Question

corporate governance, Enron case study: What mechanisms could have averted a collapse? Compensation structure? Regulations? Culture? Disclosure? Board oversight?

Answer 1

The Enron disaster had many causes, not all of which were directly related to the fraudulent accounting that ultimately brought the company down. Some of mechanisms which could have avoided the scandal are as follow:

1. Fewer Perverse Incentives (Compensation)

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 (Culture)

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 Regulations

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 (Disclosure)

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.

5. Board oversight

Had the board and top level executived kept proper oversight on the internal workings and accounting of the company, these could have been detected at early stage and thus preveting such big scandal.