The Enron Scandal and the Neglect of Management Integrity

Capacity
Joseph A. Petrick, Wright State University
Robert F. Scherer, Clevland State University

Introduction

Corporate managers are expected to maximize investor returns while complying with regulatory
standards, avoiding principal-agent conflicts of interest, and enhancing the reputational capital of their
firms (Useem 1996; Whitman 1999). The recent arrests and resignations of top U.S. managers,
however, indicate an increasing level of managerial negligence and corporate irresponsibility on Main
Street and on Wall Street that has eroded domestic and global trust in U.S. markets (Elliott and
Schroth 2002; Mitchell 2002). The U.S. stock market volatility has added to the political pressure to
bring 1930s-style regulatory reform to businesses (Lorenzetti 2002). Corporate irresponsibility in the
Enron scandal, for example, has provoked multiple lawsuits and unprecedented outrage from a range
of stakeholders with demands for democratizing structures of corporate power, improving managerial
accountability, and legislating regulatory reform (Cruver 2002; Fusaro and Miller 2002; Swartz and
Watkins 2002).

The Enron scandal involves both illegal and unethical activity and the courts of law will determine the
precise extent of civil and criminal liability that accrues to the perpetrators (Verschoor 2002; Fusaro
and Miller 2002). People commit fraud, for instance, for a wide range of motives including perceived
lack of effective deterrent punishment and rationalization of acceptability of illegal activity (Albrecht
and Searcy 2001). To control fraud by focusing on only one dimension, such as more effective
deterrent punishments, is like trying to put out a skyscraper fire with a garden hose. In addition, people
harbor myths, such as organizations cannot proactively detect or prevent fraud, which only result in
disempowered resignation to the inevitability of corruption and more future Enrons (Albrecht and
Searcy 2001).

The focus of this article, however, is on understanding the complex, interdependent moral roots that
embed the multiple motives for Enron legal malfeasance and to provide more than a moral garden
hose to address these issues. Simplistic inspirational exhortations to do the right thing,
recommendations to impulsively follow what feels comfortable at the time, window-dressing
organizational codes of conduct, or appeals to ad hoc abstract moral theories are unlikely to provide
practical guidance to today’s managers in the responsible analysis and resolution of urgent moral
and/or legal issues (Badaracco 1997). What is needed is an interdependent moral and legal
framework that discloses the complex roots of inappropriate managerial decisions and provides
comprehensive practical remedies to reduce the likelihood of “Enronitis” and future white-collar
crimes. Such a structured framework and set of remedies are presented through discussion centered
around the following issues: the neglect of integrity capacity by managers, Enron executive practices
that led to stakeholder harms, and recommendations for improving managerial integrity capacity in
light of the Enron scandal.

The Neglect of Integrity Capacity by Managers

The neglect of managerial integrity capacity is at the moral root of Enron’s legal and financial
problems. What is legally permissible today, but morally questionable, may well become legally
proscribed tomorrow. Thus, it is important for managers to proactively understand and attend to the
multiple dimensions and moral antecedents of illegal activity (Paine 1994). Integrity capacityis the
individual and collective capability for the repeated process alignment of moral awareness,
deliberation, character, and conduct that demonstrates balanced judgment, enhances ongoing moral
development, and promotes supportive systems for moral decision making (Petrick and Quinn 2000).
It is one key intangible asset that acts as a catalyst for reputational capital and its erosion can
jeopardize the survival and credibility of organizations and markets (Petrick, Scherer, Brodzinski,
Quinn, and Ainina 1999). The spectacle of top Enron executives “pleading the Fifth” in Congressional
hearings about managerial immoral and illegal conduct is a vivid example of the consequences of the
neglect of individual and organizational integrity capacity (Cruver 2002; Swartz and Watkins 2002).
Furthermore, the frantic effort of Arthur Andersen, LLP, one of Enron’s critical stakeholders whose
integrity capacity and reputation were shattered by their unprofessional auditing services, to stem the
tide of fleeing clients while negotiating with other “Big Five” accounting firms for sale of parts of its
business, is another dramatic example of the costs of integrity capacity neglect (Toffler and Reingold
2003).
Managers and organizations with high integrity capacity are likely to exhibit a coherent unity of
purpose and action in the face of accountability pressures rather than resort to moral evasions or
other forms of irresponsible managerial decision-making (Petrick and Quinn 2000). Managers and
organizations with low integrity capacity (those that do not walk the talk in the process of daily
transactions, those that exercise poor or distorted judgment in policy formulation, those that never
morally mature beyond manipulative acquisitiveness and domination rituals, and those that refrain
from enacting supportive contexts for sound moral decision making) erode their reputational capital
and engender management distrust and stakeholder wrath (Sejersted 1996).

