Derivatives

Management 490 Business Strategy

Professor: Dr. Cahn

Student: Deana Brewster

Assignment: Enron Case Analysis

If you look at the top management of Enron it looks like they were hiding their ideas and risks from each other without noticing that the company was on a downward path. Enron began as a natural gas and oil company in 1986 and eventually became a Commodities Trader. Enron's CEO, Jeffrey Skilling was under pressure to realize Enron's objective, to expand to new markets, and be able to finance his bigger growth plan and not lose the company's critical investment grade credit levels. Skilling was forced to keep the investors happy. By all accounts, the tone at the top "Get it Done. Get it Done Now. Reap the Rewards" was the demise of Enron. This concept gives us an example of Enron's leadership headed by Ken Lay.

The first major fraud was Enron's executives' apparent use of Special-Purpose Entities (SPEs) to deceive shareholders and to enrich themselves. In other words Enron was applying for the loan through the SPEs meaning that these debts would not appear on their financial statements. Eventually Enron found itself in a situation where they needed to increase the number of SPEs to keep moving debt off the balance sheet and so began using its own stock as collateral. This resulted in the SPEs recording 'an increase in Enron's stock as income, which would thereby allow Enron to increase their income.

Profits generated from the SPEs were then used in order to structure off-balance sheet treatment of assets and liabilities, meaning that Enron was able to carry such transactions because of the fact that the accounting standards had not kept pace with new techniques in off-balance sheet financing. This meant that off-balance sheet items were used to keep liabilities of its books. All this was possible because Enron managed its SPEs by making sure that at least one SPE investor had put up at least 3% of the SPE's equity. In the 1990s Enron began to take many of its assets and liabilities off its reported balance sheet, because they continued using off-balance sheet vehicles to access capital and to reduce risk. As long as they followed various accounting rules it would not have to reveal many details about these financings.

Enron also resorted to recording revenues early and/or recording expenses and liabilities late. According to GAAP, revenue is recognized when the earnings process is complete and the rights of the ownership have passed from seller to buyer. However, the exact techniques used by Enron are unknown, but there are three main ways of illegally recognizing revenue. The method most commonly used was to hold the open books past the end of the accounting period to accumulate more sales; this meant that companies were holding the open books until they reached their target sales, which they might have promised to shareholders. Recording revenue when services are still due and shipping merchandise to private warehouses for storage before the sale is final, and counting the shipments as sales, were two other types of fraud.

Enron failed for a number of reasons. Enron's top management was in competition with each other, keeping everything secret. In Enron's lobby a banner spells out "The World's Leading Company": Greed was evident from the start of the company, and the culture talked about how much money they would make. The balance of culture, rewards and boundaries were completely absent.

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