron availed itself of the SPEs will be explained in the following.
Firstly, Enron used the method of securitization to a great extent. Securitization is a way to receive future cash flows immediately. If, for example, Enron owns an asset which is supposed to generate cash flows each month or each year, they would sell these future cash flows (at a discount) to special purpose entities or other investors. In return, Enron receives money it would have gotten in the future today (Conerly, 2008). The advantage of securitization is that the company will get a lot of cash on a short-term basis; the disadvantage is that debt has not disappeared and is still to be repaid.
Summary of Chapters
1. Introduction: This chapter provides the background of Enron’s rise and states the objective of the paper to analyze the causes and consequences of its scandal.
2. The Enron scandal: This section details the accounting manipulations, failures in corporate governance, and the key actors involved in the company's downfall.
3. Arthur Andersen as auditor: This chapter analyzes the role of the auditing firm, explaining how they facilitated the scandal by exploiting loopholes and failing to enforce proper oversight.
4. Prevention of the scandal: This chapter discusses how the collapse could have been averted through better accounting standards, regular auditor rotation, and regulated rating agencies.
5. Consequences: This section covers the impact on stakeholders, the legal outcomes for executives, and the introduction of the Sarbanes-Oxley Act.
6. Conclusion: This chapter summarizes that Enron's collapse was a result of institutional greed and systemic failure across multiple professional sectors.
7. References: This section lists all scholarly sources and documentation utilized in the paper.
Keywords
Enron, Accounting Scandal, Special Purpose Entities, Corporate Governance, Arthur Andersen, Auditing, Sarbanes-Oxley Act, Securitization, Mark-to-market, Bankruptcy, Financial Fraud, Ethics, Investor Confidence, Regulation, Kenneth Lay.
Frequently Asked Questions
What is the main focus of this essay?
The essay explores the factors that led to the collapse of the Enron Corporation in 2001, focusing on accounting practices and governance failures.
Which central topics are discussed in the work?
Key themes include the use of Special Purpose Entities (SPEs), the failures of the board of directors, the role of auditors, and the resulting legal reforms.
What is the primary research goal?
The goal is to explain the reasons behind the Enron scandal and analyze the subsequent changes in global accounting regulations.
Which scientific method is utilized?
The author performs a systematic analysis of literature, case studies, and legal documents related to the Enron case to evaluate institutional responsibilities.
What is covered in the main body of the text?
The main body examines the specific accounting techniques used to inflate profits, the failure of internal oversight, the complicity of Arthur Andersen, and the implementation of the Sarbanes-Oxley Act.
Which keywords define this study?
The study is defined by terms such as Enron, auditing, corporate governance, financial fraud, and Sarbanes-Oxley Act.
Why did Arthur Andersen escape immediate legal consequences in 2001?
The paper argues that Andersen operated within the letter of the law at the time, exploiting loopholes and a lack of specific regulations governing consulting and auditing conflicts of interest.
How did the Sarbanes-Oxley Act change accounting requirements?
The act introduced mandates for auditor independence, mandated that CEOs and CFOs sign off on financial reports, and required the inclusion of off-balance-sheet transactions.
What role did the "Friends of Enron" play?
They served as external investors to provide the required three percent capital for SPEs, allowing Enron to keep these entities off their main balance sheet.
- Quote paper
- Milena Luke (Author), 2016, The Enron Scandal. Main Reasons for the Downfall of the Company, Munich, GRIN Verlag, https://www.grin.com/document/445639
