A DISSERTATION REPORT

ON
A CASE STUDY OF ENRONS FAILURE
Submitted in partial fulfilment of the requirement for the award of the degree
Of
MASTER OF BUSINESS ADMINISTRATION

SUBMITTED BY
Kapil Choudhary
MBA
BATCH (2013-2015)
ROLL 130601320

TAPMI School of Business

Manipal University Jaipur

MANIPAL UNIVERSITY JAIPUR

CANDIDATES DECLARATION

I hereby certify that the work which is being presented in the dissertation entitled
A CASE STUDY ON ENROLLS FAILURE in partial fulfilment of the
requirements for the award of the Degree of Master of Business Administration
submitted to the Department of TAPMI school of business, Manipal University
Jaipur, Jaipur is an authentic record of my own work carried out under the
supervision of Mr. C. Annirvinna, Department of TAPMI school of business
The matter presented in this dissertation has not been submitted by me for the
award of any other degree of this or any other Institute.

Date:
Place: Jaipur

Signature:
(Kapil Choudhary)

Certificate
This is to certify that the above statement made by the candidate is correct to the
best of my knowledge and belief.

Date:
Place:

Signature:
Jaipur

(Mr. C. Annirvinna)

TABLE OF CONTENTS

CHAPTERS

CONTENT

CHAPTER-1

INTRODUCTION
Background of the study
Problem statement
Objectives of the study
Outline of the study

CHAPTER-2

Company profile

CHAPTER-3

Literature review

CHAPTER-4

Research methodology

CHAPTER-5

Results and discussions

CHAPTER-6

Conclusions and
suggestions
Limitations of the study

ABSRACT

The sudden and unexpected collapse of Enron Corp. was the first in a series of
major corporate accounting scandals that has shaken confidence in corporate
governance and the stock market. Only months before Enrons bankruptcy filing in
December 2001, the firm was widely regarded as one of the most innovative,
fastest growing, and best managed businesses in the United States. With the swift
collapse, shareholders, including thousands of Enron workers who held company
stock in their 401(k) retirement accounts, lost tens of billions of dollars. It now
appears that Enron was in terrible financial shape as early as 2000, burdened with
debt and money-losing businesses, but manipulated its accounting statements to
hide these problems. Why didnt the watchdogs bark? This report briefly examines
the accounting system that failed to provide a clear picture of the firms true
condition, the independent auditors and board members who were unwilling to
challenge Enrons management, the Wall
Street stock analysts and bond rates who failed to warn investors of the trouble
ahead, the rules governing employer stock in company pension plans, and the
unregulated energy derivatives trading that was the core of Enrons business.

As was later discovered, many of Enron's recorded assets and profits were inflated
or even wholly fraudulent and non-existent. One example of fraudulent records
was in 1999 when Enron promised to pay back Merrill Lynch & Co investment
with interest in order to show profit on its books. Debts and losses were put into
entities formed "offshore" that were not included in the firm's financial statements
and other sophisticated and arcane financial transactions between Enron and
related companies were used to take unprofitable entities off the company's books.

Enron grew wealthy due largely to marketing, promoting power, and its high stock
price. Enron was named "America's Most Innovative Company" by Fortune for six
consecutive years, from 1996 to 2001. It was on the Fortune's "100 Best
Companies to Work for in America" list in 2000, and had offices that were stunning
in their opulence. Enron was hailed by many, including labour and the workforce,
as an overall great company, praised for its large long-term pensions, benefits for

its workers and extremely effective management until its exposure in corporate
fraud. The first analyst to publicly disclose Enron's financial flaws was Daniel
Scotto, who in August 2001 issued a report entitled "All Stressed-up And No
Place to Go", which encouraged investors to sell Enron stocks and bonds at any
and all costs.

CHAPTER-1
INTRODUCTION
BACKGROUND OF THE STUDY:Once the seventh largest company in America, Enron was formed in 1985 when
Inter North acquired Houston Natural Gas. The company branched into many nonenergy-related fields over the next several years, including such areas as Internet
bandwidth, risk management, and weather derivatives (a type of weather insurance
for seasonal businesses). Although their core business remained in the transmission
and distribution of power their phenomenal growth was occurring through their
other interests. Fortune Magazine selected Enron as "America's most innovative
company" for six straight years from 1996 to 2001. Then came the investigations
into their complex network of off-shore partnerships and accounting practices

The saga of the ENRON Corporation has been unfolding in the media for well over
a year. In the span of only three years, ENRON has gone from public and
professional acclaim of the company and its senior executives to scorn, infamy and
bankruptcy. Its public auditing firm, Arthur Andersen, has basically been
destroyed, as well as publicly disgraced. Tens of thousands of employees and
investors have been emotionally and financially affected. Major financial services

firms in banking, securities brokerage and insurance have been, and may yet be,
drawn into the legal battles regarding who is to blame for the ENRON failure.

