Enron, board

governance and
moral failings
Gerald Zandstra
Gerald Zandstra is Director of Programs at the Acton Institute for the Study of Religion and Liberty, Michigan, USA.

Keywords Directors, Ethics, Responsibility,
Corporate governance
Abstract The failure of the Enron Corporation has brought
attention to the roles played by the chief executive officer and
other executives of the modern corporation. Its failure has also
produced discussion of further regulations that will, it is hoped,
prevent another collapse similar to that of Enron. This article
argues that the central reason for Enron’s crash was not a lack
of regulations or the deceptions of executives but rather a failure
of the board of directors of Enron to function in a morally and
ethically responsible manner.
Introduction
focused on information. It insists that investors have quarterly
access to information that will allow them to gain a firm sense
of the corporation’s financial situation as well as immediate
access to critical information.
The second broad principle pertains to chief executive
officers (CEOs) and other executives and their accountability
to investors. The CEO must personally vouch for the truth,
timeliness, and fairness of information sent to investors and
cannot benefit from financial statements which provide false
or misleading information. Instead of the lag time currently in
the system, the President proposes that executives who buy
or sell stock be required to more quickly inform the public.
Those who are found to be in violation would lose their right

T
he stock of publicly held companies rises and falls on
to serve in a position of corporate leadership.
the leadership of its executives and its board of
The third principle addresses audits. In the President’s
directors. President Bush recently developed a plan to
plan, it would be expected that investors would be able to
address key issues involved in corporate responsibility. His
have complete confidence in financial audits and that those
plan, however, fails to take into account one of the most
doing the audits be held to the highest ethical and
important weaknesses in the corporate governance: the
professional standards.
board of directors. Ultimately the public and especially the
Unfortunately, none of these principles addresses the role
shareholders have to trust that the board charged with
of the board of directors. While executive behavior and
company oversight will act in the best interest of the
information and auditing are certainly important matters that
company. The board is the recipient of the public and
must be considered, it is important to look carefully at the
shareholder trust and, in addition to portraying confidence to
makeup, expertise, and responsibility of the board to
investors, it is responsible to see that wise decisions are
determine if part of the blame for Enron’s collapse belongs to
made and that the law is being followed.
the board.
What role did the board of directors play in the collapse of
Enron and how will President Bush’s solutions address the
situation?

Presidential solutions
On March 7, 2002, President George Bush outlined his plan The current issue and full text archive of this
to improve corporate responsibility and protect America’s journal is available at
shareholders. The plan has three core principles. The first is http://www.emeraldinsight.com/1472-0701.htm

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The Enron board of directors
One look around the Enron board room in 2000 would instill
confidence in any investor who could be assured that the
company was in the hands of legal, ethical, political, and
economic leaders. Surely they would be sufficient gate-
keepers. In addition to Kenneth Lay and Jeffrey Skilling, there
were 15 external directors whose resumes were impeccable.
These were people with a combined total of several hundred
years worth of board oversight.
The expertise in the room is astounding. There are people
who have served as CEOs in several companies, as bank
executives, as capital management leaders, and several who
are familiar with the gas and oil business.
There are several law degrees and one person who
served as the dean of a law school. There are two
physicians. One current university president sits next to one
who is now emeritus. Multiple Harvard MBAs can discuss
their alma mater with one of its current professors in
government. One director has written multiple articles for the
Journal of Law and Economics.
The board has political experience with one member who
has served in the British Parliament, one member who is an
expert in anti-regulatory legislation, and several who have
served in one political capacity or another. They were
international, with people from or with expertise in Asia,
Europe, South America, Africa, and the Middle East. One
was an elder at his Presbyterian Church and almost all had
served or were serving on at least one non-profit board of
directors. Taken together, these 15 external directors had
served on at least 130 boards of directors of both for-profit
and non-profit organizations.
Companies are about leadership and the board of Enron
certainly had it in 2000. They had the expertise to know what
to do. They also had the incentive as many of them had
extensive Enron holdings in addition to their $300,000 annual
compensation for their board service.