Many managers implicitly adopt the myth that the top management interest is always synonymous
with corporate success and public welfare (Mokhiber and Weissman 1999). Since fifty-one of the
world’s largest economies are corporations, many corporate executives are often not held accountable
for betrayal of multiple stakeholder interests; they expect aristocratic privileges without accountability
(Kelly 2001). By succumbing to greed in secretly exercising stock options and to dishonesty in falsely
reporting the performance reality of the firm to other stakeholders, top Enron managers abandoned
the basic standards of process integrity capacity. The exposure of integrity capacity neglect by
managers justifies the need to focus on the guidance offered by the construct of integrity capacity in
the Enron scandal.

Enron Executive Practices and Stakeholder Betrayals

In December, 2001 Enron, the seventh largest U.S. corporation, collapsed and produced the second
largest corporate bankruptcy to date in U.S. history (Cruver 2002; Fusaro and Miller 2002). More than
ten Congressional committees are currently pursuing inquiries, over thirty Enron-related bills have
been introduced to address the scandal-related problems, and the full extent of collateral damage to a
wide range of Enron stakeholders is yet to be determined.

While the definitive account of the Enron scandal is yet to be written, some key elements are clear.
First, rising stars like former Enron CEO Jeffrey K. Skilling and ex-Enron CFO Andrew S. Fastow
created and implemented business ideas that led to major problems, which could not be legally or
ethically fixed, resulting in their downfall (Fusaro and Miller 2002). Second, among the big ideas was
the creation of an “asset light” company by applying Enron’s trading and risk management skills to
power plants and other facilities owned by “asset heavy” outsiders. To maintain a high credit rating
and raise capital, Enron relocated many of its assets off the balance sheet into complex off-the-book
partnerships or Special Purpose Entities (SPEs). The problem with this big idea was that some SPEs
required Enron to kick in stock if its rating and stock price fell below a certain point. In fact, Enron was
left holding a financial liability of over $5 billion in debt. When its stock and asset values began
declining, Enron was immediately vulnerable to financial overextension (Cruver 2002). Third, another
big idea was the expansion of Enron’s energy trading expertise into a wide array of new commodities
to spur earnings growth – everything from paper goods to metals to telecommunication broadband
capacity (Swartz and Watkins 2002). The problem was that Enron tried to do too much, too fast, with
little or no return (Fusaro and Miller 2002). Enron invested $1.2 billion in fiber-optic capacities and
trading facilities, but the telecommunications broadband market collapsed. Furthermore, it could never
generate adequate profits from energy trading in markets, such as metals, to cover the billion dollar
mistakes (Cruver 2002). In effect, people, processes, policies and principles that aided and
implemented the rush to financial growth at any cost all contributed to the Enron scandal.

A partial identification of Enron stakeholders and the business practices that betrayed their interests
are provided in Part I of the Appendix. Part I consists of sixteen stakeholder groups divided into
primary stakeholders, secondary stakeholders, and tertiary stakeholders, along with specific Enron
business practices that led to major stakeholder moral harms.

