Corporate Ownership & Control / Volume 8, Issue 3, 2011, Continued - 6

FACTORS CAUSING ENRON’S COLLAPSE: AN

INVESTIGATION INTO CORPORATE GOVERNANCE AND
COMPANY CULTURE
Nguyen Huu Cuong*

Abstract

This paper investigates and evaluates the weaknesses of Enron’s corporate governance structures,
weaknesses that lead to the collapse of the company. Overall, poor corporate governance and a
dishonest culture that nurtured serious conflicts of interests and unethical behaviour in Enron are
identified as significant findings in this paper.
Employing the case study method, the paper synthesises, analyses, and interprets all aspects of
corporate governance that lead to Enron's collapse based on three main reports: The Powers Report
(Powers, Troubh and Winokur 2002), the Testimony of Chief Investigation (Roach 2002), and The
Subcommittee’s Report (United States Senate’s Permanent Subcommittee on Investigations 2002).
Firstly, Enron’s Board of Directors failed to fulfil its fiduciary duties towards the corporation’s
shareholders. Secondly, the top executives of Enron were greedy and acted in their own self-interest.
Thirdly, many of Enron’s employees witnessed the wrongdoings of Enron’s top executives, and quite a
few whistleblowers came forward. Lastly, Enron outsourced external auditing for its internal audit
function instead of establishing a functionally internal audit mechanism and its external auditor
acquiesced in the application of questionable accounting and fraudulent financial reporting.
Although Enron's collapse has been widely discussed in the literature, no paper has been found that
synthesises the various aspects of corporate governance that resulted in the Corporation's collapse.
This paper contributes to the literature on the numerous weaknesses of Enron's corporate governance
structures, including the following: the role of the Corporation' board, especially its top executives; the
Corporation's corporate culture and whistle-blowing system; and the Corporation's internal auditor
and external auditors.

Keywords: Enron, Corporate Governance, Corporate Culture, Board of Directors, Executives

*Lecturer of Accounting, Danang University of Economics, The University of Danang, 71 Ngu Hanh Son, Danang City, Viet
Nam, Vietnam
Email: [email protected]

1. Introduction However, Enron was fraught with problems

throughout the 1990s, resulting mainly from the
This paper has examined and assessed the corporate creation of online energy, which aimed to carry out
governance mechanism of the Enron Corporation in contracts to supply energy products. The first problem
an attempt to provide a better understanding of why was that Enron was required to access substantial
the Corporation collapsed. lines of credit as a means of guaranteeing that it had
As is widely known, Enron was one of the sufficient funds at the end of each day to settle its
largest US-based companies, mainly providing signed contracts traded on its online system.
wholesale services, retail energy services, broadband Additionally, Enron was also suffering due to
services and transportation (Enron Corp 2001). considerable fluctuations in earnings from this
However, the corporation became well-known business. Consequently, with the intention of
because of its failures, which resulted from poor maintaining its investment-grade credit rating in order
corporate governance. It is publicly acknowledged to access low-cost financing and stimulate investment,
that the event of Enron filing for bankruptcy Enron employed numerous strategies aimed at
(December 2, 2002) marked a new period of increasing its financial and operating performance
revolutionary changes to corporate governance world- (United States Senate‟s Permanent Subcommittee on
wide, mainly focusing on law reform to prevent, or at Investigations 2002). Of these, „prepay‟ transactions,
least mitigate, future corporate collapses. „syndicating‟ assets, and hedging contacts with its
In terms of innovation, Enron‟s transition from special purpose entity (SPE) are worthy of attention.
an old-line energy company to a high-tech, globally As for prepaid transactions, in accordance with
trading energy enterprise is widely recognised. the United States‟ generally accepted accounting

