Criminal Managers and Business Ethics: Enron Scandal
CAGRI ALICIK
MANNHEIM-2013
CONTENTS ABSTRACT DEFINETION OF BUSINESS ETHICS ETHICS AND CORPORATE SCANDALS: ENRON
The Board Conflict of Interest Profits Legislation
RISE AND FALL OF ENRON ENRON INDIDENT FRAUDULENT ACCOUNTING PRACTICES CONCLUSION REFERENCES
ABSTRACT Enron has been one of the leading firms as a symbol of the new economy during the post-cold war period, and in fact his growth rate, market size, product variety, innovativeness and profitability has been superior to those of both his rivals and other average companies. The fall of Enron has been widely discussed further beyond an ordinary bankruptcy case in the economic and financial circles and in the business world as a whole. However, within the framework of most of the discussions, the components of the economic and financial system have been usually regarded as independent from each other or unrelated at all. It has been observed that the case of Enron was tried to be explained as an event which looks like the Titanic Crash or a perfect storm. According to the proponents of this opinion, the Enron case is an individual, unexpected one and for once only, and it will not be repeated in the future. Therefore, from this point of view individual crimes and/or criminals could have been detected in the crime scene, but nothing else, and they had been as such. On the other hand, having a closer look at the case of Enron helps us find out that not only the inner space but also the outer space of Enron may be held responsible for the outcome in question, the Enron debacle. To continue, it may be claimed that the effect and role of politics, regulatory authorities, mass media, the auditing firms and consulting law firms may be more or less than those of the chiefexecutive-officer, other executive directors, the board, and the auditing committee, but they are effective under all circumstances. More importantly, the individual components of the economic and financial system are inter-related and the interconnections may give rise to the emergence of a systemic failure like the serious crisis experienced in the aftermath of the sudden fall of Enron.
In this article, going over some of the important studies and researches carried out before into consideration, it is argued that the case of Enron is not an individual, but systemic failure, and for the same reason the policy options proposed to overcome and prevent similar failures such as strengthening the auditing profession or newer accounting and auditing standards have to embrace all the components of the economic and financial system in a more general approach including the national economic and market dimensions beforehand.
DEFINETION OF BUSINESS ETHICS Business ethics come up mainly in the United States began in the 1960s, 1980s, all major businesses and companies in the United States "Code of Ethics" Ethics Committees", "Ethical Service Training and Consulting Units "has been formed. One of the application areas of ethics, business ethics, in general, "in the workplacewhat is right and what is wrong to do the right thing and the meaning of "It is. Shown, in order to meet the needs of people of a particular established for the purpose of generating a profit from the economic entities. However, this is not be separated from social life, social and economic life. Businesses habits of the society in which they operate, with the moral teachings of customs and traditions
ETHİCS AND CORPORATE SCANDALS The Board One of the most important aspects of the scandal was the fact that the board of directors seemed uninterested in questioning management. Because profits and stock prices were going up, there was no real incentive to ask too many questions. The board viewed itself solely as the representative of the stockholders without any real obligation toward the general public or the employees of the firm. The big ethical issue is the role of the board in controlling management. Management seeks to enrich itself while the board seeks to enrich its stockholders. After the scandal, the role of the board in overseeing management has been reevaluated.
