WESLEYAN UNIVERSITY PHILIPPINES

College of Business and Accountancy

Good Governance, Business Ethics, Risk Management and Control
2nd Semester AY 2024-2025

Beyond the Collapse: Unraveling the Enron Scandal

A Comprehensive Analysis into Its Background, Governance Failures, Impact on
Corporate Social Responsibility, and Recovery Lessons for Future Corporate Ethics

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A Case Study presented to the

Faculty of the College of Business and Accountancy
Wesleyan University-Philippines

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In Partial Fulfillment of the

Requirements for the
Degree of Bachelor of Science in Accountancy
Good Governance, Business Ethics, Risk Management and Control

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By:

Rossan Giell F. Daño

3BSA1

10 January 2025
INTRODUCTION

Enron is the fruit of merger of two natural-gas-transmission companies, Houston Natural

Gas Corporation and Internorth, Inc. in 1986. It was founded by Kenneth Lay, but soon became

under Jeffrey Skilling's leadership after the amendments of the U.S Congress in a series of laws

concerning the deregulation of the sales of natural gas. Consequently, Enron transformed into an

intermediary between natural gas producers and their customers in the field of trading of energy

derivative contracts, mitigating the risk of energy-price fluctuations through fixing the selling price

of their products, resulting into a domination in the market and generating huge profits on its trades

(Bondarenko, 2024). Accordingly, Enron was ranked by Fortune as the most innovative company

in the United States due to its transition from the production to the knowledge economy (Moncarz,

et. al, 2006).

As the rise of Enron came to an end due to increased competition in the energy-trading

business, the company's profits shrank rapidly. The company take advantage of the accounting

limitations in managing its earnings and balance sheet to portray a stable financial performance.

They relied on unreliable accounting practices such as "mark-to-market accounting" intending to

hide its flaws. It allowed Enron to recognize transactions of unrealized future gains from trading

contracts in the current income statements, resulting to higher current profits (Bondarenko, 2024).

Moreover, Enron abused the practice of special purpose entities by using them as dump sites

through transferring their troubled assets which were wrote off in the company's books, creating

an illusion that the company only experienced minimal losses.

As the details of the accounting frauds became apparent in mid-2001, the Securities and

Exchange Commission investigated Enron's transactions between its SPEs. As a consequence, the

company's stock price drop to under $1 per share, causing significant losses to investors. The
manipulation of Enron's financial statements violated the accounting standards such that its

balance sheet did not reflect its financial risks (Healey and Palepu, 2003).

The United States' economy in 2002 weakened as the financial markets reflected

uncertainty of declining stock market prices resulting from corporate and accounting scandals

(Moncarz, et. al, 2006). This demonstrates the vulnerability of financial markets and the need to

restore integrity to the reporting system and to address issues associated with corporate

accountability. By analyzing the Enron Scandal, accounting students can gain a deeper

understanding of the importance of accurate and transparent financial reporting, the potential

consequences of violating accounting principles, as well as the impact of this issue in the regulatory

framework.

CASE ANALYSIS

Background of the Case

Enron Corporation was an American energy, commodities, and services company, initially

focused on the transmission and distribution of electricity and gas. Despite incurring significant

debt from the merger and losing exclusive pipeline rights, Enron created innovative business

strategy to further facilitate the trading of gas and guarantee supply and pricing. It transformed

into a diversified energy trader and became the seventh-largest company in the US due to its

innovative business practices and its stock's impressive performance.

The same risk management practices that defined Enron's early success also contributed to

its downfall. The company promoted the use of mark-to-market accounting, which allowed it to

recognize potential future profits on the day a deal was signed, regardless of actual cash flows
which results to overstatement of total assets on hand. Moreover, Enron's aggressive expansion

and culture of innovation involved investments financed by debt, leading to a high debt-to-equity

ratio, which was concealed through special purpose entities (SPEs) creating the illusion of

profitability. The rise of complex financial instruments like SPEs masked the actual financial

losses, inflated the reported revenue, as well as its liabilities. These limited partnerships permitted

Enron to increase leverage and return on assets without having to report debt on its balance sheet,

as well as designed primarily to achieve financial reporting objectives (Moncarz, et. al, 2006).

