Enron Corporate Control Presented by: Cary Cheung, Christie Cheung, Rita Chung, Ryan Chan D1: What has the Enron case showed about the problems of corporate

Enron

Corporate Control

Presented by: Cary Cheung, Christie Cheung, Rita Chung, Ryan Chan

D1: What has the Enron case showed about the problems of corporate

control?

Presenters:Cary CheungChristie CheungRita ChungRyan Chan

Date: Sept 30, 2002

Managerial Economics – Professor Howard DAVIES

Enron

Corporate Control


Outline

• Introduction to Corporate Control• Background of Enron Corporation• The Story of Bankruptcy• Reasons for Bankruptcy• Problems of Corporate Control • Reforms• Conclusion

Enron

Corporate Control


Nominal Corporate Structure

Senior Manager

Board of Director

CompanyStaff

ShareholdersShareholders AuditCommittee

Auditor

ExecutiveDirectors

Non-ExecutiveDirectors

Enron

Corporate Control


Ownership VS Control?

Shareholders SeniorManager

Senior managers seek for max profit?Looking for significant discretion?Is there any Control mechanism?

Enron

Corporate Control


Importance of Corporate Control

• Market Corporate Control is the market for voting shares, which give ultimate control

• value of a firm’s stock = value of the stream of future profits

Market Corporate Control should prevent managers from being lazy or pursuing objectives other than maximizing the organization’s profit

Important and powerful mechanisms

Enron

Corporate Control


Rise and Fall of an Energy Giant

Let’s see Enron case…

Enron

Corporate Control


Shareholders Structure Types

Family-ControlledSingle Shareholder hold >20%e.g Cheung Kong Holding Ltd.

managed by major shareholders

Management-ControlledNo Single shareholder hold >20%e.g. Enronmanaged by professional managers

Other shareholders:

Institutions

Corporations

Pension funds

Charities

foundations

Small individual

investors

Enron

Corporate Control


Background of Enron Corporation (1)

• Houston-based energy trading and distribution company

• Famous for advocacy of energy deregulation• In just 15 years, climb to be 7th largest

company in US (Fortune 500, 2000), with 21,000 staff

• 16th largest in the world• In 2000, stock has crested at $90 a share• Market capitalization: $80 billion• Revenue $139 billion

Enron

Corporate Control


Background of Enron Corporation (2)

• Arthur Andersen acts as accountant and consultant

• Board of director– 14 members, only 2 insiders– Most of the directors owned stock

• Employee stock ownership and retirement planning– Incentive purpose– Enhance company profit

Enron

Corporate Control


Enron’s Bankruptcy (1)

Enron announced a large loss in its quarter statement

• 3rd qtr loss of >$600 million (surprised Wall Street)

• Stock price fall from the mid-$30s to the low-

$20s (triggered a crisis of confidence in the company)

Overstated its profits by ~16%

Jul

Oct

Nov

Dec ………Bankruptcy

2001

< Year 2001Prosperous business performance…..

Enron

Corporate Control


Enron’s Bankruptcy (2)

Major reason of bankruptcy?

A substantial fraction of Enron’s reported profits over a 4

year period (1996-2000) had been the result of

accounting manipulations

--- investigation by special committee of the Enron board

Reported profit Actual profit

Enron

Corporate Control


Reason For Bankruptcy (1)

• Accounting gimmickry:– Unable to spot bad accounting practices and company’s

overstatement of profits

• Conflict of auditor:– The multiple conflicting roles of auditor– Automatic renewal of auditing contractsAffecting the independence of auditor

• Accounting and staff policy failure– Although a professor of accounting and a dean for

monitoring the company, but they all fail in their profession

– Disastrous loss in employees’ retirement fund, but the ex-CEO has cashed his own stock much earlier?

Source:Enron Posts Surprise 3rd Quarter Loss After Investment, Asset Write-Downs, Wall St. J, Oct 17, 2001

Enron

Corporate Control



• Political confusion:– Ironical relationship between governmental

monitoring parties and political parties

Source: www.cnn.com / www.businessweek.com

http://www.cnn.com/

http://www.cnn.com/

http://www.cnn.com/

Enron

Corporate Control



• Managerialism– Managers tend to build up their own empires and

scarify the profits/benefits of the organization

• Conflict of the board– Enron’s board of directors fail to control and oversee

the management– The board had been benefited in various relationship

with the companyLack of independence of the board

Source:Professor of international business and strategic management at Suffolk University, Boston, US

Enron

Corporate Control


What’s Wrong with it?

How can they be fixed?

Enron

Corporate Control


Problems of Corporate Control (1)

Stock Option Scheme

•CEOs, Managers and employees are given STOCK OPTIONS as their compensation package

•Their aim is to get a maximum reporting profit so as to boost the stock price of the company

Enron

Corporate Control



• Board members and corporate partnerships were not independent

• Allowing private partnerships (set up by employee) to be valid Enron investment

• Board members could be benefited in various relationship

Control and Management Overlapping

Enron

Corporate Control



• CFO badly perform his role

• The financial report was very complicated to be understood

• A special team of reviewing the reports fails to perform their role

Failure in Financial management

Enron

Corporate Control



• Over 50% of Enron’s employee retirement schemes’ asset are invested in Enron’s share

• All employee have a common goal to boost the stock price of the company

Employee Retirement Schemes

Enron

Corporate Control


Reform (1)

Monitoring

• The selection of Qualified CEO to monitor the work of senior staff

• An independent committee of external board of directors to work with the company’s auditors

• Auditors should not be allowed to perform other services that may compromise their independence

• Management’s compensation should be a flat rate

Enron

Corporate Control


Reform (2)

Corporate governance regulation

• Government and Stock Exchanges should tighten regulations and rules to avoid any insider-trading

• Limitation of percentage of assets of retirement funds which can be invested in their own company.

Enron

Corporate Control


Reform (3)

A good Financial reporting system

• The financial report should not be too complicated (like Enron)

• It is dangerous that the report was only understood by only one or two people

• Reports should be made to a “easy-to-read” and easy to be understood by shareholders

Enron

Corporate Control


Conclusion

Enron challenges some of the core beliefs and practices that have underpinned the

academic analysis of corporate law and governance

we rely on assumptions of the efficacy of corporate governance/control in monitoring

managerial performance

Enron

Corporate Control


THANK YOU

END of D1 Group’s Presentation

Enron

Corporate Control


Appendix

1. Execution of nominal corporate control2. Enron’s Governance Structure

Enron

Corporate Control


How is the Corporate control executed?

• Non-Executive directors – independent view to strategy performance,

resources and standards of conduct• Executive directors

– business decision makers • Shareholders

– voting rights – layoff/appoint any Board of Director who is beneficial

to the company such that the future profit will reflect on stock price

• Audit Committee – consists of non-ex director and Financial Director

(without voting rights) – assurance of independence between Director and

Auditors

Enron’s Governance Structure

BoardKen Lay: Chair; Co-chair ZZZ

Audit, Compensation Cees.

ManagementLay, Skilling: CEO

Fastow, CFO; KoppersCausey, CAO; Buy, CRO

Watkins; Kaminsky; McMahon

Company Policies

Code of Conduct

Internal Audit ?

Whistleblowers ?

AuditorArthur

Andersen

Outside Law Firm

Consultant: Arthur Andersen

MissingSuspended

Compliance

GuidanceFinan.

ReportsSPEs

© L. Brooks

Documents

Enron Corporate Control Presented by: Cary Cheung, Christie Cheung, Rita Chung, Ryan Chan D1: What has the Enron case showed about the problems of corporate