The Smartest Guys in the Room

2 February 2017

The purpose of this paper is consider three possible rationales for why Enron collapsed—that key individuals were flawed, that the organization was flawed, and that some factors larger than the organization (e. g. , a trend toward deregulation) led to Enron’s collapse. In viewing “Enron: The Smartest Guys in the Room” it was clear that all three of these flaws contributed to the demise of Enron, but it was the synergy of their combination that truly let Enron to its ultimate path of destruction.

As in any organization, the executives ultimately drive company policy, practices and accepted behavior. The three key executives that led Enron down its fatal path were, Ken Lay, Jeff Skilling and Andy Fastow. Like most successful leaders they possessed intelligence, ingenuity and a charisma that inspired those around them. Unfortunately, those same characteristics instilled them an exaggerated sense of pride, arrogance and greed. While it was widely know that Ken Lay was a prime example of the American Dream, he proved to be an ethical nightmare for those around him.

The Smartest Guys in the Room Essay Example

Despite what one would imagine as an ethical upbringing as the son of a Baptist minister, Ken Lay showed none of those characteristics as an executive and leader of Enron. One of his first and possibly most telling unethical actions was that of his handling of the traders of the Valhalla, NY trading scandal. The Valhalla trading scandal erupted because of the discovery that rogue traders were diverting funds into their personal accounts. When this was discovered by Enron’s internal audit committee and suggested to Ken Lay that they be fired, the idea was quickly dispatched.

Ken Lay stated that “the traders made too much money to let them go”. This simple statement was evidence of what Ken Lay valued most, money. By ignoring suggestions that the rogue traders be fired, he further instilled this type of unethical behavior. It seems evident that Ken Lay used Gellermans rationalization that because the activity helps the company, the company will condone it and protect the people that engage in the activity. This rationalization comes into play on two levels in this instance. Since the traders were the ones making huge profits for the company, they believed that any superiors would condone their actions.

Likewise, Ken Lay believed that preventing those traders from being fired would ultimately improve the financial condition of the company and thereby improve its status with shareholders and the board. Due to those rationalizations he believed his actions would be condoned. It was until the traders ceased to make large profits for the company that they were finally fired. While Ken Lay greatly admired those who could generate money by their actions, those who had the idea’s for those actions were held in even greater regard.

There was no other executive who personified that role greater than Jeff Skilling. From trading natural gas to pursuing the electricity market, Jeff Skilling was brimming with new and in some regards revolutionary business ideas. These ideas were the source of much of Enron’s potential for success. One of Jeff’s most influential ideas was the concept that Enron should switch to mark to market accounting. In laymen’s terms, mark to market accounting allowed profits to be booked on Enron’s income statement that had not actually been realized yet. They were in essence, future expected profits.

While not entirely an unethical practice, it proved to be the major catalyst for some of Enron’s future unethical behavior. Jeff possessed many characteristics that would label him as a charismatic tyrant. The most compelling part of his personality in this regard was his attitude toward his own ideas. Part of his reasoning for moving to mark to market accounting was that people in the future should not be able to book profits for ideas that were not originally theirs. He also believed that his was uniquely intelligent and therefore should not have dissent from those surrounding him or even those above him.

In accordance with this, because his traders were the main source of income for Enron, he believed that they should be catered to and admired, no matter how they achieved their profits. All of these factors contributed to Jeff’s unwillingness to concede his wrongdoing, right through his trial after the collapse of Enron. While Jeff Skillings’ traders were making a killing for Enron, many of their other projects were disasters. The man who allowed Enron to continue operating despite massive losses from their core operating business was Chief Financial Officer, Andy Fastow.

To finance Enron’s existing activities, they needed massive amounts of capital. Most notable were the special purpose entities also known as SPE’s that chief financial officer Andy Fastow created for Enron. These off balance sheet subsidiaries were created primarily to obtain additional financing without having to tarnish its balance sheet with additional long term debt. In conjunction with these SPE’s, Andy Fastow created many complex financial structures which allowed Enron to continue its operations without having to account for ebt or losses that law abiding corporations would place on their balance sheet or income statement.

While complicit in the deception of investors and the general public, Andy Fastow most likely used the idea of diffused responsibility to justify his actions. Before being able to create these special purpose entities, both the board of directors and Enron’s accounting firm Arthur Anderson approved of the proposed entities. This would have left Andy Fastow with the sense that was he was doing was acceptable and therefore there were no impropriety on his part.

