**8. A corporate governance failure**

The biggest scandal of twenty-first century is the case of Enron corporate governance failure. Enron Corporation was established in 1986 as a pipelines company from the merger of Houston Natural Gas and InterNorth. In the procedure of the emerge, Enron gained a huge debt and, according to the legislation, lost all rights regarding its pipelines. It was a financial disaster, and a new innovated strategy was required to survive and accumulate capital, financial inflows. The owner engaged McKinsey & Co (a young consultant named Jeffrey Skilling was assigned to the issue) to develop a new strategy and the outstanding strategy was found. According to the new strategy, a Gas Bank should be set up, which would be used by buyers and sellers of natural gas, at the same time, Enron would be involved as an intermediary, which guaranteed reliability and predictability regarding pricing and delivery for both parties. By the beginning of 1990s, Enron was transformed into a major gas trading operation and established a new division called Enron Finance Corp., which became a leader of the market for natural gas contacts dealing with more suppliers and customers comparing to its competitors [14, 15].

Skilling transformed the corporation culture to suit its new trading strategy; he decided to hire the brightest and most perspective traders; in exchange for overworking, he provided some additional services like a company gym and corporate perks, besides that, they suggested a bonus system on a merit base.

With a growth of external power of a corporation, there was a slight degradation of the internal culture; skilling launched a tough employee-ranking system, based on the values of Enron: respect, integrity, communication, and excellence; however, the key measure of a performance was the amount of profit they can produce. With the implementation of the new evaluation system, the turnover of employees grew up to 15% annually, and under those conditions, the priority moved from long-run goals to current increase in the profit and new contracts signed.

In 1996, Skilling as a chief operating officer suggested to use the gas bank model in the market for electric energy as well. In 1997, Enron acquired electric utility company Portland General Electric Corp. and named it as Enron Capital and Trade Resources, by the end of the year, the division transformed into the nation's largest wholesale buyer and seller of natural gas and electricity, by that time revenue increased from \$2 to \$7 billion with employees from 200 to 2000.

The most financially significant was a creation of Enron Online in 1999, an electronic commodities trading web site. Enron was counterparty to every transaction conducted on the platform; besides that, Enron was either a buyer or a seller in each transaction, and its credit was crucial to provide safe and reliable environment for energy industry. Enron Online shortly reached an incredible success with \$335 billion in online commodity trades in 2000. In August 2000, Enron's stock reached its maximum of \$90.56 and the company was recognized as one of the most admired and innovative in the world by Fortune and other publications [15].

Meanwhile, in the beginning of 2001, the energy prices began to fall and the world economy got in the recession, thus Enron's profitably sharply reduced, specifically the finance division, where contracts were signed regardless the possible future risks. As investments inflows are related to a company's estimated risk, representatives of Enron started to influence credit rating agencies as Moody's and Standard & Poor's on improving the credit ranking. There were other ways of reducing its financial debts as a reduction in hard assets accompanied by increasing paper profits in order to increase the return of assets and lower the debt-to-total-assets ratio, making a company more attractive for investors. Another way to hide the real financial situation was to use a limited partnership with an outsider partner ["special purpose entities" (SPEs)], the company provides hard assets and related debt to an SPE in exchange for an interest, then an SPE is able to borrow huge amounts of money from financial institutions to purchase assets or conduct other business; in this case, the debt or assets would not be shown on the company's financial documents. Thus, Enron used thousands of SPE to hide its debts and modify its financial reports as well as to maintain a share price.

As a result of accumulation of debts and failures in launched projects, the price of an Enron share fell to \$60 and continued to fall. In October 2001, Enron announced about \$591 million in losses and an additional \$628 million in liabilities. The equity market reacted immediately, and a share price became less than \$10. On November 30, the stock closed at 26 cents a share and, on December 2, Enron announced about its bankruptcy [14].

#### **8.1. Discussion**

The transactions and potential interdependence between shareholders and managers should be regulated by the existing legislation and internal policies regarding balancing the interests of shareholders, creditors, managers, and stakeholders, supervision of negotiations, and adopting the system of compensation in accordance to the strategic long-term goals rather than short-term benefits. An improvement in corporate governance can be considered as a comparative advantage, which attracts new investments and can be an excellent foundation for further growth of a corporation; from the point of view of creditors and shareholders, appropriate governance eliminates and minimizes possible risks and ensures the future return.

The biggest scandal of twenty-first century is the case of Enron corporate governance failure. Enron Corporation was established in 1986 as a pipelines company from the merger of Houston Natural Gas and InterNorth. In the procedure of the emerge, Enron gained a huge debt and, according to the legislation, lost all rights regarding its pipelines. It was a financial disaster, and a new innovated strategy was required to survive and accumulate capital, financial inflows. The owner engaged McKinsey & Co (a young consultant named Jeffrey Skilling was assigned to the issue) to develop a new strategy and the outstanding strategy was found. According to the new strategy, a Gas Bank should be set up, which would be used by buyers and sellers of natural gas, at the same time, Enron would be involved as an intermediary, which guaranteed reliability and predictability regarding pricing and delivery for both parties. By the beginning of 1990s, Enron was transformed into a major gas trading operation and established a new division called Enron Finance Corp., which became a leader of the market for natural gas contacts dealing with more suppliers and customers comparing

Skilling transformed the corporation culture to suit its new trading strategy; he decided to hire the brightest and most perspective traders; in exchange for overworking, he provided some additional services like a company gym and corporate perks, besides that, they sug-

With a growth of external power of a corporation, there was a slight degradation of the internal culture; skilling launched a tough employee-ranking system, based on the values of Enron: respect, integrity, communication, and excellence; however, the key measure of a performance was the amount of profit they can produce. With the implementation of the new evaluation system, the turnover of employees grew up to 15% annually, and under those conditions, the priority moved from long-run goals to current increase in the profit and new

In 1996, Skilling as a chief operating officer suggested to use the gas bank model in the market for electric energy as well. In 1997, Enron acquired electric utility company Portland General Electric Corp. and named it as Enron Capital and Trade Resources, by the end of the year, the division transformed into the nation's largest wholesale buyer and seller of natural gas and electricity, by that time revenue increased from \$2 to \$7 billion with employees from 200 to 2000.

**8. A corporate governance failure**

18 Corporate Governance and Strategic Decision Making

to its competitors [14, 15].

contracts signed.

gested a bonus system on a merit base.

The case of Enron raised up a question on some of the key functions of corporate governance as the adequate disclosure practice and the integrity of the independent audit. In the manner of Enron's management, the following risk factors can be seen :


Enron's case started the era of global mistrust between investors and corporations, the general belief that the American companies have the most transparent and fair way of doing business disappeared. Shortly after Enron, another American corporation WorldCom announced about its bankruptcy, which made even bigger the gap between managers' and investors' goals and ruined the reputation of fast-growing corporations. These failures taught a good lesson for businesses; internal stimulation methods as bonus systems do not guarantee the longterm growth and stability, the participation of state and public participants (stakeholders) are crucial in appropriate corporate governance, which ensures and protects the rights of shareholders.