Conflict of Interest The purpose of an auditing firm is to work with the board in checking the state of a firm's finances. It is supposed to act as the diagnostic eyes and ears of the stockholders. In Enron's case, however, Arthur Andersen was also a consultant to Enron. This meant that the auditors had an interest in the continued prosperity of the firm and, therefore, had no incentive to expose the fraudulent record books Enron kept. Again --- so long as the money rolled in, and the board was happy, there was no incentive to blow the whistle. Profits Many firms struggle with the dilemma of pursuing short-term profits versus stable development. It was clear that Enron, once exposed, had chosen the former option. Stockholders, represented by the board, seek dividends or capital gains on their holdings. At least for the short-term, Enron made everyone happy: the auditors,
stockholders, the board and the management. Short-term profits meant rising stock prices, and quick fortunes were made by all investors. Once the fraud was detected, the stock plummeted, and these quick fortunes were lost. A policy of stable, long-term development would not have necessitated the fraudulent accounting practices of Enron. The ethical issue here is the real purpose of the firm: Is it a profitmaking machine or a stable, productive economic unit? Legislation The Enron scandal was the real cause of the 2002 passage of the Sarbanes-Oxley Act. This act sought to eliminate the conflict of interest between auditors and firms. It empowered the federal government to create its own auditing boards and commissions that exist to make sure such collusion never happens again. Executives in all firms, according to the act, are to take total, personal and financial responsibility for the accuracy of all financial reports made available to the pubic and stockholders. Enron's establishment and expansion of the natural gas markets, and can be summarized in relation to developments in the U.S. economy. Accordingly, Enron, was established in 1985 with the merger of two natural gas distribution company, and the U.S. has had the longest pipeline network. Until 1980, the natural gas market is a stable structure, the history liberalization with regulations easier to spot market transactions carried out and the resulting long-term "take or pay" contracts rather than spot market transactions to increase began. Decided to follow in order to grow faster than Enron diversification strategy and start to deal with natural gas trading. Business model natural gas, electricity, coal, steel, paper, pulp, water, and broad-band optical fiber and cable industries and market maker in the financial instruments to be gone the route of administration. In 2001, Enron, the international levels, pipelines, power plants, paper mills, broadband assets, water plant operators in the financial markets and the trade of products and services that have become a group.
Deregulation of natural gas markets, they often reduce prices and expand the supply of gas prices, despite the increased variability. At this point, Enron, just work as a commercial bank established a projected gas bank, suppliers and consumers of natural gas to intermediary services and users have started to offer long-term contracts. Enron, based on the contracts and the spot to make deliveries to reduce the risks caused by fluctuations in the market by the manufacturer entered into a long-term fixed-price arrangements and swaps, forward contracts and futures are used as financial derivatives. To fund most of the transactions in question, known as the off-balance sheet financial instruments admitted to special purpose entities. EnronOnline's in 1999 with the establishment of the financial contracts to manage virtual commerce model and created a new platform to market. In 2000 50% of all operations were carried out in this way. At the end of the 1990s, "heavy equipment, but the information is useful in the production should be achieved." Approach by moving assets and as a result have started to follow mitigation strategy is up to 20 times the capacity of the pipeline began to perform financial transactions. Enron, customized, particularly in the energy markets have entered the markets in Eastern Europe, Africa, the Middle East, India, China, Central and South America, and made significant investments in various energy projects. On the other hand, only deals include new and emerging markets, and especially the political risks also included. It comes with risks, Enron's gas market dominance of competitors to enter rapidly weakened significantly reduced the profitability of the competition adverse developments in national and international markets started to collapse of Enron, the company tried to put off the collapse of the accounting tricks and manipulations. Enron's collapse at the end of this process, where new competitors to enter markets and Enron is synchronous with the leadership of new competitors into the markets and eroded profit margins narrowed and competitive advantage began to disappear. The company borrowed more to maintain leadership in the market, this is a