Enron grew wealthy due largely to marketing, promoting power, and its high stock
price. Enron was named "America's Most Innovative Company" by Fortune for six
consecutive years, from 1996 to 2001. It was on the Fortune's "100 Best
Companies to Work for in America" list in 2000, and had offices that were stunning
in their opulence. Enron was hailed by many, including labour and the workforce,
as an overall great company, praised for its large long-term pensions, benefits for
its workers and extremely effective management until its exposure in corporate
fraud. The first analyst to publicly disclose Enron's financial flaws was Daniel
Scotto, who in August 2001 issued a report entitled "All Stressed-up And No
Place To Go", which encouraged investors to sell Enron stocks and bonds at any
and all costs.

PROBLEM STATEMENT:The firm projected itself as a highly profitable, growing company - an image which
quickly turned out to be an elaborate mistruth. Enron's statements about profits
were shown to be untrue, with massive debts concealed so that they didn't show up
in the company's accounts

Not only that, but the company was seen to have been extraordinarily active in
political lobbying - with large numbers of legislators close to the company in one
way or another. This fact had not been enough to save it, but raised questions about
how appropriate such closeness between a corporate and the political system
actually is.
Enron provided millions of dollars to finance Mr Bush's 2000 election campaign.
Mr Bush was a personal friend of Mr Lay, but has been quick to distance himself
from any involvement with the firm.

The Enron fraud case is extremely complex. Some say Enron's demise is rooted in
the fact that in 1992, Jeff Skilling, then president of Enron's trading operations,
convinced federal regulators to permit Enron to use an accounting method known
as "mark to market
ENRON had excessive compensation plan which resulted in major cash drains
Enron's non transparent financial statements did not clearly depict its operations
and finances with shareholders and analysts
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 favourable depiction of its performance
Investment banks and commercial banks, for not identifying the pitfalls for Enron
associated with complexity and large amounts of leverage.

The CFO initiated many of the transactions that can be criticized.

OBJECTIVE OF THE STUDY:

Everything in life holds some kinds of objectives to be fulfilled. This study is not
an exception to it. The following are a few straight forward goals which I have
tried to fulfil in the project:
1. To know the crises of Enron
2. To know the accounting irregularity followed by Enron
3. To highlight the failure of the regulatory authority and loopholes in corporate
law.

OUTLINE OF THE STUDY:

The first chapter explains about the introduction to the research topic, problem
statement, objectives, and limitations of the study. The profile of the company is
presented in the second chapter. The reviews of different literatures are presented
in the third chapter. The fourth chapter explains the Research Methodology. The

results and discussions of the study are presented in the fifth chapter. The
conclusions and suggestion of the study are presented the sixth chapter

CHAPTER-2
COMPANY PROFILE

Enron traces its roots to the Northern Natural Gas Company, which was formed
in 1932, in Omaha, Nebraska it was reorganized in 1979 as the leading subsidiary
of a holding company, Inter North which was a highly diversified energy and
energy related Products Company. Inter north was a leader in natural gas
production, transmission and marketing as well as natural gas liquids and an
innovator in the plastics industry. It owned Peak Antifreeze and developed EVAL
resins for food packaging. In 1985, it bought the smaller and less diversified
Houston Natural Gas.
The separate company initially named itself "HNG/InterNorth Inc.", even though
InterNorth was the nominal survivor. It built a large and lavish headquarters
complex with pink marble in Omaha (dubbed locally as the "Pink Palace"), that
was later sold to Physicians Mutual However, the departure of ex-InterNorth and
first CEO of Enron Corp Samuel Segnar six months after the merger allowed
former HNG CEO Kenneth Lay to become the next CEO of the newly merged
company. Lay soon moved the company's headquarters to Houston after swearing
to keep it in Omaha and began to thoroughly re-brand the business. Lay and his
secretary, Nancy McNeil, originally selected the name "Enteron" (possibly spelled
in camel case as "EnterOn"), but, when it was pointed out that the term
approximated a Greek word referring to the intestines, it was quickly shortened to
"Enron". The final name was decided upon only after business cards, stationery,
and other items had been printed reading Enteron. Enron's "crooked E" logo was
designed in the mid-1990s by the late American graphic designer Paul Rand.
Rand's original design included one of the elements of the E in yellow which
disappeared when copied or faxed. This was quickly replaced by a green element.
Almost immediately after the move to Houston, Enron began selling off key assets
such as Northern Petrochemicals and took on silent partners in Enron
Cogeneration, Northern Border Pipeline and Tran western Pipeline and became a
less diversified company. Early financial analysts said Enron was swimming in
debt and the sale of key operations would not solve the problems.

Main Divisions of Work:

Online Marketplace Services: EnronOnline.com commodity trading system - the
largest web based ecommerce site in the world and dwarfs all other energy
marketing web sites combined.
This includes EnronCredit.com, ClickPaper.com (online pulp & paper
information), online energy risk management, Water2Water.com (online water
marketplace), Waterdesk.com (water industry workspace, brings water industry
buyers and sellers together).
Enron Broadband Services: Internet Broadband - streaming media applications,
customizable bandwidth solutions.
Enron Transportation Services: The Gas Pipeline Group, which formally
changed its name in September 2000 to Enron Transportation Services.
Enron Energy Services: The retail arm of Enron, serving business users of
energy in commercial and industrial sectors.
Enron Wholesale Services: Project Development and Management - Enron
delivers more than two times the natural gas and power volumes as does its nearest
energy marketing competitor.
Wholesale Services includes: Azurix Global Water; energy infrastructure
development, engineering, procurement, and construction services; global
exploration and production; and wind power services.

