Dr. Dan Deines
15 October 2014
The Meteoric Rise and Fall of Enron
Enron was created in 1985 after a merger between Houston Natural Gas and Internorth. By 2002 it was gone forever. Its stock price rose to $90/share in August of 2000 before bottoming out at $0.40/share when they filed for bankruptcy on Dec. 2nd 2001. It only took 16 years for one of the largest Fortune 500 companies to completely dissolve, taking employee jobs, pensions, Arthur Andersen, and the American public’s faith with it. Enron and its young McKinsey consultant created the energy derivative and used it to form the new natural gas division that dominated the market. However, ...view middle of the document...
Kenneth Lay, CEO, hired Jeffery Skilling who was a young consultant working for McKinsey & Co. It was Skilling who came up with the idea to “buy gas from a network of suppliers and sell it to a network of consumers” which would lock in both the “supply and the price” while picking up transaction fees (Thomas, 2002, The Rise and Fall of Enron). By creating this new product, an energy derivative, they were able to lead the natural gas industry. Because Enron had the most suppliers, customers, and contracts they were able to “predict future prices with great accuracy, thereby guaranteeing superior profits” (Thomas, 2002, The Rise and Fall of Enron). Skilling was quickly hired on to run the new division, Enron Finance Corp, and immediately started hiring the best and brightest MBA grads to trade and expand the quickly growing company. Soon Skilling convinced Lay that the same natural gas model could be used other energy industries as well. They purchased Portland General Electric Corp for $2 billion in 1997 and by the end of the year revenue had increased from $2 billion to $7 billion. In October of 1999 Enron launched Enron Online (EOL), an electronic commodity trading web site. It was a huge success generating $335 billion in online trades in 2000 and “played a big role in moving gas and power trading to the Internet” (Buxbaum, 2002, Energy Trading). Enron Online became the “largest business site in the world” and eventually accounted for “90 percent of its income” (CBC News, 2006, The Rise and Fall of Enron: A Brief History). Enron reached its peak in the summer of 2001 when it was worth around $70 billion and its shares were around $90/share. Enron’s stock soared in 1999 and 2000 when it gained 56% and 87% compared to the S&P with a 20% increase and 10% decrease respectively. However, these impressive gains signaled to analysts that something wasn’t adding up.
Fraudulent and Questionable Activities
There were many different reasons why Enron eventually collapsed. There were not only extremely confusing financial statements, but also a few fraudulent activities going on within upper management that directly aided in the bankruptcy. Among the different items, mark-to-market accounting and the use of special purpose entities (SPE’s) were two of the most important aspects that eventually ended in jail time for executives. Also, the competing interests of Arthur Andersen and Enron’s relationship with their auditing/consulting contractor led to the failure of accurate auditing. While executive compensation isn’t a fraudulent activity it also contributed heavily to the demise of the company.
Mark-to-market accounting is the practice of valuing assets/liabilities to reflect their current market value and not their book value. It is not a fraudulent accounting method but Enron used it in situations where “market value had to be estimated rather than observed” and this “introduced an excessive amount of arbitrary and...