company engaged in the trading of the Enron energy being transformed by removing the provident fund speculative. Downward trend in the markets and in the 2000s the world economy entering into recession and bear markets are seen with signs of Enron has become translated into high levels of debt. Enron's liquidity crisis, the bear market has worsened due to decreases in Enron stocks. Enron's investments, impairment losses occurring in the completion of the drawbacks in the financial markets, industrial and commercial failures. In 2001, Enron's water activity $ 287 million, $ 180 million investment in broadband and other investments worth $ 544 million loss. In total, this figure reaches 22% of fixed investments Enron during the period 1998-2000 reached a significant size. Again, a power plant at a cost of $ 1.9 billion in 2001 to $ 1.1 billion, took place on the disposal of the damage. The falling value of assets and losses raised doubts about the sustainability of the business model of Enron trade in foreign markets
ENRON INCIDENT FRAUDULENT ACCONTING PRACTICES Enron case error, fraud and manipulations are collected in two major problems. It can be said that none of these two problem areas edilebilseydi, Enron incident happened. The first of these two accounting system caused by fair value accounting. This system comprises a method and a hypothetical future energy will be sold at a certain price, for example, 10 years, suggesting that it is possible to save the current financial statements, profit is calculated. Fair value accounting has advantages because it is becoming possible to obtain a valid and up to date information in the valuation, measurement and reporting on bringing innovation, helps in ensuring the effectiveness of governance, transparency, and full disclosure has been developing applications. On the other hand, the lack of well-designed and effective control systems, this method has created great opportunities at the point of abuse. Existing control systems, adequate protection and
prevention within the framework of historical cost accounting functions can be fulfilled, but they are not suitable for fair value accounting. The pair (hybrid) accounting system, distorting the consistency of the reporting system, revenue, profit, and in general allows for financial statements and reduces the effectiveness of the existing control systems. The internal control system, financial statements prepared in accordance with fair value accounting is not enough to provide honest, because it determines the current market value or fair value accounting values are devoid of references to approve. Fair value accounting, complex and long-term energy contracts and transactions related to the present value of estimated future earnings and management required to be saved. This approach Enron management to predict future revenues accruing interest rates and energy prices are used.
The costs associated with the fulfillment of these contracts and the contract despite serious problems on the revenue recorded at the present value of future cash flows. The traditional approach to accounting records, accounting carrying values are caused by the opening of the fair value of the difference between reality and the recognition of the economic difficulties were encountered. Estimates unrealistic and difficult to verify the assumptions used to a large extent based on discretion. Fair value accounting, Enron, long-term energy contracts geliriymiĹ&#x; be achieved in the coming years as
revenue of the current year has the possibility of saving. However, these gains have not been charged in the current year and future years will be about the years without being charged. Through the application of Enron showed higher revenues than it actually is. For example, in 1999, Enron, South America, on the basis of a project, a pipeline under construction recorded revenues of $ 65 million. in determining the fair value of energy contracts and derivatives based on these contracts were with companies that have a wide range of movement. As a result, revenues and expenses of unearned profit / loss account. Yet, according to the principles of the income statement, contingent events and can be reasonably estimated to be close to the truth accrued expenses and losses are recognized in the income statement. For income contingent, however, highly probable, albeit not performed any accrued, are disclosed in the notes.
Enron, the second problem area is the implementation of the relevant standards and consolidation of special purpose entities. According to Healy and Palepu’s Enron special purpose entities, certain assets (eg natural gas reserves) established to fund and manage the risks associated with these assets. Special purpose entities, established a sponsor on the firm side, but independent mechanisms funded partners and external sources. Are reflected in the financial statements, special-purpose assets is a separate legal entity in order to determine the sponsor was a set of rules. According to them, which is an independent third-party partners, special-purpose entities that share a significant amount of capital and this share should be the source of a special-purpose assets to total debt and equity of at least 3% of the interpreted. Independent third-party partners, more than 50% controlling stake in the special-purpose assets to be retained by any other condition. If these regulations are being adhered to, the special purpose entities must be consolidated with the activities of the sponsor company.