Products
Enron traded in more than 30 different products, including the following:
Products traded on Enron Online
o Petrochemicals
o Plastics

o Power
o Pulp and paper
o Steel
o Weather Risk Management
Oil and LNG transportation
Broadband
Principal investments
Risk management for commodities
Shipping / freight
Streaming media

Water and wastewater

Online marketplace services

EnronOnline (commodity trading platform)
ClickPaper (transaction platform for pulp, paper, and wood products)
EnronCredit (the first global online credit department to provide live credit
prices and enable business-to-business customers to hedge credit exposure
instantly via the Internet.)
ePowerOnline (customer interface for Enron Broadband Services)
Enron Direct (sales of fixed-price contracts for gas and electricity; Europe
only)
EnergyDesk (energy-related derivatives trading; Europe only)

 NewPowerCompany (online energy trading, joint venture with IBM and

AOL)
Enron Weather (weather derivatives)
DealBench (online business services)
Water2Water (water storage, supply, and quality credits trading)
HotTap (customer interface for Enron's U.S. gas pipeline businesses)
Enromarkt (business to business pricing and information platform; Germany
only)
Broadband services
Enron Intelligent Network (broadband content delivery)
Enron Media Services (risk management services for media content
companies)
Customizable Bandwidth Solutions (bandwidth and fiber products trading)
Streaming Media Applications (live or on-demand Internet broadcasting
applications)
Energy and commodities services
Enron Power (electricity wholesaling)
Enron Natural Gas (natural gas wholesaling)
Enron Clean Fuels (biofuel wholesaling)
Enron Pulp and Paper, Packaging, and Lumber (risk management derivatives
for forest products industry)

 Enron Coal and Emissions (coal wholesaling and CO2 offsets trading)
Enron Plastics and Petrochemicals (price risk management for polymers,
olefins, methanol, aromatics, and natural gas liquids)
Enron Weather Risk Management (Weather Derivatives)
Enron Steel (financial swap contracts and spot pricing for the steel industry)
Enron Crude Oil and Oil Products (petroleum hedging)
Enron Wind Power Services (wind turbine manufacturing and wind farm
operation)
MG Plc. (U.K. metals merchant)
Enron Energy Services (Selling services to industrial end users)
Enron International (operation of all overseas assets)

Capital and risk management services

Commercial and industrial outsourcing services
Commodity Management
Energy Asset Management
Energy Information Management
Facility Management
Capital Management
Azurix Inc. (water utilities and infrastructure)

Project development and management services

Energy Infrastructure Development (developing, financing, and operation of
power plants and related projects)
Enron Global Exploration & Production Inc. (oil and natural gas field
services)
Electro Electrician e Services SA (Brazilian electric utility)
Energy transportation and upstream services
Natural Gas Transportation
Northern Border Pipeline
Houston Pipeline
Transwestern Pipeline
Florida Gas Transmission
Northern Natural Gas Company
Natural Gas Storage
Compression Services
Gas Processing and Treatment
Engineering, Procurement, and Construction Services
EOTT Energy Inc. (oil transportation)
Enron manufactured gas valves, circuit breakers, thermostats, and electrical
equipment in Venezuela through INSELA SA, a 5050 joint venture with General
Electric. Enron owned three paper and pulp products companies: Garden State

Paper, a newsprint mill; as well as Papiers Stadacona and St. Aurelie Timberlands.
Enron held a controlling stake in the Louisiana-based petroleum exploration and
production company Mariner Energy.
Enron International
Enron International (EI) was Enron's wholesale asset development and asset
management business. Its primary focus was developing and building natural gas
power plants outside North America. Enron Engineering and Construction
Company (EECC) was a wholly owned subsidiary of Enron International, and built
almost all of Enron International's power plants. Unlike other business units of
Enron, Enron International had a strong cash flow on bankruptcy filing Enron
International consisted of all of Enron's foreign power projects, including ones in
Europe.

Leadership
Rebecca Mark was the CEO of Enron International until she moved over to lead
Enron's newly acquired water business, Azurix, in 1997. Mark played a major role
in the development of the Dabhol project in India, Enron's largest international
endeavour.

Projects
Enron International constructed power plants and pipelines across the globe. Some
today are still up and running, including the massive Teeside plant in England.
Others, like a barge mounted plant off Puerto Plata in the Dominican Republic,
cost Enron money through law suits and investment losses. Puerto Plata was a
barge mounted power plant next to the hotel Hotelero del Atlantico. When the plant
was fired up, winds blew soot from the plant onto the hotel guests' meals,
blackening their food. The winds also blew garbage from nearby slums into the
plant's water-intake system. For some time the only solution was to hire men who
would row out and push the garbage away with their paddles. Through mid-2000

the company collected a paltry $3.5 million from a $95 million investment. Enron
also had other investment projects in Europe, South America, Argentina, Brazil,
Bolivia, Colombia, Mexico, Jamaica, Venezuela, and across the Caribbean.
India
Around 1992 India came to the United States to find energy investors to help with
India's energy shortage problems. In December 1993, Enron inked a 20-year
power-purchase contract with the Maharashtra State Electricity Board. The
contract allowed Enron to construct a massive 2,015 megawatt power plant.
Construction would be completed in two phases, and Enron would form the
Dabhol Power Company to help manage the plant. The power project was the first
step in a $20 billion scheme to help rebuild and stabilize India's power grid. Enron,
GE (who was selling turbines to the project), and Bechtel (who was actually
constructing the plant), each put up 10% equity.