The Enron scandal’s adverse moral impact on the primary stakeholders is evident in Part I. Enron’s
top managers chose stakeholder deception and short-term financial gains for themselves, which
destroyed their personal and business reputations and their social standing. They all risk criminal and
civil prosecution that could lead to imprisonment and/or bankruptcy. (Board members were similarly
negligent by failing to provide sufficient oversight and restraint to top management excesses, thereby
further harming investor and public interests (Senate Subcommittee 2002). Individual and institutional
investors lost millions of dollars because they were misinformed about the firm’s financial performance
reality through questionable accounting practices (Lorenzetti 2002). Employees were deceived about
the firm’s actual financial condition and deprived of the freedom to diversify their retirement portfolios;
they had to stand by helplessly while their retirement savings evaporated at the same time that top
managers cashed in on their lucrative stock options (Jacobius and Anand 2001). The government was
also harmed because America’s political tradition of chartering only corporations that serve the public
good was violated by an utter lack of economic democratic protections from the massive public
stakeholder harms caused by aristocratic abuses of power that benefited a select wealthy elite.

The Enron scandal also harmed secondary and tertiary stakeholders. For example, Enron top
managers pressured Arthur Andersen to certify maximum-risk, questionable accounting practices in
part to retain their lucrative consulting business and, by acceding to this pressure, Arthur Andersen
won huge contracts in the short run but ultimately lost their professional credibility and client base
(Toffler and Reingold 2003). A parallel process occurred in the legal profession when Enron
managerial pressure on Vinson and Elkins to legally condone investor and employee fraud prevailed.
Again, Citigroup, J.P. Morgan, and Merrill Lynch made over $200 million in fees from deals that helped
Enron and other energy firms boost cash flow and hide debt, and, by failing to exercise their own
adequate due diligence, they multiplied the harm done to other stakeholders. The industry’s
reputation, furthermore, was tarnished by Enron’s aggressive market leadership practices, the
taxpaying public incurred additional shifting risk to eventually cover bankruptcy collateral damage, and
ultimately America’s stature as a model of democratic capitalist practices was replaced by fear of the
global export of Enron-like corporate irresponsibility and crony capitalism (Mitchell 2002; Sirgy 2002).

These multiple stakeholder damages can be viewed as the result of serious lapses in the four
dimensions of management integrity capacity–process, judgment, development, and system as
indicated in Part II of the Appendix. Understanding and correcting these lapses provides a structured
way to address the moral roots of current stakeholder remedies and reduce the likelihood of future
Enrons.

Process Integrity Capacity and Enron

Process integrity capacity is the alignment of individual and collective moral awareness, deliberation,
character, and conduct on a sustained basis so that reputational capital results (Petrick and Quinn
2000; Rest, Narvaez, Bebeau, and Thoma 1999). The need to address lapses in process integrity
capacity is manifest by the routine fragmentation of managerial moral attention and behavior that
arouses stakeholder concern about the moral hypocrisy of management practices (e.g., Enron top
managers tout their public relations images as responsible corporate citizens while defrauding
investors and employees and secretly lining their own pockets with diverted funds) (Brunsson 1989;
Messick and Bazerman 1996).

While it is unlikely that Enron executives failed to perceive the relevant moral issues, it is clear that
they were not sensitive to them. They appeared to be erroneously and overly confident of their initial
distorted perceptions of morally acceptable business conduct, and when challenged, as Fastow was
regarding the appropriateness of his financial structures, retaliated against accusers and sought
information in ways that confirmed what they already believed (Messick and Bazerman 1996). Since
top management and board members ignored whistleblower feedback, they became morally blind,
deaf, and mute, thereby diminishing their capacity for ethical awareness and eventual strategic
responsiveness—for which they are held morally accountable (Cavanagh and Moberg 1999; Swartz
and Watkins 2002). Moral deliberation, the second component of process integrity, is the capacity to
engage in the critical and comprehensive appraisal of causal factors and recognized moral options to
arrive at a balanced and inclusive reasonable decision/resolution/policy that provides a standard for
future determinations (Petrick and Quinn 1997). The decision making style of the Skilling-Fastow-
Kopper circle demonstrated a tendency to suppress all but one aspect of a moral decision, i.e., its
short term financial impact, and to exclude other parameters that might inhibit decisive action or
constrain executive perks (Messick and Bazerman 1996). Enron managers and board members, who
poorly analyzed and resolved moral conflicts of interest through self-centered policies also ignored or
trivialized the harm caused to other stakeholders. For their diminished capacity for balanced moral
deliberation Enron managers are held morally accountable (Fusaro and Miller 2002; Swartz and
Watkins 2002).