As the anomalies come to light, the company's stock price fall to less than $1 per share.

Consequently, Enron admitted to manipulation of their financial statements by overstating its

earnings by approimately $600 million. On December 2, 2001, Enron filed for Chapter 11

bankruptcy protection, making it one of the largest bankruptcies in US history and the greatest

failure in the history of American capitalism as well as its major impact on financial markets

(Bondarenko, 2024).

This scandal affected numerous key stakeholders, primarily the thousands of Enron

employees who faced financial ruin from losing their pension funds and job security and

shareholders who suffered significant financial losses from their investments. Moreover, financial

institutions that had business relationships with Enron also faced repercussions from the scandal

including, Arthur Andersen LLP, Enron’s auditing firm, which was implicated for its role in

misleading financial reporting. The firm was ultimately found guilty of obstructing justice for

destroying documents related to the audit, leading to its subsequent downfall and ceased

operations. This led to relevant changes in corporate governance and financial regulation aimed to

increase the transparency and accountability in corporate financial reporting (Cabello, 2006).
Violations of Good Governance

Corporate governance refers to the set of laws, policies, and accountability that governs the

relationship between the investor and the management. The relationship between the Enron

scandal and the principles of good governance is illustrated by the failures of the company's board

of directors, who were entrusted with the critical role of overseeing corporate management to

protect shareholder interests (Thomas, 2002). At the core of the scandal was Enron's manipulation

of financial statements through complex accounting practices, which obscured the true financial

health of the company. This breach of accountability and lack of transparency not only misled

investors but also undermined the trust that stakeholders should expect from publicly traded

corporations. Enron's board disregard conflict of interest policies by making decisions that

prioritized personal gain over the company's welfare and ethical considerations. The Enron scandal

led to widespread public distrust in not only Enron itself but also in the financial systems and

regulatory frameworks meant to protect investors (Dibra, 2016). Ultimately, while corporate

governance measures can help detect unethical practices, they cannot entirely eliminate them,

especially given the complexities of human behavior. The Enron case illustrates the critical

necessity for governance structures that align the interests of management with those of

shareholders, promoting integrity and accountability in corporate operations.

Impact on Corporate Social Responsibility

Prior to the scandal, Enron positioned itself as a leader in ethical business practices and

sustainability, promoting its commitment to innovative energy solutions and corporate

accountability (Healy & Palepu, 2003). The company engaged in various charitable initiatives,

including funding education, community activities, and environmental projects. Its leadership
promoted the image of a socially responsible entity and leader in ethical business practices.

However, when the truth behind its accounting fraud and manipulative practices came to light, the

company faced not only legal consequences but also a staggering loss of public trust. The

investigation conducted by the Securities and Exchange Commission (SEC) exposed the unethical

behavior among Enron's executives, resulting to bankruptcy and dissolution. After the scandal, the

corporation could no longer uphold its image as a responsible corporate citizen as they loss their

credibility. The scandal served as a wake-up call for the business world, prompting a reevaluation

of corporate governance and ethical standards, as well as legal reforms including the Sarbanes-

Oxley Act of 2002, aimed at improving financial disclosures and corporate governance (Thomas,

2002). Enron's inability to act as a responsible corporate citizen was evident in its failure to

prioritize stakeholder interests and transparency, resulting in significant losses for employees,

shareholders, and the broader community.

Recovery and Lessons Learned

The Enron scandal served as lesson for other corporations about the importance of aligning

business practices with ethical standards and genuinely committing to CSR. Companies should

understand that responsible citizenship necessitates a sincere commitment to honesty, integrity,

and engagement with all stakeholders.