In 1996, when India's Congress Party was no longer in power, the Indian
government assessed the project as being excessively expensive and refused to pay
for the plant and stopped construction. The Maharashtra State Electricity Board
(MSEB), the local state run utility, was required by contract to continue to pay
Enron plant maintenance charges, even if no power was purchased from the plant.
The MSEB determined that it could not afford to purchase the power (at Rs. 8 per
unit kWh) charged by Enron. The plant operator was unable to find alternate
customers for Dabhol power due to the absence of an open free market in the
regulated structure of utilities in India. From 1996 until Enron's bankruptcy in 2001
the company tried to revive the project and spark interest in India's need for the
power plant without success.

Overview of ENRON:

The following timeline for ENRON is presented to set the major milestones for the
company:
July 1985- Houston Natural Gas merges with InterNorth to form ENRON, as an
interstate natural gas pipeline company. Kenneth Lay is CEO.
1989- ENRON starts trading natural gas commodities and commodity derivative
financial contracts.
1994- ENRON begins trading electricity as a commodity and related financial
derivative contracts. Jeffrey Skilling is executive in charge of this new business
venture.
Nov. 1999- Enron Online is launched as a web site for the global trading of energy
commodities and derivative contracts. Jeffrey Skilling leads this continued
transformation from a natural gas pipeline company to a global marketer and trader
of oil, gas and electric energy. Stock price trades at $45 per share.
2000- Stock price trades at high during year of $91 per share.
Feb. 2001- Jeffrey Skilling takes position as CEO, and Ken Lay remains as
Chairman of the Board. Stock price is trading at high range of $84 per share.
Aug. 2001- Jeffrey Skilling resigns as CEO, and Ken Lay returns to position as
CEO and Chairman. ENRON vice president, Sherron Watkins, writes anonymous
letter to Ken Lay about severe problems with partnerships known as LJM and
Raptor, the accounting for those partnerships, the role of the ENRON CFO in the
partnerships, and the possible adverse effect of these partnerships and their
accounting if the information were ever revealed to the investment markets.
Jan.-Aug. 2001- Lay and Skilling sell $41 million of ENRON stock. Other
corporate insiders sell $71 million of stock. Employees are restricted from selling
stock from 401(k) retirement accounts unless retiring or leaving employment.
Sep. 2001- Stock price trades around $28 per share, after 9/11 terrorist attacks.

Oct. 2001- ENRON reports a $618 million loss for the third quarter, and restates
past financial statements that results in $1.2 billion write down of ENRON's
stockholder equity. Loss and write downs result from Special Purpose Entities
(partnerships) created under the direction of Chief Financial Officer (CFO) Andrew
Fastow. The Securities and Exchange Commission (SEC), requests further
explanation and information on the reported losses and financial restatements. CFO
Andrew Fastow is relieved of his position. ENRON's problems largely related to
"aggressive" accounting related to reporting of indebtedness on balance sheet,
reporting of profits from asset sales and reporting of earnings and cash flow from
on-going operations.
Nov. 2001- SEC upgrades inquiry into ENRON to a "formal investigation".
ENRON states that its profits over last five years have been "overstated" by $586
million. Public auditing firm, Arthur Andersen, receives request from SEC for its
records on the ENRON audits. ENRON attempts to raise cash by delaying loan
repayments and seeking new sources of short term capital. Merger attempt with
Dynegy Corp. is cancelled.
Dec. 2001- ENRON files for Chapter 11 bankruptcy protection. CEO of Arthur
Andersen tells Congress that ENRON might have violated securities laws.
Jan. 2002- Justice Department begins criminal investigation of ENRON's failure.
Reports are received about document destruction at ENRON and Arthur Andersen
after SEC investigation was announced. ENRON stock trades at prices between
$0.20 and $0.50 per share.
Feb.-Aug. 2002- Ongoing investigations by SEC, U.S. Justice Department, U.S.
House of Representatives, U.S. Senate, et al. Companies such as Merrill Lynch,
Citicorp and J.P. Morgan Chase are called to testify about their dealings with
ENRON. Role of ENRON in the California energy crisis is investigated. ENRON
employees sustain massive losses in 401(k) retirement accounts and employee
layoffs continue. Federal government evaluates need for new laws related to
employee pension accounts, regulation and oversight of public auditing firms, and
corporate fraud and governance issues.

