Realthe Reasons Enron Failed

6 Pages Posted: 16 Nov 2006

See all articles by Bennett Stewart

Bennett Stewart

EVA Dimensions LLC; Stern Stewart & Co.

Abstract

In desperate attempts to keep up with aggressive earnings targets, Enron`s managers became so indiscriminate in committing the firm`s capital that, in 1999, the international energy division presented Skilling with a plan that contemplated earning just $100 million in profit on a capital base of $7 billion. With that kind of performancewhich amounts to a loss of several hundred million in terms of economic profitsthe CFO faced considerable pressure to use deceptive tactics to put off the day of reckoning. The real Enron story may thus be more than the morality play told in press accounts. A major part of the blame must be assigned to the design of the company`s performance measures and internal controls.This article argues that the popular accounts may confuse causes and consequences and suggests that the seeds of Enron`s demise were sown years before criminal behavior took root. The more fundamental causes appear to have been matters of organizational designin particular, bonus plans that paid managers to increase reported earnings; the use of mark-to-market accounting, with the blessing of the SEC, in generating those earnings; and CEO Skilling`s decision to permit CFO Fastow to make finance a profit centerall of which happened five to ten years before Enron`s bankruptcy filing.Why did Enron fail? Was it the criminality of key corporate executives, and their resort to deceptive bookkeeping and off-balance sheet financing, as the popular accounts suggest?This article argues that the popular accounts may confuse causes and consequences and suggests that the seeds of Enron`s demise were sown years before criminal behavior took root. The more fundamental causes appear to have been matters of organizational designin particular, bonus plans that paid managers to increase reported earnings; the use of mark-to-market accounting, with the blessing of the SEC, in generating those earnings; and CEO Skilling`s decision to permit CFO Fastow to make finance a profit centerall of which happened five to ten years before Enron`s bankruptcy filing.In desperate attempts to keep up with aggressive earnings targets, Enron`s managers became so indiscriminate in committing the firm`s capital that, in 1999, the international energy division presented Skilling with a plan that contemplated earning just $100 million in profit on a capital base of $7 billion. With that kind of performancewhich amounts to a loss of several hundred million in terms of economic profitsthe CFO faced considerable pressure to use deceptive tactics to put off the day of reckoning. The real Enron story may thus be more than the morality play told in press accounts. A major part of the blame must be assigned to the design of the company`s performance measures and internal controls.

Suggested Citation

Stewart, Bennett, Realthe Reasons Enron Failed. Journal of Applied Corporate Finance, Vol. 18, Issue 2, pp. 116-119, Spring 2006. Available at SSRN: https://ssrn.com/abstract=944967 or http://dx.doi.org/10.1111/j.1745-6622.2006.00092.x

Bennett Stewart (Contact Author)

EVA Dimensions LLC ( email )

15 Watersedge Court
Locust Valley, NY 11560
United States
516-759-3711 (Phone)

HOME PAGE: http://www.evadimensions.com

Stern Stewart & Co. ( email )

New York, NY 10022
United States

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