In the aftermath of Enron's bankruptcy, there are several actions taken by the corporation

to restore trust. According to Santa Clara University (2002), a Special Committee of the Enron

Board of Directors was established to oversee the company's liquidation and sale of assets. This

committee's independence played a crucial role in ensuring that the company's actions were

transparent and fair. The departure of key executives, including former CEO Kenneth Lay, who
resigned in 2002, and Jeffrey Skilling, who was sentenced to prison for his involvement in the

scandal, marked the beginning of a new era for Enron. The new management team prioritized the

establishment of a culture rooted in transparency, ethics, and accountability, implementing new

policies and procedures aimed at preventing future scandals. Additionally, Enron's creditors and

investors received some compensation for their losses through the company's liquidation, which

contributed significantly to rebuilding trust with stakeholders.

Implementing robust governance structure with independent directors, as well as strong

internal controls and auditing procedures would have detected the accounting irregularities and

prevented the scandal. Furthermore, the executives at Enron prioritized short-term gains over long-

term sustainability, which contributed to a significant lack of transparency and accountability.

Lastly, Enron's risk management strategies were insufficient, resulting in excessive exposure to

market fluctuations and ultimately leading to the company's downfall. By developing and

implementing effective risk management strategies, the risks could have been mitigated, providing

a more stable foundation for the organization.

Enron could have adopted several key recommendations in governance and corporate

social responsibility (CSR) to reduce the risk of similar scandals occurring in the future by

establishing a more independent board with diverse backgrounds and experiences as well as

consistent evaluation of board performance such as regular assessments. Moreover, to effectively

oversee financial reporting and internal controls, as well as identifying and mitigating risks, an

independent audit committee and dedicated risk management committee are vital. On the front of

corporate social responsibility, engaging stakeholders is important to strengthen relationships and

enhance corporate reputation. Additionally, investing to sustainability through environmentally

responsible practices, committing to community programs to provide the company's social,

environmental, and economic impact would build transparency and trust with stakeholders. Had

these measures been implemented, the risk of unethical and irregularities leading to a company's

downfall could have been mitigated.

CONCLUSION

The Enron serves as a lesson highlighting the consequences of unethical corporate practices

and inadequate governance. These manipulations ultimately misled investors, resulting in a drastic

decline in stock prices and culminating in the company's bankruptcy. The failures in corporate

governance, particularly the board's negligence and lack of transparency, were pivotal in

facilitating the scandal. Additionally, Enron's initial commitment to corporate social responsibility

eroded as it prioritized profit over stakeholder's interest. In conclusion, the Enron case emphasizes

the need for robust corporate governance mechanisms, including independent oversight and

rigorous internal controls, as well as a genuine commitment to ethical practices and stakeholder

engagement. Implementing these recommendations could foster a culture of accountability,

transparency, and ethical corporate practices, ultimately preventing similar corporate misconduct

in the future.

REFERENCES

Moncarz, E., Moncarz, R., Cabello, A., Moncarz B. (2006). The Rise and Collapse of Enron:

Financial Innovation, Errors and Lessons. Retrieved from

https://www.redalyc.org/pdf/395/39521802.pdf

Dibra, R. (2016). Corporate Governance Failure: The Case Of Enron And Parmalat. Retrieve from

https://www.redalyc.org/pdf/395/39521802.pdf
Thomas, C. (2002). The Rise and Fall of Enron. Retrieved from

https://www.journalofaccountancy.com/issues/2002/apr/theriseandfallofenron.html

Healy, P. M., & Palepu, K. G. (2003). The Fall of Enron. Journal of Economic Perspectives, 17(2),

3-26. Retrieved from https://www.aeaweb.org/articles?id=10.1257/089533003765888403

Santa Clara University (5, March, 2002). Lessons from the Enron Scandal.

https://www.scu.edu/ethics/focus-areas/business-ethics/resources/lessons-from-the-enron-

scandal/