Organizational Design and the Failure of Enron
This is an analysis of how the application of specific organizational-behavior theories could have predicted the failure of Enron. Although there are many types of core topics of organizational behavior, the focus of this study will be on how leader behavior and power, and motivation contributed to the bankruptcy of Enron.
In addition, a comparison and contrast will be discussed on the relationships between the board, executive management, middle managers, and the organization contributed to the failure. Many people assumed that creative accounting was the major downfall of Enron but according to Stewart (2006) “the more fundamental causes appear to have been matters of organizational design” (p. 116). Leader Behavior and Power It has been widely publicized that when CEO Jeff Skilling joined Enron in 1990 he immediately pushed the pipeline company into becoming an energy bank.
This change in process allowed Enron to become the middle man for the gas market that at that time had become unreliable due to de-regulation. This action resulted in an accelerated growth of the company. Skilling also persuaded the Securities Exchange Commission (SEC) and Arthur Andersen, an accounting firm to approve the use of mark-to market accounting (M2M) which is a technique where future profit streams normally spread over the life of a specific contract can be taken up front when the contract is signed.
Stewart (2006) stated that “Enron used this authorization to record in a single year all of the profit that would normally be recorded over a 10 to 20 year period” (p. 116). This method of accounting made the company appear to be more profitable; however, the profit based on future earnings that may or may not exist for years. Since the company appeared to be financially stable no one questioned the methods. Contributing Factors to the Organizations Failure Enron’s organizational structure contributed to a culture that it was acceptable to earn profit at any cost.
The board continuously turned a blind eye; the executives develop business deals that they knew were not profitable, and the managers conducted business as a means to obtain high bonuses. The entire organizational structure was built on self-centered incentives to motivate the employees to earn without regard for the financial health of the company or its shareholders. Motivation Motivation is defined as the process that accounts for an individual’s intensity, direction, and persistence of effort toward attaining a goal. The motivation for the organizational to reach its goal reflects a singular interest in a work-related behavior.
Enron’s organizational goals focused on fast growth and high profit margins. This singular interest was the reason that Enron’s made a critical mistakes that contributed to its failure. The organization’s leader used financial incentives as a method to encourage their employees to reach their goals. Another critical mistake was when the board approved annual bonuses to be funded based on a percentage of its reported net income. They also approved an incentive to financially reward managers based on closing deals regardless of profitability.
These types of incentives motivated employees and shaped the culture of the organization. According to Stewart (2006), in a letter to shareholders in 2000, Lay and Skilling stated, “Enron is laser-focused on EPS, and we expect to continue strong earnings performances, without a doubt, getting ahead at Enron would be a matter of producing book earnings, the more the better. (p. 116-117). Issues with Board’s Motivation The issue with Enron’s structure is that it allowed managers to use creative accounting principles on paper without any board oversight.
The board’s motivation for fast growth and increased profit put extreme pressure on management to meet goals regardless of the methods. Issues with Senior Management’s Motivation Jeff Skilling’s method to meet the demands of the board, allowed his CFO to change their finance department into a “profit center” in an effort to continue Enron’s aggressive earning targets. To continue to reach their goals, they continued to pressure managers to find deals and unique ways to show profit on the books. These policies were factors that contributed to the organizations failure.
In 1999, Skilling agreed to a plan that would earn potentially 100 million dollars in profit with a capital base of 7 billion dollars. This amounts to several million dollars in losses but faced pressure to continue growing; Fastow would find deceptive accounting methods to make it appear profitable on paper. Stewart (2006) stated, “The outcome was as predictable as it was unfortunate” (p. 117). Issue with Middle Manager’s Motivation This pressure from top management created a culture for managers to engage in similar practices when conducting trades.
An example of this is that managers failed to deduct the cost for using shareholders capital. They would also treat fee income as a reduction in initial capital investments instead of a component of ongoing earning and treat loan proceeds as cash flow (Stewart 2006 p. 117). Organization Behavior with Systematic Study Enron failed to define their organizational structure in terms that would ensure the financial stability of the shareholders, corporation, and employees. According to Rapoport (2009) p. 23), “never base your structures on the presumption that people are good (even if you believe that the are [sic]).
Enron based its organizational structure on potential earnings and spent earnings that did not exist by paying themselves large salaries and bonuses. Enron’s board did not take measures to ensure that the profits that were being cited on the balance sheet were legitimate. Enron did not develop incentives that demanded true performance from their managers. They were only concerned with the balance sheet and engaged in risky deals that failed to measure up. This company’s failure based on organizational behavior study clearly predicates a recipe for failure.
Enron needed a board that used oversight to protect shareholders, incentives that motivated employees to produce real profits, and management that ensured the financial stability.