The Year 2001

In the year 2001, Enron was the seventh largest US Corporation (based on
revenues) and possibly would have been ranked larger if the revenues of all the
subsidiaries and special-purpose entities (SPEs) were factored into the calculation.
It would have been ranked much lower if trading transactions were not treated as
revenue. Interestingly, Enron was ranked number five in the Fortune 500 listing for
2001, published in March 2002. But no matter where we exactly rank it, Enron was
a large profitable corporation before October 2001. If we consider only the
available public information as of August 2001, it was a very profitable
corporation. On 17 December 2001, the Enron Corporation filed an 8-K report
with the Securities and Exchange Commission (SEC). It stated that on
December 2, 2001, Enron Corp. (the Company) and certain other
subsidiaries of the Company (collectively, the Debtors) each filed voluntary
petitions for relief under chapter 11 of title 11 of the United States Code (the
Bankruptcy Code) in the United States Bankruptcy Court for the Southern
District of New York Thus, in December 2001, Enron filed for bankruptcy. How
did a seemingly healthy, profitable corporation transform itself into the biggest
corporate scandal of the new millennium? The newspapers have reported
extensively on the clienteles that have been harmed by the Enron collapse. These
include: Employees with 401-K plans heavily (or exclusively) invested in Enron
stock; Employees who have lost their jobs at Enron; Employees and investors who
held worthless Enron stock; Debtholders who owned debt that had lost most of its
value (including bank debt). But, the list of those affected greatly is much longer,
including: Top management with reputations in shatters and significant reductions
in wealth. Arthur Anderson A once highly respected public accounting firm was
struggling to stay afloat and subsequently was forced to shut down operations.
Security analysts who recommended Enron stock. Bond rating agencies who had
imperfect crystal balls. Politicians who accepted donations from Enron. At the
beginning of 2001, Enrons common stock was high compared to its earnings. How
does a CEO manage a company whose stock is overvalued? Enron management
chose to take actions that presented a sunny smile to the public while painful
events occurred. There were some executives who, fooled by the firms own
accounting and financial tricks, actually thought things were bright.

CHAPTER-3
LITERATURE REVIEW
Baker (2003)1 has analysed the fall of Enron from different perspectives he
discussed the business model of Enron and external factors such as deregulation of
industry in that era. He has examined the growth of Enron which transformed itself
from regulated gas distribution Company into an international trading company
and through all the stages of its collapse he investigated Enron as American public
private partnership

Then David Baker (2005)2 views Enrons bankruptcy as an accounting failure in

which the investors and creditors of the company were misled and presented with
false financial information .In his view the bankruptcy losses of the investors could
have been reduced to some extent if they had been provided with the transparent
financial information and its result.

Joanne and john (2006)3 discussed the some issue and use the term Hypermodern
Organization they argued that the continuous growth of Enron as an organization
was based on hyper flexibility in terms of size and survival of its business units. In
reaction to the market opportunities Enron acquired and disposed off businesses. It
acquired Portland General Corporation to enter to the market of utility electricity.

1
2
3

Konstantin (2005)4, showed that during the period1996-2001 there was increase in
the revenue of the company while the net income decreased from 5.66% to 0 .97%.
In this research different ratios were used like price to earnings, Price to book
value, ratio Return on asset, and use of Net margin and use of risk management.

Coffee (2003)5 has discussed the same issue in his working paper what caused
Enron states: as in late as October 2001 sixteen or seventeen security analysts
recommended buy or strong buy for Enrons stock however the stock price of
Enron already in 2000was six times of its book value and 70 times earnings,
however the first brokerage firm which recommended sell recommendation for
Enron was prudential securities which at that time was not engaged in the
investment banking business.

Giovanni and Andrew (20026) discussed the institutional activism in Europe they
argued that crisis in public model security and reforms in stock market exchanges
and birth of the single market in Europe has changed the domestic institutional
investors.

Levi (2001)7 statement: difference in outcome is derived from DNA of

companies i.e. which is the organizational infrastructure, its capabilities, culture
and leadershipthese are the elements that create the working context for
operating and managing intangibles

Enrique (2003)8 have studied the reaction of Enron and discussed its aftermath. He
found that the reaction on collapse of the Enron on Europe and UK has been
Different than USA. In his view Block holders of European Companies must have
been working more effectively than the institutional investors and monitors in
5
6
7
8

USA. After Enron in USA there are quite a few companies who faced serious
problems in Europe

Higgs (2003)9 recommended that half of the board members should be nonexecutive directors and the role of CEO and the chairman should be separate. In his
view independence of auditors and directors is very important. Luca Enrique 2003
discussed the developments in EU countries in the post Enron era. On May 25,
2003,the European commission issued to council and European parliament setting
out its agenda to modernize European Corporate Law and to enhance corporate
governance in E.U. With respect to U.K post Enron corporate Governance reform
there has been study on non-executive directors commissioned by government
funded organization sand also some initiatives on audit and accounting issues.

Chatzekal (2002)10 view that the changing nature of finance enterprise and
accounting capability should be in parallel and the one way to achieve is through
reviewing the accounting for intangibles and he raises the important question of
how to reduce the opportunity for new Enron in future.

9
10

CHAPTER-4
RESEARCH METHODOLOGY

Research methodology is a systematic approach in management research to

achieve pre-defined objectives. It helps a researcher to guide during the course of
research work. Rules and techniques stated in research methodology save time and
labour of the researcher as researcher know how to proceed to conduct the study as
per the objective.

