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wanjiru wanjiru

on 6 December 2013

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Transcript of ENRON SCANDAL

Enron: House of Cards
Enron Organizational Chart June 2000
Timeline of Events
Special Purpose Entities (SPEs)
Mark-to-market accounting treatment
Implications of the scandal
California energy crisis
Enron origins
Structure of Enron
Timeline of events
Key issues that caused the fall
Mark-to-market accounting treatment
Special Purpose Entities (SPEs)
Executive compensation
Rank and Yank performance assessment tool
California Energy Crisis
Weak oversight from regulatory bodies
Obscure financial statements revealed
Implications of the scandal

Origins of Enron Corporation
It allowed Enron to book potential future profits as soon as a contract was closed despite no money being received
Cost related to the contracts were hard to predict
To the outside world, Enron's profits could be whatever Enron said
Enron's figures were overly optimistic and inflated
By mid 2001 they had a cash crisis because they mostly had paper cash

Crimes of Enron Board
Fate of Key Players
Fiduciary Failure-failed to safeguard Enron shareholders
High Risk Accounting-knowingly allowed Enron to engage in high risk accounting practices.
Inappropriate Conflicts of Interest-allowed Enron’s CFO to establish and operate the SPE's which transacted business with Enron and profited at Enron’s expense.
Extensive Undisclosed Off-The-Books Activity-failed to ensure adequate public disclosure of material off-the-books liabilities
Excessive Compensation-approved excessive compensation for company executives
Lack of Independence-certain board members had financial ties with the company
Tan Yeong
Juliet Maina
Wanjiku Kiarie
Causes of Enron's demise
Mark-to-market accounting
Special Purpose Entities (SPEs)
Executive compensation
Rank and Yank appraisal system
California energy crisis
Weak oversight bodies
Revelation of obscure disclosures
SPE are legal entities used as off-balance sheet vehicles
Legal requirements for an SPE:
(1) at least 3% of the equity had to come from outside investors (i.e. not-Enron)
(2) the entity could not be controlled by Enron
(3) Enron was not liable for any loans or other liabilities.
They were not independent since they were run by Enron employees
They had to be disclosed in Enron's financial statements depressing earnings and debt levels severely
Between 1996 and 2000, the average chief executive salary and bonus increased by 24% to $1.72 million, according to a Forbes study of proxy reports.
Total CEO compensation, including stock options and restricted stock grants, grew 166% to an average of $7.43 million. In the same period, corporate profits grew by 16%, and per capita income grew by 18%. (source: Forbes Magazine)
Executive Compensation
Bottom 10% are laid off
Steered competition instead of cooperation
Forced employees to use unethical means to make money for the company
'The end justifies the means'
Bonuses were based on the ranking
Rank and Yank appraisal method
20000 employees were laid off
Loss of pension
As of December 31, 2000, 62% of the assets held in the corporation’s 401(k) retirement plan consisted of Enron stock.
Financial community and the economy
The rules for company financial reporting and corporate governance were drastically sharpened: Sarbanes-Oxley Act (2002).
Investors trust was destroyed as they lost $60 billion in a matter of days.
Arthur Andersen (LLP) lost its license to do business
Banks that did business lost their credibility i.e. JP Morgan Chase, Citibank, Merrill Lynch
Enron was a member of the S&P 500 index
Some on Enron's projects were shut down e.g. Dabhol plant in India and Azurix water plant in UK
Electricity price increased
Kenneth Lay, Founder, Chairman and CEO, convicted but died in 2006, months before his sentencing

Jeffrey Skilling, HBS graduate, former employee of McKinsey, CEO of Enron from Feb 2001, advocate for mark-to-market, launched Enron Online. Sentenced 24.3yrs

Andrew Fastow, CFO, mastermind of the SPEs, pleaded guilty, got a lighter sentence of 6yrs from 10yrs in exchange of testifying against Lay, Skilling and other former executives

There should be a healthy corporate culture in a company. Senior executives believed Enron had to be the best at everything it did
Business ethics is the most thesis point people doing business should focus on. Enron put earnings before scruples-profits at all costs-the end justified the means
There is need for more regulation and better governance.The lack of it is what brought Enron to its knees.
Establishment of an ethics committee that is independent of the company to check on the company's compliance to its code of ethics
Weak oversight bodies
Conflicts of interest and a lack of independent oversight of management by Enron's board
Conflict of interest between the two roles played by Arthur Andersen, as auditor but also as consultant to Enron
US Security and Exchange Commission allowed them to use “mark to market” accounting method
The CFTC's primary mission is to ensure that the commodity futures and options markets operate in an open and competitive manner
FERC regulates the interstate transmission and market for energy products
Kenneth L. Lay
(Board Chairman)
Andrew S. Fastow
Jeffrey K. Skilling
Obscure disclosures
October 16, 2001 Enron announced its first quarterly loss
November 8, 2001 it announced restatement of its financial statements back to 1997 to reflect consolidation of SPEs it had omitted
Resulted in a loss of $591 million plus liabilities of $628 million as of end of 2000
Founded by Kenneth Lay in 1985 through a merger of Houston Natural Gas and Internorth, two natural gas pipeline companies
largest marketer of natural gas and electricity in the US
7th largest company in the US
Voted by Fortune 500 as the most innovative company 6 times in a row
Enron's operations
Wholesale services unit - responsible for marketing wholesale commodity products that allowed industrial companies to hedge against price fluctuations and commodity delivery
Energy services unit - retail arm of Enron. Offered energy services to commercial and industrial companies
Global services unit - included pipeline businesses like Northern Natural Gas, engineering services like Enron Wind, and Enron-Online an e-commerce site for global commodity transactions
1985 and 2000 comparison
Full transcript