Enron and corporate governance

In 2001, when Enron filed for Chapter11 bankruptcy protection, it ranked as the seventh largest corporation in the United States. But it was a small gas- pipeline business only a few years ago. In order to realize their dream of turning Enron into the world's largest energy trader, Lay and Skilling broke every rule of doing good business. Just to give a few examples: In order to inflate the revenues, Enron routinely entered into "roundtrip" transactions with other companies in the same sector. These were, in effect, bogus operations by which the parties massaged each other's revenues, whenever the actual fell short of the forecasted revenues. In order to show a continuous increase in the EPS (earnings per share), the company executives set up several off-balance-sheet entities. The company booked profits from the sale of fixed assets as operating profits. All this was done with the knowledge and connivance of Arthur Anderson, the company's external auditors. The ultimate objective of all this "creative accounting" was to help drive up the stock prices, which in reality meant cheating the stakeholders. Again, in order to keep the government regulators away from probing too deeply into these fiddles, the company built up a network of lobbyists in places of power through generous financial gratifications.

As corporations grow in size and complexity, operating in different sectors and dozens of different countries, it becomes increasingly difficult for the shareholders, the employees, customers and the suppliers of goods and services to keep track of the state of the businesses in which they have acquired a stake. This is all the more true in oligarchic corporate structures with megalomaniac CEOs with a gift of arrogance, who do not like to be accountable to the shareholders or even to directors, who are dependent on the approval of shareholders. As a result, the stakeholders are forced to rely on the mechanisms of good corporate governance to give them a fair view of the state of affairs. But as we have just seen in the case of Enron, the traditional corporate governance system which mainly consisted of external auditors and government regulators failed to protect their interests.

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The Serbanes Oxley Act of 2002 made significant improvements to the corporate governance procedures. An integrated approach to corporate governance, which encompasses not only the traditional aspects but also a wide range of other issues such as risk management, internal controls and independent audit committees, shareholder and stakeholder activism in the form of regular Operating and Financial Reviews requiring disclosure of not only financial information but also all material non-financial information, has since been introduced in the US and the UK. The principal objectives of an effective corporate governance structure are not only greater accountability and transparency but also to provide "a fair view" of the company's financial condition to the stakeholders.

Both Lay and Skilling failed to give a fair picture because they lied and deliberately used off-book partnerships to manipulate earnings and "touted" Enron's performance while knowing it was losing millions. Sean Berkowitz, the head of government appointed Enron Task Force said after the verdict that the system, meaning corporate America, functions. But this is an after-the-event consolation. It is not going to satisfy the thousands of shareholders who lost their savings, the employees who lost their jobs and the pensioners whose pension funds were wiped out. Therefore, it is important to strengthen the government regulatory functions to oversee that corporate governance mechanisms function adequately so that the CEOs and the board of directors enter into a culture of accountability before the catastrophe hits the corporation and not afterwards.

The writer is a columnist of the Daily Star