Moral character, the third component of process integrity, is the individual and collective capacity to be
ready to act ethically. The greed, dishonesty, arrogance, selfishness, cowardice, hypocrisy,
disrespect, and injustice that characterized top Enron executives’ intentions discloses their culpable
motives and the corrupting workplace culture they created (Sennett 1998). The overemphasis on
personal financial gain at the expense of others destroyed any remnant of employee trust. The
visionless accumulation of rapid wealth exposed the absence of leadership wisdom and the deliberate
obfuscation of financial structures to preclude a fair picture of the financial health of the firm eroded
their characters; they de-humanized themselves and others with whom they interacted. The lack of the
political virtue of citizenship is particularly damaging to internal and external character cultivation
(Logsdon and Wood 2002).
Moral conduct, the fourth component of process integrity, is the individual and collective carrying out
of justifiable actions on a sustained basis. Managers that exhibit ethical conduct develop a reputation
for dependability and alignment of moral rhetoric and reality but the duplicitous exploitation of
employee retirement savings exposed the cruel behavioral hypocrisy of top Enron executives (Cruver
2002).

Judgment Integrity Capacity and Enron

Managers can attempt to evade full moral accountability by compartmentalizing and fragmenting their
handling of management and ethics issues. One way to address this evasion is to enhancejudgment
integrity capacity, the capability of analyzing complete moral results, rules, character, and context in
management practices (Petrick and Quinn 2000). The way Enron executives manage implicitly
commits them to certain ethics theories, and just as simplistic, distorted managerial judgments
produce poor results in handling behavioral complexity, so also do simplistic, distorted ethical
judgments produce poor results in handling moral complexity (Paine 1994; Petrick and Quinn 2000).

For business leaders and their firms, exhibiting judgment integrity means being held accountable for
achieving good outcomes (results-oriented teleological ethics), by following the right standards (rule-
oriented deontological ethics), while strengthening the motivation for excellence (character-oriented
virtue ethics), and building an ethically supportive environment within and outside the organization
(context-oriented system development ethics). Although all four theories of ethics (teleological,
deontological, virtues, and system development) can be isolated, the main point is that all four
theories are necessary to fully analyze and resolve moral conflicts.

Business leaders that overemphasize or underemphasize good results, right means, virtuous
character, and morally supportive contexts when facing morally complex problems incur the same
adverse consequences as managers that cannot handle behavioral complexity (i.e., offended
individuals, neglected opportunities, eroded trust, and corrupt environments). Enron executives,
greedily pursued short-term economic returns while manipulating the rules of their industry, ignoring
the negative morale impacts of their bad example. They exhibited poor moral judgment when they
were callously indifferent or ruthlessly hostile to contextual constraints.

The narrow focus on financially elite results by Enron executives, particularly Lay, Skilling, Fastow,
and Kopper, resulted in tragic consequences. Their evasion of regulatory rules, their corrupting abuse
of power and use of political influence, their suspension of organizational moral code and elimination
of extra-organizational guidelines, victimized many innocent stakeholders (Fusaro and Miller 2002).

Developmental Integrity Capacity and Enron

Developmental integrity capacity according to Logsdon and Yuthas (1997) and Rest et al. (1999) is
the cognitive improvement of individual and collective moral reasoning capabilities. Moral reasoning
moves from preconventional self-interested regard (collective connivance) through a stage of
conforming to external conventional standards (collective compliance), and finally, to a stage of
postconventional commitment to universal ethical principles (collective integrity).