Even if this justification was not enough, Fastow, much like Ken Lay, could have used another rationalization from Gellerman. He most likely believed that since it was signed of on by the board and their accounting firm that the activity was within reasonable ethical and legal limits and that it was not “really” illegal or immoral. With their own improprieties being internally justified, Lay, Skilling and Fastow paved the way for immoral behavior to run rampant throughout Enron. This resulted in associates at all levels approving of, and even modeling the behavior of their so called leaders.

This created a flaw in the organization which contributed to furthering already great problems at Enron. As with any company large or small, culture and ethics are shaped from the top down. Their adventuresome excursions hammered home the point that Jeff Skilling and Andy Fastow were risk takers. This risk taking behavior seeped into the very soul of Enron. It was no more evident than with the traders. Specifically, the company showed its employees that risk taking behavior was valued and would be rewarded. The traders took this idea and ran with it.

Whether it was trading beyond their approved thresholds or creating artificial circumstances so they could have “arbitrage opportunities”, the traders did whatever was needed to make sure Enron’s stock price and their own wallets continued to inflate. One specific example of this was traders having California electrical plants go offline, so the price of electricity could be artificially inflated for their own gain. This fits perfectly with how Trevino and Nelson described a reward system that encouraged unethical behavior.

The traders at Enron were willing to go to whatever lengths to meet and exceed their goals, no matter what wake they had to leave in their path. In accordance with this rewards systems, Skilling has further enforced this behavior by not disciplining those who engaged in this type of behavior but instead encouraged them to maintain that level of performance at all cost. Further adding to the pressure placed not only on traders, but all employees, was the performance review committee (PRC), otherwise known as rank and yank.

This intense performance review format heightened an already overwhelming atmosphere of performance. Due to this fact, many Enron employees saw those associates sitting next to them as their competition or even their enemy. This, coupled with Enron’s off kilter reward/punishment system further exacerbated the already growing problem of unethical behavior. Besides rogue executives and some internal flaws, there were also several external factors that contributed to Enron’s demise. One such factor was the trend toward a deregulated energy market in the United States.

Deregulated markets removed whatever accountability and transparency that existed in the energy sector. The result of this deregulation allowed Enron to manipulate the price and supply of electricity. With free reign to manipulate the market, Enron no longer had the government controlling their behavior. It was now up to their own internal processes to control their actions. With no internal processes to speak of, and no punishment for gouging consumers, rolling blackouts ran rampant throughout California.

Another external factor that helped Enron along its way was the complacency of its outside accounting firm Arthur Anderson and many major banks. As an outside accounting firm, it was Arthur Anderson’s responsibility to question the legitimacy of the financials that they were auditing. Despite this fact, they willingly helped Enron deceive the public and ultimately those who were investing in the company. This again was most likely another case of diffused responsibility. The accounting irregularities were accepted both at the highest level of Enron and also at the highest level of Arthur Anderson.

It’s obvious why Enron accepted the accounting practices, but the top executives at Arthur Anderson valued the profits from their client more than keeping the integrity of their audit. The audit committee from Arthur Anderson handling the work therefore chose to accept those accounting practic es at face value and not question their validity. In addition to Arthur Anderson, many major banks helped contribute to Enron’s ability to deceive the investing public. These banks engaged loans that Enron used to create SPE’s and by doing so, allowed them to hide that debt from the public.

The banks believed that because other banks were helping Enron in this respect, that it was an acceptable practice and therefore would not be considered out of the ordinary. More importantly, Enron exerted pressure on the banks to keep their stock rated as a strong buy. If they did so, they were rewarded with Enron’s lucrative banking arrangements. This coupled with Arthur Anderson’s relationship showed that even outside entities were capable of being corrupted by Enron’s deep pockets.

All in all, the failure of Enron was caused not only by individuals and the organization itself, but also by outside factors that allowed it to spiral out of control. The flawed individuals within Enron caused a trickle down effect into the entire company. With Enron as a whole being flawed, and no strong outside force to deter it from unethical behavior, it was only a matter of time before things imploded. One thing is certain, without the combination of all three of these factors Enron might not have become the largest corporate bankruptcy in the history of the United States.

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