SELECTION OF TOPIC: The selection of topic is a crucial factor in any research

study. There should be newness and it should give maximum scope to explore the
ideas from different angles.
After consultation with the internal guide, the topic was finalized and titled
as-ENRONS FAILURE
RESEARCH DESIGN: A Research design is the arrangement of conditions for
collection and analysis of data in a manner that aims to combine relevance to the
research purpose with economy in procedure The research design followed to
study ENRONS FAILURE is Descriptive and Analytical Research Design.

SOURCES OF DATA COLLECTION:

1. Secondary data collection
The secondary data are those which have already collected and stored. Secondary
data easily get those data from records, journals, annual reports of the company
etc. It will save the time, money and efforts to collect the data. Secondary data also
made available through trade magazines, annual reports, books etc.

CHAPTER-5
RESULTS AND DISCUSSIONS

Gains and Losses from Stock Investment:

Assume an independent entity buys 1,000,000 shares of Enron stock at a price of
$50 per share and the price increases to $80. The independent entity has made an
unrealized gain of $30 per share or $30,000,000 in total. Following mark-to-market
accounting this gain will affect the independent entitys income. Enrons income
will not be affected. Now assume an entity, completely owned and controlled by
Enron, buys 1,000,000 shares of Enron at a price of $50. When Enron did this sort
of transaction, it would sometimes accept a notes receivable in exchange for the
stock. Good accounting would require that there be no increase in stock equity or
assets of Enron when the asset received is a note receivable. For this example,
assume the entity paid $50,000,000 cash to Enron for the stock. Now assume the
stock price goes up to $80 per share. When the entity buying the stock was
independent of Enron, there was a $30,000,000 gain. Now generally accepted
accounting requires that there be no gain or loss for Enron associated with
transactions involving Enron stock.

: Consider the following table:

Enron
subsidiary
Assets 50,000,000
Stock equity 50,000,000

an owned and controlled

50,000,000 (Enron stock)
50,000,000

If we consolidate the financial affairs of the two entities we have:

Consolidated
Assets

50,000,000

Stock equity

50,000,000

Now assume time passes and the controlled entity (and Enron) earns $20,000,000
and the value per share increases. The controlled entity is not marked-to-market.
We now have:
Enron
An owned and controlled subsidiary
Assets
70,000,000
Stock
70,000,000

70,000,000
equity

70,000,000

If we consolidate the financial affairs we have

Consolidate
d
Assets

70,000,000

Stock equity

70,000,000

But assume the controlled entity uses mark-to-market accounting and the value of
its asset (Enron stock) increase to $80,000,000. The parent (Enron) should not
record the $10,000,000 of market appreciation (above the $20,000,000 of earnings)
as income. It results from the stock price change of Enron stock and this should not
affect Enrons income. The $30,000,000 increase in the Enron stock price does not
give rise to Enron income or an increase in Enron assets. The $20,000,000 of
Enron earnings are recorded.

Reported net income

in income

Decrease

1997
million
1998
million
1999
million
2000
million
Total
million

$105 million

$28

703 million

133

893 million

153

979 million

91

2680 million

405

Enrons reported debt would be increased by $628 million in 2000 as a result of the
consolidations

In this analysis they used the following valuation model:

They found that the Enron stock price which was $90 in 2000 at the time was
consistent with the ROE and its revenues but the important point here is that theses
earnings and returns were based on the information which was fraudulent therefore
any assumption that stock price of Enron in (2000) created value to its shareholders
would be wrong. This is the reason the fund managers were led to wrong decision.
Palepu (2003) states that:
Several reasons have been proposed that why the leading managers were so
slowing to recognize the problem to Enron, they were misled by the accounting
statements or by sell side annalists or the incentives of fund managers to seek out
high quality information were poor.

4
5

3
2
1

ENRON
Account
In
Profit

Special
Purpose
Entity
(SPE)

Partnership

1. Enron sets up partnership using stock as funding

2. Partnership sets up SPE
3. SPE agrees contract to pay Enron if its investment
declines in value
4. Payment made as investment declines
5. Payment posted as profit, even though it is Enrons
own money

Evaluating Arthur Andersen:

Let us consider the performance of the accounting firm Arthur Andersen. It
destroyed documents related to the Enron collapse. Early in 2002, it was revealed
that documents were destroyed in October 2001 after the world was aware that
Enrons accounting was faulty and would be investigated. The author of this book
cannot judge the legality of the document shredding, but he does know that at a

minimum it was bad public relations. It would be surprising if there were

revelations on the shredded documents that were as bad as interested parties
thought they were after the shredding. Arthurs second error was in not keeping
Enrons Board aware of its concerns early in 2001 or before. Duncan and others at
Arthur Andersen were aware in February 2001 that Enron had significant risks that
were not of public knowledge. Why not inform the Enron Board? Let us assume
that Arthur Andersen did not know in 1997 that Chewco did not have 3%
independent equity. Thinking Chewco qualified for non consolidation it was
reasonable not to consolidate Chewco until 2001 when Arthur Andersen found out
that Chewco and JEDI should have been consolidated since 1997. Did Arthur
Andersen truly find out in 2001 or did it know previously that there was not a 3%
independent equity? There is also the issue of the $1.2 billion entry (debit) to notes
receivable and entry to stock equity (credit). Accounting principles do not allow
one to record an increase in stock equity balanced by a promise to pay in the
future. Recording the increase in stock equity is not acceptable accounting, but it is
not a high crime. Why was Arthur Andersen fooled? It is possible that the complex
array of SPEs hid the true nature of the transaction until 17 October 2001. Or it
could be that Arthur Andersen allowed an incorrect accounting entry. It is very
difficult to see why Arthur Andersen would knowingly allow an incorrect
accounting entry. It is more likely that the complex manner of structuring the
transaction hid the transactions basic nature.