Collective connivance is a molar stage of moral development characterized by the use of direct force
and indirect manipulation to determine moral standards. According to Sejersted (1996) managers who
sustain this stage of collective moral development are either issuing threats of force (e.g., “Get it done
now or else”) or developing exclusively exploitative relationships based on mutual manipulation (e.g.,
“What’s in it for me”? and “Forget the others.”). Collective compliance is the intermediate molar stage
of moral development characterized by the use of popular conformity to work processes and
adherence to externally imposed standards. Managers who sustain this stage of collective moral
development are either admonishing employees to secure peer approval by “getting with the program”
or commanding them to comply with organizational hierarchy and externally imposed regulations.
Collective commitment is the highest molar stage of moral development characterized by the use of
democratic participation and internalized, principled regard for other stakeholders as a basis for
determining moral standards (Petrick and Quinn 1997). Managers who sustain this stage of collective
moral development are either surveying democratic majority trends or responding to the question,
“What principled system is worth multiple stakeholders’ ongoing participation and commitment?”

The literature on organizational ethical climate assessment and development is crucial to

understanding how morally underdeveloped organizations facilitate unethical and illegal activity
(Trevino, Butterfield, and McCabe 1998; Dickson, Smith, Grojean, and Ehrhart 2001). The ethical
climate of organizations at different levels has been demonstrated to influence process and judgment
dimensions of integrity capacity (Wimbush, Shepard, and Markham 1997; Barnett and Varcys 2000).

With respect to Enron’s developmental integrity capacity, the Senate Subcommittee Report on the role
of the Board of Directors in Enron’s collapse concluded that the firm had developed a pervasive
culture of deception (Senate Subcommittee 2002). As such it was designed and operating at the level
of connivance. CEO Lay used direct force to fire any possible successor with whom he disagreed and
either he or other top Enron managers used indirect force to deceive and manipulate employees and
other stakeholders for top executive advantage. Whatever standard operating procedures were
developed at the level of conformance were honored only to the extent that they did not infringe upon
executive perks or interfere with top executives exercising a type of feudal control over internal
subjects. When external compliance threatened to restrict Enron corporate prerogatives, aggressive
tactics to reduce or eliminate regulatory standards were routinely employed. The extent and degree to
which illegal non-compliance was the cultural norm at Enron will be determined in the courts. Enron
did not reach the commitment level; it never democratized its power structures so that employee and
community input could shape strategic direction or restrain executive perks. For all intents and
purposes, the work culture of Enron was that of a moral jungle where abuse of power dominated
principled economic democratic norms; it was a moral powder keg ready to explode.

System Integrity Capacity and Enron

System integrity capacity is the alignment of organizational infrastructure and extra-organizational

environment to provide a supportive context for sound moral decision making (Driscoll and Hoffman
2000; Petrick and Quinn 2000). Managerial system accountability today is determined by the extent to
which leaders continually improve the organization’s moral infrastructure and work to improve the
external organizational environment, so that moral performance can be realistically sustained (LeClair,
Ferrell, and Fraedrich 1998).

At the organizational level, one of the key system decisions is whether to focus on a compliance-
directed system or an integrity-directed system (Petrick and Quinn 2000). Although both systems can
be complementary, world-class managers are expected to design and adhere to moral codes that
ensure a supportive intra-organizational context (barrel) for enhancing individual (apples) process,
judgment, and developmental integrity capacity. One guideline for building a compliance-based
system is the U.S. Federal Sentencing Guidelines for Organizations (FSGO). Organizations that install
a compliance-based system with whistleblower protection and uniform enforcement of company code
violations invest in this ethical risk management technique to minimize potential financial losses in the
event of illegal activity (LeClair et al. 1998). The integrity-directed approach entails processes for
internalizing organizational system moral improvement through regular organizational ethics needs
self-assessments, ethics measures in all business functions, and benchmarked disclosures in annual
audits (Petrick and Quinn 2001). The fact that Enron executives engaged in illegal activities and
overrode their own organizational code of ethics with impunity indicated that the moral infrastructure at
Enron was too weak to constrain a culture that supported rampant immoral and illegal activity.