Enron, within the framework of long-term fixed contracts to deliver natural gas to consumers and public institutions, and often to buy natural gas forward contracts with producers nearly 3,000 special purpose entity established. Many special-purpose entity, it is structured mainly for financial reporting purposes. 3% rule, care has been taken not to be ignored until the end of 2001 formally and thus avoided the introduction of special purpose entities consolidated with Enron. Since Enron's balance sheet, low debt, shareholders' equity and profit demonstrated that high. Because of the special-purpose assets and liabilities accounted for 23% of the profits during the 1997-2000 period, reaching 6% of corrections had to be made. Special purpose entities are consolidated with the financial statements of the sponsor or the sponsor's financial statements and the financial statements exclude transactions with special purpose entities evaluated and treated as transactions with independent third parties is observed as the most important accounting issues.Sponsored special purpose entities, most of the time there is no share of their assets to a special purpose entity is a part of the capital, and in turn transfer the debt / affiliate tool, will occur as a result of a special benefit for the right to participate in future activities of the asset, the right to hire is obtained as the returns. Sponsor, most of the special-purpose entity to allow implementation and consolidation of off-balance sheet financing, in order to evade the requirement around the specialpurpose and special-purpose entity is not the owner of the asset share of capital control over the activities of the organization phase of the
articles of association and so on. The provisions laid down by the documentation provides. Enron case, the rules related to the consolidation of special purpose entities are flexible and are very limited. In the first began to be used in the early 1980s, although weak capital structure of special purpose entities, are designed to be converted to cash assets such as trade receivables. Receivables are sold to a special purpose entities for cash has been collected from the sale of the asset value and profit / loss there has not been a difficulty in the determination. Sponsoring organization, a special-purpose entity guaranteed debt, although it is likely to turn into an obligation, provided by independent third parties to be adequate to cover possible losses due to capital remains very low. Therefore, it did not create any problems consolidation made. Over time, the special purpose entities, facilities, purchase of machinery and equipment have been used, or sold or leased back. The main problem with Enron's special purpose entities kullanmas覺ndaki, however, they have weak capital structure, but only formally Enron small number of rules in this area, following the established etmemesindedir consolidated special purpose entities. Even if virtually all the risks assumed by Enron's special purpose entities are not subject to consolidation.
Enron, not as participate in special-purpose entities, such as independent legal kiĹ&#x;iliklermiĹ&#x; structured. Created as you participate in these partnerships, the SEC made a more detailed description and the implementation of more stringent accounting methods isteyebilecekti. Enron, the SEC's strict supervision of special-purpose entities and independent auditing firm Arthur Andersen to miss skepticism and legal advisers from Vinson & Etkins's technical support. Special purpose entities, although in substance and economic participation for the purposes of, so called, and is as legally independent subsidiaries. Third parties involved in putting capital to special purpose entities, or owned by Enron or Enron or Enron-funded companies have been given assurances by the various cash and in kindIn other words, the special purpose entities controlled by Enron and related parties have been made. Special purpose entities, in order to overcome the crisis of liquidity by Enron used special purpose entities in this context, the company shifted nonperforming assets and losses resulting from them are excluded from the financial statements of Enron. In a nutshell, the stock options are configured with special purpose entities and complex financing techniques give less tax purposes, the less information to explain and to avoid consolidation increased its profit by selling Enron assets to special purpose entities, more accurately, the higher are shown. Special purpose entities, Enron were instrumental in the removal of debt from the balance sheet because the balance owed in terms of Enron, the debt / equity ratio will increase the cost of raising capital. is removed from the balance sheet by selling assets to special purpose entities, being spontaneous and artificially increasing profitability ratios. Inaccuracies in the configuration of a special-purpose assets, Enron's special purpose entities continued with the unveiling of an incomplete relationship with. Public announcements, Enron lost its liquidity and investment risks of the transactions with special purpose entities stated that protection, but investors shares in special-purpose assets, risk and financial guarantees to protect Enron learned how to use.
CONCLUSION In the past, the company used the latest management techniques and creative strategies Enron said today that the bankruptcy not only has the highest market value of the company markets as a result of developments after remember The agenda of the accounting profession in the process of change. This exchange of high quality How is that information can be achieved. This knowledge of international accounting standards with a full range of financial information and disclosures in accordance with, comparable to the economic realities showing the risks of reliable financial statements reflect the achievable accuracy and completeness. Ensure reliability in the "corporate governance" concept and the international auditing standards is important.The main factor in audit, accounting, public interests protected in accordance with standart determination. Hopes that the public will question the auditors. The gap between their expectations and the public auditor of the public auditor can be provided with the establishment of restoring confidence in the audit profession. To re-establish confidence in the public confidence in corporate reporting.There are the three basic element needed transparency, asked what he has done account corporate culture and honest people. World capital markets activity, the trust of the community, it is trust directly related to the provision of reliable information on the subject and, in short, an adequate level of transparency due to the provision.
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