Touted as the largest bankruptcy reorganization in American history at that time, Enron (with $63.4 billion in assets) filed for bankruptcy in Dec 2001. The most widely known reasons for it are the financial scandals that it was involved in. According to Wikipedia, “its complex business model and unethical practices required that the company use accounting limitations to misrepresent earnings and modify the balance sheet to portray a favorable depiction of its performance”. While such scandals are not new and unique, one begs the question of how such misfortunes could have happened to such a profitable organization. Was it just due to the greed and non-ethical actions of a few top brasses? Or is there more?
Although greedy and non-ethical businessmen are not a rarity in the high-end business world, we do not see companies going bankrupt every other day. This is because of the strong regulations established by governments, and more importantly, the internal checks and balances of every organization. In a typical large organization, there would be a Board of Directors (in addition to the shareholders) and Advisors (i.e. auditors, legal counsel, etc.) overseeing the Management. Together, the Board and Advisors serve as the “gatekeeper” of sorts, keeping the Management in check of its operations. In Enron’s case, it was quite possible that the Board was oblivious to the ongoing scandals, and the key reasons are very much affiliated to the two levers discussed above.
On the issue of Decision Rights, Enron’s Board did well in delegating operational decisions to the Management. In fact, it probably did it too well. In Enron’s structure, the Board was perceived with little or no authority and relevance in the decision-making process. All power went to the Management, and this was because of the corporate structure. Enron’s Board Directors were devoted to their responsibilities for the most part as a part-time commitment. They delegated most, if not all, of the executive powers to the Management, and simply took the easy way out by relying on the Advisors to help them keep the Management in check. However, they made a grave mistake by allowing their Advisors to play a dual-role as Consultants for the company. Apart from being auditors, Enron’s financial auditor, Andersen, was also employed as consultants. And since the consultant fees were far more profitable, Andersen worked in the interest of the powerful Management, and against the passive Board.
This led to the issue of Information Flow. With Advisor and Management in cahoots, a group hierarchy system that was ranked according to access of information and knowledge of Enron operations was established. Through this, the Management was able to restrict access of information to the Board in order to increase their own authority in the decision-making process. As a result, the Board became less informed and relied on the Advisors to determine if the dealings proposed by Management were appropriate. With this, a vicious cycle was formed. Because the Board depended a lot on the Advisors, getting approvals from the Board became insignificant, which resulted in less important information raised to it, and in the end, it became less of an authority in the decision-making process.
To sum it all up, the key reasons for the scandals were due to an ineffective Board that delegated too much authority to the Management, allowing the latter to buy over the Advisors and create information blockages to the Board to undermine its authority. The Management was then free to partake in the scandals without the Board’s knowledge, thereby causing the organization’s ultimate downfall. Could Enron have adverted this disaster? Yes, I believe that if the Board had been able to regulate its authority delegation and information flow better, Enron would still be alive today making handsome profits as before.