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| Fig. 1: Enron corporate logo. (Source: Wikimedia Commons) |
Enron Corporation (see Fig. 1) was an American energy company based in Houston, Texas. It was founded in 1985 following the merger of two small regional energy companies, Houston Natural Gas and InterNorth. Over the years, Enron expanded its business plan to increase profitability. Now acting more like a hedge fund, Enron dealt in commodities and services including natural gas, electricity, paper, freight, water, and communication technology. Enron was praised for its innovative business model; the company was named "America's Most Innovative Company" by Fortune magazine every year between 1996 and 2001. Enron's stock price reached a high of US$90.75 per share in mid-2000. After it was revealed that the company had been engaging in accounting fraud - had, in fact, been hiding billions of dollars in debt via various accounting loopholes - the company's shareholders filed a $40 billion lawsuit. Enron's stock price plunged to less than $1 per share by the end of November 2001. On December 2, 2001, Enron filed for bankruptcy. At the time, Enron's meteoric fall marked the largest corporate bankruptcy in US history. [1]
Enron engaged in mark to market (MTM) accounting, for which the company received official US Securities and Exchange Commission (SEC) approval in 1992. This accounting method allows companies to value their financial situation based on the "fair value" of the company's assets, which may change as market conditions change. Enron used this accounting method to overinflate the company's estimated profits and mislead investors. [2] To hide its mounting debt, Enron used special purpose vehicles (SPVs: shell companies capitalized entirely by Enron stock) to borrow money on Enron's behalf. By 2001, Enron had used hundreds of SPVs to hide its debt. [2]
By the end of 2001, investor confidence in Enron had started to decline. Jeffrey Skilling took over the role of CEO after Kenneth Lay retired in February. Skilling resigned for "personal reasons" in August. Analysts began to downgrade Enron's stock rating. On October 16, Enron reported the company's first quarterly loss. Shortly thereafter, the SEC announced it was opening an investigation into Enron and its SPVs. Enron restated the company's earnings (or lack thereof) and revealed that the company had $628 million in debt and $591 million in losses. [2] After Dynegy, a company that had previously stated plans to merge with Enron, backed out of the deal, Enron filed for bankruptcy. [3]
In the end, many of Enron's executives were charged for insider trading, securities fraud, and conspiracy. Former CEO Kenneth Lay was convicted of six counts of fraud and conspiracy and four counts of bank fraud, but he died of a heart attack before he could be sentenced. [4] Jeffrey Skilling was convicted of insider trading, fraud, and conspiracy. Skilling was finally released from prison in 2018. [5]
Enron's collapse prompted President George W. Bush to sign into law the Sarbanes-Oxley Act, a law designed to protect investors from corporations' fraudulent accounting activities. [6] At the time, Enron's collapse was the biggest to ever hit the US financial world. It was soon surpassed, however, by WorldCom, in 2002. [7]
© Rachel Smith. The author warrants that the work is the author's own and that Stanford University provided no input other than typesetting and referencing guidelines. The author grants permission to copy, distribute and display this work in unaltered form, with attribution to the author, for noncommercial purposes only. All other rights, including commercial rights, are reserved to the author.
[1] W. W. Bratton, "Enron and the Dark Side of Shareholder Value," Tul. L. Rev. 76, 1275 (2002).
[2] P. M. Healy and K. G. Palepu, "The Fall of Enron," J. Econ. Perspect. 17, 3 (2003).
[3] "An Implosion on Wall Street," New York Times, 29 Nov 01.
[4] A. Clark, "Disgraced Boss Ken Lay Dies at Luxury Ski Chalet," The Guardian, 6 Jul 06.
[5] C. Morris, "Former Enron CEO Jeff Skilling Released From Prison," Fortune, 31 Aug 18.
[6] E. Bumiller, "Corporate Conduct: The President; Bush Signs Bill Aimed at Fraud In Corporations," New York Times, 31 Jul 02.
[7] N. B. Rapoport, "Enron, Titanic, and the Perfect Storm," Fordham L. Rev. 71, 1373 (2002).
