These 5 Things Could Have Prevented the Enron Disaster

The word “Enron” wasn’t always synonymous with “epic corporate fraud on a massive scale.” Back in the late 20th century, Houston-based Enron was a totally respectable, seemingly above-board energy conglomerate with tens of thousands of employees and a ten-figure market capitalization. Its C-level executives made millions of dollars per year in cash and stock compensation. The Houston company and its associates were, for lack of a better term, living high off the hog.

And then it all went to hell. Turns out Enron’s accountants were, with the knowledge and consent of its executives, blatantly fudging its profit and loss reports to make the company appear robust and successful — when it was, in fact, built on a house of cards. The final straw came in late 2001, when a planned rescue merger with crosstown rival Dynegy fell apart in a hail of acrimony. A number of people involved in the Enron scandal, including company executives and outside accountants who helped the firm cook its books, either went to prison or retired in disgrace.

The Enron disaster had many causes, not all of which were directly related to the fraudulent accounting that ultimately brought the company down. Here’s a look at what company employees and executives could have done differently to keep Enron alive — and avoid destroying more than 20,000 careers in the process.

1. Fewer Perverse Incentives

One of Enron’s fundamental problems: a perverse bonus structure that strongly incentivized executives to pursue short-term profits (or the appearance thereof) at the expense of sustainable, long-term growth. An insatiable thirst for ever-larger bonuses is arguably what set Enron’s executive team on the road to ruin. A more sensible compensation scheme may have been enough to turn them down a brighter path.

2. Better Internal Communication

According to a recent post by Rosemary Plorin, a Nashville-based PR and crisis communications expert, the Enron scandal worsened in large part due to poor internal communication protocols within the sprawling organization. Enron’s executives were able to exploit this weakness to hide their misdeeds for far longer than would have been possible at a better-governed, more transparent organization.

3. Tighter Financial Regulation

In the wake of the Enron disaster, the United States Congress got its act together and passed the landmark Sarbanes-Oxley Act, a complex piece of legislation designed to prevent (or at least reduce the likelihood of) corporate fraud on such a massive scale. (SarbOx, as it was known, didn’t come soon enough to prevent the even bigger WorldCom scandal, which exploded the year after Enron’s demise.)

Better late than never, right? Had SarbOx, or something like it, been on the books in the 1990s, Enron would likely not be a household name right now. And tens of thousands of people would still have high-paying jobs right now.

4. Better Auditing & Risk Management

In retrospect, Enron’s demise was a warning sign — an ominous foreshadowing of the dangers of complex derivative instruments that few executives, and even fewer regulators, really understood. Enron liberally and recklessly employed derivatives as hedges against energy price fluctuations; a few years later, banks would use even more convoluted mortgage-backed derivatives for similar purposes, precipitating the global financial crisis of the late 2000s.

Had Enron been more careful about its use of derivatives — and its outside accountants less willing to look the other way as the company violated basic accounting rule after basic accounting rule — it’s likely that the company’s bad debts wouldn’t have done it in. But, over a number of years, the problem was allowed to get out of hand.

Fair warning.

Published by Kidal Delonix (1198 Posts)

Kidal Delonix is a contributor to Mr. Hoffman's blog. The views and opinions are entirely his/her own and may not reflect Mr Hoffman's views.