At what stage should Arthur Andersen have demanded that the curtain be drawn on
the Raptors? Before the assets held by Enron decreased in value there was no
important accounting issue concerning the Raptors. At some stage the Raptors
could no longer honor their put liabilities to Enron. We do not know when this
happened, but it was somewhat before October 2001. The Enron Board should
have been informed that the puts held by Enron were not fully effective.
There are many issues regarding the recording of debt, the timing of revenues, the
timing of expenses, and the recognition of gains on sales of assets, where it is
possible that the assets were not actually sold (the buyer had puts to sell back to
Enron). We need more information before determining guilt.

Arthur Andersen was tried in the court of public opinion and found guilty before its
legal trial. The fact that the US Government indicted the firm did not help Arthur
Andersens customer relations. It became very difficult for a public corporation to
hire Arthur Andersen as its auditor. CFOs did not want to defend the choice of
Arthur Andersen as the firms auditor. The fact that Arthur was later found not to
be guilty did not help the already dissolved firm.

There is some significant probability that the accounting errors that were made by
Enron were not Arthur Andersens responsibility and that, aside from shredding, no
crimes were committed by Arthur Andersen prior to 2001 (whether the shredding
was a crime is for history to decide; Andersen was not convicted of that crime).
Arthur Andersen, as of May 2002, seems to have gotten a raw deal from the press
and the US Justice Department.

Arthur Andersen had a group of outstanding accounting experts available in its

Chicago office to answer questions as to the appropriate accounting for difficult
issues. This service was available at no cost to any operating office. However, the
operating office having received the expert opinion did not have to follow the
advice, though it normally did. It is likely that the Chicago experts offered the
Houston office advice that could have avoided the issues that ultimately trapped
the firm.

Kenneth L Lay
By one definition Lay is responsible for any mistake that was made by an Enron
employee. This follows the US Navy tradition that a ships captain is responsible
for anything that happens on the ship. This rule is great in theory because it causes
the captain to take a deep interest in all activities that could lead to trouble.
Captains of US Navy ships at sea do not get to sleep through the night very often.
Ultimately, a captain is a single person of limited scope. He or she cannot be
everywhere. Informed of all possible dangers the captain will soon be exhausted

and will become a walking zombie. There are things that happen for which it
would not be sensible to hold the captain responsible. Similarly, Lay delegated
responsibilities to Enrons senior officers. Lay retired as the CEO in February 2001
and Skilling was named as the CEO. On 14 August 2001 Skilling resigned for
personal reasons. Lay resumed the job of CEO. But Lay was more interested in big
issues and the political scene than the details of accounting and finance as they
applied to Enron. Lay hired Skilling and Fastow to take care of the accounting and
finance. The accounting problems that ultimately led to the need to revise the
operating results for 19972001 (first half) were very technical. Now, the world is
aware of the nature of Enrons accounting problems, there will be differences of
opinion as to whether or not Enron should have been allowed to record the entries
that they did. Even though, when Enron was in error as with Chewco, it was an
error because of a technicality. Chewco failed to have a 3% independent equity,
that should have been consolidated. But why 3%? Also, how is the 3% to be
measured and what should be included as equity? The rules should have been
followed, but these rules were not carried down by Moses from the Mount.

The Extent of Corruption

Was Enron corrupt? How evil was the Enron management? Let us leave out from
consideration the shredding of documents by both Arthur Andersen and Enron
when they knew investigations were pending. Also, leave out the amounts taken by
Fastow and other employees from the several related entities. While upsetting,
these actions were not the core elements of Enrons bankruptcy. Consider the SPEs
that were established or utilized for hedging purposes and the accounting for these
entities (for example, Chewco and the Raptors). To a minor extent these were
actually hedges (for small price changes of the hedged asset). The accounting and
economic problems came into being when the losses became large. It is interesting
that the accounting for Chewco would have been technically acceptable (if not
admirable) if an additional $7 million of independent equity had been raised. The
failure to raise the $7 million is stupidity or carelessness, not corruption. There
were several other (maybe many other) departures from good accounting. These
were not consistent with the traditional objectives of financial accounting, but they
did not necessarily indicate the existence of corruption. It was desirable for Lay
and Skilling to pay more attention to the accounting and financial details, but one
can conject that they did not. Fastow was both too clever and not knowledgeable

enough. He failed to consider the consequences of a severe fall in the value of the
merchant assets and the value of the SPEs assets. Fastow established a house of
cards that could not withstand a slight breeze. The auditors and the CFO of Enron
did not keep the Board adequately informed. The investment banks and
commercial banks helped to raise the capital necessary for Fastow to play his
games.