Who could doubt the viability of Enron? The company’s
business was complicated to be sure. But with Lay
and Skilling driving the ship and this talented board of
directors charting the course, no one would doubt that
Enron would remain a world business leader for a very
long time.
So what happened? Where was Enron’s board of
directors? How could this group of world-class business,
political, and legal leaders allow such a catastrophe to occur
on their watch? Enron has exposed one of the issues which
modern corporations and all stockholders must face: the role
of the board of directors in today’s companies. Another
Enron will not be prevented by a new series of regulations or
laws or accounting practices. Creative accountants and
savvy executives will always find ways around such attempts
to control them. Adding laws to the legal code does not
necessarily solve the problem of crime.
The development and function of the board of
director system
Samuel Gregg (2001, p. 11) makes the argument that the
roots of the corporation can be found in the Middle Ages.
Stanley Vance (1983, p. 3) tells the story of Alexander
Hamilton’s corporation, ``The Society for Establishing Useful
Manufactures’’ as an example of an early American
corporation and it is interesting to note that the company
failed ``because the absentee outside directors failed to
involve themselves in the affairs of the enterprise.’’ Despite
similar failures, the corporate concept quickly spread so that
``by 1800, the US had more business corporations than all of
Europe combined’’ (Gregg, 2001, p. 12).
While each corporation is governed by state statute and
no state has legal requirements to be eligible for board of
director membership, each board of directors has at least
the following three functions. First of all, the board of
directors is responsible for lending an air of legitimacy to the
corporation. While this is a passive function, it is important
that the company have a board made up of people with
some prestige attached to their name. They ought to be
people with expertise and experience in business. Their
involvement ought to lend a level of confidence to the
enterprise and those who purchase stock in it. But it is vital to
remember that this is not where board responsibility ends.
The second function is focused on auditing and legal
requirements. The board is entrusted with the duty of
ensuring that any information given to stockholders, the
public, and the government is accurate. Auditing oversight is
usually completed by an auditing committee, which is a
subset of the board. The entire board is responsible to
ensure that every legal requirement is met. Neither of these is
a simple task. Both require a high level of specialization in
finance and law. Those on the auditing committee certainly
must be able to read a financial report with the eye of an
expert who is able to discern the location and depth of
trouble spots which threaten the vitality of the company.
The third is more of a directorial role. The corporate board
of directors is expected to determine, modify, and approve a
business plan. Obviously, corporate executives are
responsible for entering into dialogue with the board, framing
the discussion, giving input and implementing board
decisions. This may be one of the more difficult aspects of
being a board member in a corporation with thousands of
employees, projects that extend around the world, and a
level of complexity that few can master. The difficulty is one
of knowledge. It is far more difficult work now than it was for
those who made up the board of Alexander Hamilton’s
corporation. But the primary legal responsibility for the
direction of the company remains in the hands of the board
of directors.
These three functions are aimed at preserving the
stockholder’s equity and the stock’s value. They are also
aimed at providing the best service possible for the
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customer, a matter upon which the survival of the
corporation depends. Failure to take seriously these three
functions leads to collapses similar to that of Enron and, in
the end, are moral failures on the part of those who serve in
the board of directors.
The moral obligations of directors
The representative nature of a board
The real issue of Enron’s and every other corporate board is
a moral one. Those who accept public responsibility for
oversight must be diligent in their tasks no matter if they are
paid or volunteer. This is certainly not unique to a board of
directors in a corporation. The public is reliant on a variety of
people in whom they have placed their trust. All sorts of
organizations represent the citizens and do for them what
they are not able or willing to do for themselves. Police, fire
fighters, politicians, teachers, housing inspectors and a host
of other government and non-government groups take upon
themselves certain public responsibilities. And they are
expected to take their duties seriously. Failure to do so can
cause significant physical harm, loss of property, and in
some cases, loss of life.
