The Enron Scandal

It is widely recognised that it is important to teach ethics in accounting education and this is adhered to in most business schools (Cameron & O’Leary, 2015). Northumbria University is no exception to this and so I have spent two weeks (weeks 9 & 11) learning about Contemporary Issues in Financial Ethics. So, for my final blog, I will be looking at financial ethics and focusing on a business case I have researched. I am sure many of you will be familiar with the infamous case of Enron. This is the business case I will focus on throughout this week’s blog. First, I will briefly introduce what ethics in financial business is and different ways of interpreting it. Then, I will give some background to the case of Enron, looking at the events leading up to their eventual bankruptcy and the punishments that followed. Finally, I will also look at reasons why companies commit fraud and adopt fraudulent accounting practices because, after all, if you want to prevent these kinds of activities you first need to understand why it is happening.

There are two main types of ethics which apply both in finance and in general (Van Staveren, 2007). Utilitarianism and Deontology (Van Staveren, 2007). Utilitarianism is focused around looking after the majority. For example, if the majority do not suffer then it is ethical (Van Staveren, 2007). Deontology is the approach that if even a single person suffers, then it is unethical (Van Staveren, 2007). These are two very different standpoints on what it means to be ethical and so it is difficult to measure how ethical a company is (Van Staveren, 207). 

Enron owned pipelines used for transporting natural gas and so were able to act as an intermediary between suppliers and consumers of gas (Healy & Palepu, 2003). Enron were concerned about the lack of barriers to market entry and so decided to diversify their company to reduce risk and so they extended this model to other utilities such as electricity, coal, water and broadband to name a few (Healy & Palepu, 2003). Enron’s extremely complex business model allowed them to take advantage of the limitations of accounting (Healy & Palepu, 2003). Enron adopted the mark-to-market accounting practice which allowed them to present information on their balance sheet as estimated forecasts as opposed to actual real figures (Healy & Palepu, 2003). For example, Enron signed a deal with Blockbuster Video to introduce entertainment on demand. Enron recorded the profits from this as $110 million even though they hadn’t received any money yet and there were serious doubts about the success of the project (Healy & Palepu, 2003). Enron also used special purpose entities to make acquisitions and purchases without having to record the debt on their balance sheet. In simpler terms, they used other companies which were owned in some way by Enron (by an executive for example) to acquire companies and make purchases so that the debt could be recorded on this other companies balance sheet as opposed to Enron’s (Healy & Palepu, 2003). Other accounting malpractices carried out by Enron led to their liabilities being underestimated and their revenues and equity being overestimated (Healy & Palepu, 2003).  When news of Enron’s accounting irregularities spread, their share price proceeded to drop to $0.26 at the end of 2001, a massive drop from Enron’s share price of $83.13 at the end of 2000, and the company subsequently went bankrupt (Healy & Palepu, 2003). Jeffrey Skilling, the then chief executive of Enron, was charged with fraud and conspiracy and sentenced to 24 years but this sentence was later reduced to 14 years (Financial Times, 2018).

According to Wolfe and Hermanson (2004), the best way to understand why companies commit fraud is by looking at the Fraud Diamond and the four elements of fraud in accounting practice. The four elements of fraud are Incentive, Opportunity, Rationalisation and Capability (Wolfe & Hermanson, 2004). Incentive and Opportunity are two elements of fraud which can easily relate to the case of Enron.  Incentive is about a company having a reason to commit fraud (Wolfe & Hermanson, 2004). For example, Enron had to hide debt in order to maintain a positive company image and keep share price high (Healy & Palepu, 2003). There is opportunity if there is a fault or weakness which could be exploited (Wolfe & Hermanson, 2004). In Enron’s case, this weakness was the mark-to-market accounting practice as this helped them to inflate revenues and profits (Healy & Palepu, 2003).

According to Rapoport (2009), there are lessons to be learned from the unethical actions of companies like Enron. One of these lessons is that structures are not enough to stop companies from committing fraud (Rapoport, 2009). For example, Enron implemented an ethics code which said every decision had to meet four criteria, respect, integrity, communication and excellence (Rapoport, 2009). Yet this did nothing to prevent their unethical behaviour (Rapoport, 2009). Other lessons which Rapoport (2009) says we can learn from companies like Enron and their unethical behaviour is to ensure structures are put in place on the presumption that people will try and get around them. This will help to make sure it is difficult to ignore structures which have been put into place to prevent ethical behaviour (Rapoport, 2009). Another lesson to be learned is be sure to verify any information in order to ensure the information is correct as well as checking anything that sounds wrong (Rapoport, 2009).

To conclude, the unethical actions of Enron were dealt with by the authorities with Jeffrey Skilling being originally sentenced to 24 years in prison for his actions (Financial Times, 2018). However, there is still fraud being committed and so it is important to continue to educate accounting and finance students to prevent future companies like Enron (Cameron & O’Leary, 2015).

Reference List

Cameron, R., & O'Leary, C. (2015). Improving Ethical Attitudes or Simply Teaching Ethical Codes? The Reality of Accounting Ethics Education. Accounting Education, 24(4), 275-290. doi: 10.1080/09639284.2015.1036893

Financial Times. (2018). As Skilling leaves prison, Enron’s old businesses are thriving | Financial Times. Retrieved from https://www.ft.com/content/ed75c0c4-ad57-11e8-89a1-e5de165fa619

Rapoport, N. (2009). Lessons from Enron – And why we don’t learn from them. Scholarly Works.

Wolfe, D. T., & Hermanson, D. R. (2004). The fraud diamond: Considering the four elements of fraud.

Van Staveren, I. (2007). Beyond utilitarianism and deontology: Ethics in economics. Review of Political Economy, 19(1), 21-35.