Professional Documents
Culture Documents
In the following lines, I will discuss the Enron scandal. I will start by an
introduction on “cooking the books” in order to give us an idea of why drove Enron
and many other companies into fraudulent activities. I will then talk about Enron, I
will start with an introduction of the company, I will then follow with a discussion of
the fraudulent activities the company where involved in and I will finally present
To begin with, what does “cooking the books” mean? Well, companies cook
the books when they do not tell us their real earnings. Managers cook the books and
present us fake earnings to improve their earnings per share (EPS) of stocks. But
why do companies cook the books? Companies cook the books because they have
the pressure to deliver good earnings in order to attract investors to invest in them
and most importantly to keep current investors happy. Let us note that public
companies’ projects are mainly financed by public investors. Executive bonuses are
also tied to the company’s earnings and managers are tempted to manipulate
Company – the ancestor of Enron – was established in 1930. In 1979, InterNorth Inc
bought Northern Natural Gas Company and placed it under a new management. In
the 1980s, the United States Congress passed legislation deregulating the sale of
natural gas. At the beginning of the 1990s, Congress passed a similar legislation
targeted at the sale of electricity. These steps launched a new era in the energy
market, allowing companies like Enron to prosper. In 1985, Kenneth Lay, CEO of
Houston Natural Gas devised a new company and changed InterNorth’s name to
Enron Corporation. This newly formed company was at first involved in distributing
gas and electricity in the US and in selling power plants and pipelines worldwide.
However, the company started to deviate into many non-energy-related fields – i.e.
business, risk management, and internet bandwidth. Even though Enron’s core
business remained gas and electricity, most of the company growth came from
How fraud happens at Enron? This is going to be the topic of this paragraph.
Let us start by saying that the Enron fraud case was extremely complex. People say
that the roots for the Enron scandal date back to the beginning of the 1990s. In fact,
in 1992, Jeff Skilling, who was the president of Enron’s trading operations, convinced
federal regulators to allow Enron to use mark to market accounting. Mark to market
accounting is “a measure of fair value of accounts that can change over time, such
as assets and liabilities. Mark to market aims to provide a realistic appraisal of the
accurately reflect the underlying asset’s true value, problems can arise. This is what
is happening in the economy with fair value FAS 157. With FAS 157, companies like
private equities for instance are forced to calculate the selling price of their assets
or liabilities during this unfavorable volatile time. Investors are fearful and thus
liquidity is low and makes the selling price of the asset or liability very low, which
brings the value of the asset or liability to an all time low level. Conversely,
companies can use mark to market accounting unethically, which is what Enron did.
Enron used mark-to-market accounting for its energy segment in the 1990s and
used it excessively for its trading transactions. Under this accounting rule, when
balance sheets at the end of a quarter, they must appraise them using fair value
and record unrealized gains and losses to the quarterly income statement. The
subtlety is that there are no quoted prices upon which to base valuations for long-
term future contracts in commodities such as gas. Companies with these types of
derivatives are free to value those assets or liabilities using their own models and
current income. Those contracts represented money that might not be collected for
many years. Investigators found that this accounting method was used to
gains accounted for a little more than of Enron’s $1.1 billion reported pretax profit
for 2000. The use of this accounting measure, as well as the use of other
questionable measures, made it difficult for the public to see the business model of
Enron. In fact, the numbers were recorded on the books but the company was not
Moreover, we know that Enron has been buying a big number of ventures
that looked promising. We know that Enron has also been creating off balance sheet
entities in order to remove the risk of their financial statements. However, how did
accounting explained above, Enron recorded all-time high revenues. The company
thus wanted to be involved in other areas. For instance, Enron was buying or
vertical integration (buying a retail business around that pipeline for instance). This
strategy required huge amounts of initial investments and was not going to
generate earning or cash flow in the short term. If Enron elected to present this
strategy on its financial statements, it would have placed a big burden on the
company’s ratios and credit ratings, and credit ratings investment grade was crucial
for Enron energy trading business. In order to find a solution to this issue, Enron
decided to look for outside investors who would like to make those deals with them.
Special Purpose Entities (SPE). Also, since Enron’s executives believed Enron’s long-
term stock would remain high, they looked for ways to use the company’s stock to
hedge its investments in these SPEs. Enron did this through a complex
arrangement of special purpose entities the company called the Raptors. The
Raptors were created to cover those SPEs losses if their stocks were falling. When
the telecom industry experienced its first decline, Enron experienced poor financial
performance as well. In fact, when Enron stocks fell below a certain level, it caused
the Raptors’ stock to collapse. This is mainly due to the fact that the Raptors’ stocks
were back up by Enron’s stock (through the hedging described above). The telecom
industry downturn was thus the underlying event that uncovers the fraud scheme at
Enron.
Issam Chleuh