Exercise #1
The Fall of Enron September, 2017 Name/Uni
Enron, founded in 1985, collapsed in 2001 in one of the fastest reversal of fortunes in corporate America. The purpose of this exercise is to evaluate your understanding of the key issues and opportunities missed by Enron’s management team. Enron had a Blue Chip board and the technical expertise to management its risks so what worked and what led to the rapid failure of Enron’s strategy.
I. In 1985, the U.S gas market was going through a great deal of change through deregulation. How did Enron adapt to these changes?
At that time, FERC decoupled the purchase and delivery of gas by limiting pipeline firms’
gas purchase so that gas customers will do buying and delivery request separately to
save money. As the result, pipeline firms transformed to firms that provided gas trans-
portation primarily. Jeffery Skilling suggested Enron to make use of the short-term
volatility leaded by the deregulation.
II. How did Enron use deregulation to improve their trading of gas and other commodity products?
Skilling advised Enron to make long-term
price-guaranteed contracts with their customers so that their customers wouldn’t be
worried about price and the separate gas-purchasing and delivery. However, Enron had
to manage the risks. This smart strategy brought Enron to a big success in several years.
II. The new president of Enron trading operations, Jeff Skilling, began to refine the trading model regarding “heavy” assets, such as pipelines. What impact did this have on Enron’s operations? Was it positive or negative and why?
Skilling suggested that Enron to cut down the hold of heavy assets like pipelines in order
to free more money of the company. Enron sold or syndicated almost half of their
pipelines by 2000. He then shifted his attention to other markets: electric power. Enron
bought Portland General Electric and solved the electricity peak-demand problem.
Enron then extended the trading model into bandwidth trading. Skilling’s
transformation suggestion was positive, which grew Enron’s revenue aggressively in
2000.
IV. Enron began to make strategic acquisitions in the following countries
Choose all that apply: A, B, C, E, G
A. The United Kingdom
B. India
C. Eastern Europe
D. Tunisia
E. The Middle East
F. Canada
G. Central & South America
H. Alaska
I. None of the above
IV. Enron’s strategy depended largely on deregulation and market fragmentation.
Select the strategic and proactive steps taken by Enron to grow their business in deregulated and fragmented markets. Choose all that apply: A, B, D
A. Enron made strategic investments in countries with little regulation and were highly fragmented
B. Enron diversified into water and power plants.
C. Enron sold assets in highly regulated markets
D. Enron became a vocal advocate for deregulation of prices in the energy markets (large lobby effort)
E. Enron pushed the envelope in accounting for their complex trading strategy because existing accounting standards did not fully incorporate the assumptions used by Enron and agreed to by their external auditors, Arthur Andersen
F. Only A., C. and E. above
G. All but C. above
V. Enron was known for its risk management practices. Please explain how Enron managed risk?
Skilling built a independent risk assessment group: RAC. This group analyzed and
reported all risks for Enron’s business to Skilling directly. Enron also applied different
evaluations tools like VAR to examine sudden economic risks. Enron also has the
whole strict process of evaluating new business plan. Besides, Enron has its 64-pages
Code of Ethics to manage its employees.
VI. Enron’s Risk Assessment and Control group (RAC) employed Value at Risk (VaR) methods and supplemented that analysis with Monte Carlo simulations to evaluate sudden economic shocks to their model True T/F
VII. How did Enron change the accounting standards to accommodate their interpretation of accounting for their complex trades? Place an “X” by your choice(s):
_____X_____ Use present value accounting for long-term contracts (mark to market)
____X______ Early recognition of revenue based on present value of future income streams
__________ Extensive use of forward contracts with exposure to counterparty credit risks
_____X_____ Extensive use of special purpose entities (SPEs) which allowed off-balance arrangements while permitting income and losses to be recognized in income statements
VIII. Enron ran a relatively tight ship while managing a great deal of complexity. In your opinion what key actions led to Enron’s failure?
There are several things that led to Enron’s failure:
1,Enron’s external auditor, Anderson, considered Enron was engaging in high-risk
accounting. However, His concern was never shared with the audit committee.
2, Several senior executive who has worked and played key roles in Enron resigned at
the same time period.
3, Directors didn’t pay enough attention to issues that LJM SPEs created.
4, Even Fastow’s trick was revealed, neither management nor the board had put any
significant measures to review relevant transactions and Fastow’s compensation.
As long as I concerned, I think the bullet point that made Enron collapsed is their
management method. They did have several committees, Code of Ethics and democratic
way of management. But I don’t think those department connected and interacted
tightly enough.