A board of directors is no different. It is supposed to act
on behalf of shareholders. Directors are also aware that their
actions, or their failure to act, can have serious
consequences beyond merely the shareholders, to whom
they are primarily responsible. In Enron’s case, the collateral
employees have lost their jobs and retired employees have
lost the funds on which they depend. Mutual fund investors
have also felt the impact of a serious drop in value of Enron
stock. Beyond that, Enron’s accounting irregularities have
caused other companies to fall under a shadow of suspicion
that has hindered the stock market for several months.
When boards fail in their moral obligations
In his book, Servant Leadership, Robert Greenleaf (1991,
p. 101) writes that if directors:
. . . satisfy legal requirements and give the cover of legitimacy but
little more, is not this arrangement neglect by trustees? Who is being
deceived? At whose expense is this carried on? One is inclined to
answer ``All of those who are served by or depend on the institution,’’
which, if it is a major one, can be a large number of people.
Some sense of the true number of people affected when a
board of directors fails in its moral obligations is brought into
view when it is remembered that ``publicly-listed corporations
constitute barely 1 percent of all business organizations. Yet
in 1997, they produced more than half of the United States’
economic output’’ (Gregg, 2001, p. 10).
None of this is to argue that being a board member is a
simple matter. Louis Cabot once described his experience of
serving on the board of Penn Central Railroad as it struggled
through the 1970s and 1980s. He said:
We were treated like a rubber stamp. Board meetings would last only
a half an hour. We’d start with the waiving of the minutes of the prior
meeting, and then we’d have only a summary of those. Then we’d
slog through a long list of capital expenditures, item for item for
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hundreds of different locations you never heard of . . . .Then we’d turn
to the financial reports. They weren’t in any form I’d ever seen. They
were summaries. They didn’t show all the facts that later turned out to
be crucially important (Waldo, 1985, p. 4).
Sins of commission and omission
Enron did not fail because it was not a viable business. It did
not collapse because it failed to make a profit. Ultimately, it
failed because of its deceptions. There is no doubt that some
of Enron’s business decisions showed poor prudential
judgment. But every organization makes bad business
choices and most of them survive. Enron failed because its
board failed. Either they knew what was happening with the
secret partnerships, conflicts of interest, and the cooking of
the books, in which case they are culpable for a sin of
commission. Or they were inept, slothful or simply did not
understand their role as members of the board of directors at
Enron, in which case they are culpable for a sin of omission.
Perhaps there is one further option: they should be
exonerated and the blame should be laid at the feet of the
executives. But before anyone rushes to this conclusion, it is
important to hear the words of Enron’s own board on its
actions. Three members of Enron’s board were given the
task of performing an investigation of the company and its
business practices in light of its implosion. The assignment
was given in late October of 2001, following the disclosure of
hidden debt and exaggerated profits. The report was made
public on February 1, 2002.
Those issuing the report claim that the board ``cannot be
faulted for the various instances in which it was apparently
denied important information’’ (Powers et al., 2002, p. 23).
This statement would defend them against the charge that
the board committed an act of commission. In other words,
the committee does not believe that the board had all the
facts that were required to know the true state of affairs of its
own company.
But sins of commission are not the end of moral and
ethical issues. There are also sins of omission in which a
person fails to do what they agreed to do. What others are
depending on them to do. What is is good and right. Sins of
omission are those which, by inaction, do what is hurtful and
wrong. The investigative committee believes that Enron’s
board failed:
. . . it can and should be faulted for failing to demand more
information, and for failing to probe and understand the information
that did come to it (Powers et al., 2002, p. 23).
A description of moral board behavior
Samuel Gregg provides a solid overview of the moral
responsibilities of the board:
Directors must be able to identify the key issues facing the
corporation. They must be able to ask the questions necessary to
safeguard the owners’ interest and obtain, evaluate, and act on the
answers. Their responsibilities are to ensure that the corporation
remains loyal to its corporate purpose, to exercise prudential
judgment, and to demonstrate moral courage in carrying out these
functions (Gregg, 2001, p. 16).
