What happened to Enron? The Enron Scandal Explained

The so-called “Enron scandal” describes a series of events resulting in one of the largest bankruptcy filings in United States history. The scandal consisted of a mixture of bad culture, aggressive sales incentives, and serious accounting manipulations, resulting in one of the greatest American scandals of history.

Background

Enron was an American commodities, energy, and services company founded by Kenneth Lay in 1985. It was mostly associated with the electricity, natural gas, communications, and pulp and paper industries.

Before its much-publicized bankruptcy in 2001, Enron employed 29,000 staff with revenue of approximately $101 billion. The company was also designated as “American’s Most Innovative Company” for six years running by Fortune magazine.

Problems with culture

Eventual COO Jeffrey Skilling instituted a cultural change across Enron, with the company reinventing itself as an energy derivative contracts trader. Here, Enron acted as an intermediary between natural gas producers and their customers and enjoyed very large profit margins as a result.

Skilling hired MBA graduates from the top business schools in the United States. He also fostered an intensely competitive culture where employees were motivated to close as many lucrative trades in the shortest possible time. Greed and a win-at-all-costs mentality became standards for which employees and indeed Enron more generally were judged. 

Enron’s management would enable the long-term practice of unethical or illegal activities for years by turning a blind eye.

Problems with leadership

Skilling was a bad leader who was tasked with taking Enron to the next level in terms of returns and the formation of an executive team. 

He frequently relied on past achievements to manage the company in an increasingly dynamic industry and fired anyone who challenged or questioned him.

Bull markets and the dotcom boom

The bull market of the 1990s helped Enron achieve its aggressive growth strategy and saw it ready to create a market for anything that anyone was willing to trade. Indeed, derivative contracts were traded for electricity, steel, paper, coal, and even the weather.

As the bull market and dot-com bubble showed signs of capitulating, Enron faced increased competition – particularly in energy trading. Profits shrank at a rapid pace, which caused company executives to essentially create profits out of thin air.

Bad accounting

Under Skilling, Enron transitioned from the traditional historical cost accounting method to market-to-market (MTM). 

MTM is an accounting process involving the adjustment of the value of an asset to reflect its value as determined by current market conditions. In other words, market value is stipulated by whatever the company would expect to receive for the asset if sold at a predetermined point in time.

Market-to-market was the beginning of the end for Enron. Bad actors in senior management used the method to log estimated profits as actual profits which in turn encouraged further accounting manipulation. In one instance, Skilling advised his accountants to set up special purpose entities (SPEs) to hide company debt by transferring it to multiple subsidiaries.

2001 discovery

Analysts began reading over Enron’s financial statements in 2001 with the Securities and Exchange Commission also investigating transactions between Enron and its SPEs. 

When details of Enron’s indiscretions were made public, the price of Enron shares plummeted from $90 in mid-2000 to less than $1 by November of 2001. Bankruptcy proceedings began in December that same year.

Key takeaways:

  • Enron was a commodities, services, and energy company founded in 1985 by Kenneth Lay. The company entered into bankruptcy proceedings in late 2001, at the time the largest corporate bankruptcy in U.S. history.
  • Enron had a toxic culture and suffered from poor leadership. A win-at-all-costs mentality encouraged a culture where unethical and illegal practices could persist for years.
  • Enron engaged in fraudulent accounting practices to inflate profits as the 1990s bull market and dot-com boom ended. The company was eventually ousted in late 2001 with a catastrophic fall in share price.

Main Free Guides:

Published by

Gennaro Cuofano

Gennaro is the creator of FourWeekMBA which reached over a million business students, executives, and aspiring entrepreneurs in 2020 alone | He is also Head of Business Development for a high-tech startup, which he helped grow at double-digit rate | Gennaro earned an International MBA with emphasis on Corporate Finance and Business Strategy | Visit The FourWeekMBA BizSchool | Or Get The FourWeekMBA Flagship Book "100+ Business Models"