In addition to the intra-organizational system, the extra-organizational system needs to be shaped by

managers. Managers can comply with and proactively foster regulatory standards to eliminate or
control corruption outside the organization and support those domestic and international groups that
do likewise. Managers can support harsher penalties for white-collar criminals and tougher, fraud-
detection professional association accounting standards. Managers can partner with industry, public,
and nonprofit organizations to enhance stakeholder relations in an economically democratic manner
rather than only focusing on ruthless means to extend market leadership.

Enron executives, using campaign contributions and aggressive political lobbying to affect industry
deregulation, limit liability, and minimize reporting; corrupted rather than cultivated a morally
supportive external environment (Cruver 2002). Unlike other business scandals that involved
managers who ran beneath the government radar for unacceptable business conduct, Enron
executives worked to eliminate any government radar stations that could warn and regulate
unacceptable business conduct (Swartz and Watkins 2002). Their brazen undermining of system
integrity indicates the need for extensive reform and multiple stakeholder remedies that strengthen the
moral environment and enhance the prospects of stakeholder economic democracy.

Recommendations for Improving Managerial Integrity Capacity

 If managers cannot afford to neglect integrity capacity as an important management strategic asset,
the following three practices can serve as proposed remedies. These remedies are recommended for
improving the moral resources of managers. First, the more aware managers and other stakeholders
are of the nature and importance of integrity capacity as a strategic asset, the more likely it is that they
can cooperate in nurturing it and avoid the adverse effects to its stakeholders of integrity capacity
neglect (Petrick and Quinn 2001). By gaining competence in the conscious, balanced integration of
management and ethics approaches, managers can hold themselves and other stakeholders
accountable for principled decisions that inclusively and systematically address moral results, rules,
character, and context. Thus, Practice I deals with managerial and organizational learning.

Practice I: Provide education for managers to increase awareness of the importance of (a) sustaining
process and developmental integrity capacity as a strategic management asset and (b) of accountability
for developing judgment integrity by balancing management and ethics competencies.

Second, in addition to reformed U.S. accounting and financial reporting standards, the social and
environmental accounting literature (SEAL) is now sufficiently well developed in Great Britain,
continental Europe, and Australasia to generate auditing and reporting mechanisms that are
responsive to changing patterns of stakeholder accountability (Lehman 1999). The Shell Report 2000,
for example, is available online. This report comprehensively documents the economic, social, and
environmental performance of the Royal Dutch/Shell Group of Companies, and acknowledges areas
for environmental improvement in Shell holdings in Nigeria. The transparency of this process of
deepening stakeholder relationships around core financial, as well as non-financial, values enhances
the moral credibility and reputational capital of the manager and the firm. It is just this broader sense
of managerial context accountability that is entailed in system integrity capacity as a management
strategic asset. Practice II is based on accountability.

Practice II: Expand the scope of managerial accountability to include system integrity capacity
development, including the regular implementation of transparent economic, social, and environmental
accounting systems.

Third, one of the chief impediments to system integrity improvement is the uncritical acceptance of the
belief that the exclusive fiduciary duty of corporate management is the legal maximization of investor
profits by means of a hierarchic power structure. On the contrary, expanding the scope of managerial
fiduciary duty to all stakeholders, especially employees and community, by means of an economic
democratic power structure would create a system more conducive to system integrity capacity
development (Kelly 2001; Petrick and Quinn 2001). It is this formal recognition of employee and
community contributions, for example, to corporate wealth and democratic participation in corporate
governance during the “Information Age” that are often precluded and devalued in conventional
accounting and financial documents (Mokhiber and Weissman 1999; Petrick 1998; Petrick and
Scherer 2000). Practice III is based on stakeholder economic democracy in corporate governance.

Practice III: Expand the scope of managerial fiduciary duties to include institutionalized stakeholder
democratic participation in corporate governance.

Given these three practices to improve moral resources and ethical decision making within the
organization, Part III of the Appendix provides some possible remedies for current and future
victimized Enron stakeholders.