Analysts recommended Enron stock after the investment banks knew that there
were difficulties. This could be an illustration of the analysts bailing out the
investment banks or it could be that the wall between investment banking and
security analyses actually worked.
Sharing the Blame:
Identifying the entities that can share in the blame for the Enron collapse results in
a long list that includes:
1. Enrons top management and Board did not stop transactions that they did not
understand (and maybe did not know about).
2. Investment banks and commercial banks, for not identifying the pitfalls for
Enron associated with complexity and large amounts of leverage.
3. A law firm that seemed not to keep the Enron Board informed of all conflict of
interest situations.
4. Rating agencies and security analysts that did not insist on better information.
5. The auditors seemed to be too permissive.
6. The CFO initiated many of the transactions that can be criticized.
7. Investors who paid too much for the stock (hindsight helps us with this one).
8. The designers of the accounting rules that facilitate the hiding of debt.

CHAPTER-6
CONCLUSION

The aim of this thesis is to examine and discuss the major scandal of Enron in
relation quality financial reporting and corporate objective of shareholder wealth
maximization. Through the analysis of Enron case I have tried to show that how
the directors of the Enron used financial reporting to mask the real financial
position of the company. Discussion and analysis also showed that financial
reporting was not the only factor for demise of Enron there were other factors such
as business model of Enron, Auditors independence, deregulation energy industry
in USA, flaws in US Generally Accepted Accounting Principles (GAAP),
Accounting Standards and corporate Governance. But there is consensus that
Enron executives used financial reporting as a tool to mask the real financial
position of the company and also all these factors are linked directly or indirectly
with financial reporting.
This thesis evidences of the corrupt practices of the Enron executives and their
contribution in reporting the fraudulent financial statements. In essence the lack of
presentation of high quality information, poor corporate governance and
environment of corruption lead to downfall of Enron. The discussion and analysis
of this thesis suggest that Financial Reporting of a company can be key factor in
disclosing or hiding financial health. In this whole paper I have emphasized on
quest of transparent financial statements which can not only be achieved through
enforcing quality Accounting Standards but it is influenced by a number of other
institutional factors which I have discussed throughout in the discussion part of this
paper using the Enron case.
Transparency and Accountability are the two key words and lack of both in the
financial systems result in scandals like the Enron. It is a basic conception in
finance that increased debts can increase the financial risk of an entity but how
the investors of a company would know if debts do not appear on the financial
statements of the company? Therefore it can be argued that if Enron had presented
their financial reports with transparency and had shown their assets and liabilities
accordingly, the financial losses to the investors would have been minimized.
Financial analysts use financial information for valuations purposes and forecast
the earnings of the company which has impact on the security prices. The Enrons
earnings were inflated fraudulently and debts were shown as profits. Which in turn
inflated the stock prices but it did not create value to the shareholders as these

prices were based on false information. Therefore it can be argued that quality
reporting can lead to quality forecast and estimates, which will be based on true
and fair view and can help investors in quality decisions and it can create value to
shareholders and value to corporate in the long run.

SUGGESTIONS

There are several lessons to be learned from the Enron:

First and most importantly, a finance officer can be too smart. Using clever
financial and accounting devices that confuse analysts and investors might work
for a short while, but when the system collapses the consequences are magnified. If
Enron had reported its merchant investment losses to go with the firms trading and
operating profits, the market would have digested this information and Enron
would have survived.
Any firm that is heavily dependent on short-term credit is vulnerable to bad news
reports that shake the markets faith in its reports. The media can bring down a firm
that needs short-term credit.
Enron did many transactions whose primary objective seemed to be to mislead the
person evaluating its financial performance. All the accounting hedges were of this
nature as well as many of the put purchase transactions with the SPEs.
Unfortunately, these transactions then led to a faulty accounting (failure to
consolidate three entities) and a loss of faith by the market in Enrons top
management

There are many reasons why a firms management should do right. First, it is the
honourable and correct thing to do. Second, it is likely to maximize shareholder
value. Enron, when it found it could not buy an economic hedge for its merchant
assets, should have reported the gains and losses as they occurred. If it had done
this simple and the correct thing the Enron Corporation would still be operating
and growing.
Enrons stock price implicitly promised large and continuous profitable growth.
Enrons actual business activities were not always profitable and they did not
promise continuous growth. What do managers do when their stock is greatly
overvalued? In the Enron case some
of the managers tried to sustain the illusion of continuous profitable growth.
Unfortunately, it was an illusion. The Enron stock price as of 1 January 2001 could
not be justified by the revised accounting numbers.

Websites:
www. Wikipedia.com
www. Enron.com
www. Scribd.com
www. slideshare.com
www. Authorstream.com

LIMITATIONS OF THE STUDY:-

1. Due to time restraints it was not possible to study in depth.

2. Many facts and data are such that they are very large and it is not possible to
solve the all problems.
3. Since the financial matters are sensitive in nature the same could not acquire
easily.
4. limited data available on the internet .