In short, the board of directors in every corporation must
provide moral leadership in which the truth is sought
vigorously and told completely. In which responsibilities are
taken seriously. In which integrity matters. They must
demand accurate, relevant, and up-to-date information.
Transparency is vital to the free market and one of its
foundational principles. Without transparency at all levels, the
market system will not function to its fullest potential and
corruption will be systemic. And transparency, for the
corporate world, begins in the boardroom. The temptation to
artificially drive up stock prices, to invent profits and to hide
losses is too great for those whose jobs depend on results.
Without the board insisting on and guaranteeing
transparency, the checks and balance system of the
corporate market system will fail.
Perhaps in the short term, board members are content to
do little. Greenleaf writes that ``nominal trustees customarily
accept, somewhat uncritically, data supplied by internal
officers and take no steps to equip themselves to be critical.
They restrict themselves to affirming the goals that are set by
the administrators and staffs’’ (Greenleaf, 1991, p. 99).
Those who ask hard questions and demand truthful
answers may not be voted in again. Holding an executive
accountable might cause public jitters and a drop in the price
of the stock. While this might be temporarily true, it is a failure
to see beyond the agenda of the day. Enron is a fine example
of what happens when the board of directors does not
exercise its authority, ask questions, and demand
accountability from its executive leadership. It shows the
result of short-term omissions that cause long-term
devastation.
Assuming that Enron’s board was unaware of the true
state of the company because of misleading information
from Kenneth Lay and Jeffrey Skilling, it is appropriate to ask
whether or not they could have discovered such information
with more effort. It is instructive to note that the special
internal investigative committee of the board was able to
produce a 203-page report within three months of being
commissioned with the task.
It is also important to remember the depth and variety of
knowledge and experience on Enron’s board. They are
bright, competent and seasoned business leaders. They
know the law and they know accounting. They know how to
read a financial report and they know what questions to ask
to ascertain the truth. And yet they claim to have failed to see
the collapse coming off in the distance. It is this fact that led
Rep. Chris John, R-LA to declare to members of Enron’s
board appearing before his committee:
The board has a responsibility. You can only say ``They didn’t tell us’’
. . . .You were paid $300,000 a year and you didn’t know? That’s just
amazing (Beltran, 2002, p. 1).
Conclusions
Board membership is a serious matter. It is not about padding
a re
Âsume  or receiving high fees for little work because of one’s
reputation. It is not about filling the boardroom with people who
will be pliable tools in the hands of executives. It is about
courageous moral leadership that asks tough questions,
insists on complete answers, and takes its role in the company
and in society seriously. As Enron demonstrates, the impact of
such failures is wide and deep. The stock market continues to
struggle as it wonders if there are other time bombs ticking
away. Thousands of people have lost their retirement funds. At
last count, there were no fewer than nine congressional
committees investigating.
Could a properly functioning board have prevented the
collapse? Yes, if its members were willing to take their
responsibility seriously. Those who are unwilling to shoulder
the ethical responsibilities to shareholders and the public
should not allow themselves to be nominated to any board of
directors. The potential for significant damage to the nation,
the economy, and individual lives is too great to have
anything less than serious leaders in board of director
positions.
References
Beltran, L. (2002), ``Enron: fathow takes fifth’’, (accessed 2 February).
Available at: http://money.cnn.com/2002/02/07.news/
enron_hearing/
Greanleaf, R. (1991), Servant Leadership: A Journey into the Nature of
Legitimate Power and Greatness, Paulist Press, New York, NY.
Gregg, S. (2001), Corporations and Corporate Governance: A Return to
First Principles, The Centre for Independent Studies, Sidney.
Powers, W., Troubh, R. and Winokur, H. (2002), Report of Investigation
by the Special Investigative Committee of the Board of Directors of
Enron Corp, Enron Corporation, Houston, TX.
Vance, S. (1983), Corporate Leadership: Boards, Directors, and
Strategy, McGraw-Hill, New York, NY.
Waldo, C. (1985), Boards of Directors: Their Changing Roles, Structure,
and Information Needs, Quorum Books, Westport, CT.
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