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principles, prepayments must be recorded as debt and structuring numerous questionable entries through
cash flow from financing. However, in the case of prepay and merchant investment hedge transactions.
Enron, with an attempt to improve its credit ratings As a consequence of Enron‟s collapse, both the
and boost its share price, prepayments were booked as regulators and the accounting profession took
a trading liability and cash flow from operations disciplinary action as a response to the accusation of
(Roach 2002). Because the value of these transactions insufficient requirements for corporate disclosure and
is extremely high in comparison with Enron‟s cash lack of guidance on the treatment of SPE transactions.
flow from operations10, prepaid transactions had an In particular, the U.S. government passed the
enormous influence on the picture of Enron‟s Sarbanes–Oxley Act 2002 that aimed to address the
performance. Further, Enron‟s energy trading was corporate disclosure of accurate financial information
considered as its crown jewel (Gordon 2002). In this (Dnes 2005); and the American Institute of Certified
sense, when such manipulated transactions were Public Accountants had to publish a toolkit for
discovered and the financial statements were adjusted, accounting and auditing for related parties and related
Enron‟s share values declined dramatically as an parties‟ transactions12 (The American Institute of
inevitable consequence. Consequently, Enron could Certified Public Accountants 2001).
not carry out contracts to buy and sell energy, and The remainder of the paper is organised as
accordingly no partners would continue to trade with follows. Section 2 explores and evaluates the
the corporation (Gordon 2002). weaknesses of Enron‟s corporate governance. Enron‟s
In terms of the issue of being „asset light‟ or corporate governance system and culture as a whole is
„syndicating‟ the assets, Enron transferred several analysed and then the contribution of individual
billion worth of its assets to its „unconsolidated participants in Enron‟s corporate governance,
affiliates‟. As a result, such assets that slowly including the Board of Directors, the top executive
generate cash flow were syndicated throughout its officers, the internal auditor, the external auditor, and
numerous SPEs, and a vast amount of earnings were the whistleblowers, is examined. Section 3 concludes
recorded (United States Senate‟s Permanent by identifying practical implications for corporate
Subcommittee on Investigations 2002). Therefore, the government concerns.
corporation could not avoid encountering difficulties
when the reality of these structured transactions 2. Discussion
unfolded.
Forming and making use of SPEs also got Enron 2.1. Enron’s governance system and
into difficulty. Hundreds of SPEs were established in culture
order to hedge Enron‟s investments (Millon 2003).
Through Enron-SPE transactions, Enron‟s revenue, Although corporate governance may be viewed in
earnings, and cash flow were generated, which helped different ways by various disciplines (Turnbull 1997),
Enron to improve its credit rating and maintain this term commonly refers to a set of relationships
creditability in the energy trading business, while a among the firm‟s management, Board of Directors,
burden of debt to debt investors was imposed on and stakeholders (Organisation for Economic Co-
unconsolidated SPEs (Powers, Troubh and Winokur operation and Development 2004). In other words,
2002; Schwarcz 2002). The reality, however, is that corporate governance describes all the influences that
the treatment of Enron‟s SPEs as unconsolidated have effects on the institutional processes of a firm
affiliates was unlawful11; its consequences were (Turnbull 1997). Corporate governance is a system
extremely serious. Ultimately, a massive deduction in designed to direct and manage a firm that affects three
its reported net income and a massive increase in its main aspects used for judging a firm‟s success:
debt occurred when Enron retrospectively objectives, risks, and performance (ASX Corporate
consolidated its SPEs (Powers, Troubh and Winokur Governance Council 2003). More clearly, corporate
2002). governance is about the responsibilities of a firm‟s
Briefly, instead of making profits by buying and board in managing the firm and the board‟s
selling energy services as usual, Enron manipulated relationship with stakeholders (Pass 2004).
its profits, which ultimately led to its collapse by Given these definitions, it is easy to agree with
the point that good corporate governance enhances
not only accountability but also the creation of wealth
10
The value of prepay transaction at a rate of one or two per
year from 1992 to 2001 was $8.5 billion, while cash flow
12
from operations in 1999 was only $1.228 billion (Enron According to the American Institute of Certified Public
Corp 2001; Roach 2002). Accountants (2001), the toolkit provides an outline of
11
Concerning this issue, the U.S. Senate’s Permanent existing selected authoritative accounting and auditing
Subcommittee on Investigations (2002) reveals that the literature, the Securities and Exchange Commission’s
Enron collapse resulted from a billion’s worth of off-the- requirements, and non-authoritative best practice guidance
books transactions that were conducted in Enron through its involving related parties and related party transactions. This
unconsolidated affiliates, ultimately leading to material off- implies that the treatment of Enron-SPEs transactions is
the-books liabilities which are deliberately undisclosed. unlawful.

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(ASX Corporate Governance Council 2003; Bowden reasonable care, and competence (Brooks 2004;
2004; Organisation for Economic Co-operation and Kemper and Levine 2003; Shailer 2004). As the
Development 2004). In achieving good corporate highest level of the hierarchical corporate governance
governance, it is required that all participants in structure, Enron‟s Board of Directors not only must
corporate governance systems ensure there is have known about but also supported the Company‟s
accountability for their actions and that they fulfil questionable strategies, criticised policies, and
their responsibilities (Rezaee 2002). In the Enron devious transactions (Clark and Demirag 2002).
case, the weakness of corporate governance that
ultimately lead to Enron‟s demise was caused by all Accepting high risk accounting practices
participants, including the Board of Directors, top
executive officers, the internal auditor, the external All Enron‟s Board members were well aware of and
auditors, and whistleblowers as well. supported Enron‟s strategies, which aimed at
Enron‟s Board of Directors significantly maintaining its investment-credit rating, increasing
contributed to Enron‟s failures. The Board cash flows, and reducing its debt burden (United
inadequately oversaw key business and transactions in States Senate‟s Permanent Subcommittee on
the corporation. Further, the Board ineffectively Investigations 2002), although they claimed to be
controlled the implementation of the Corporation‟s victims of a cruel hoax and to be misled and
code of conduct or policy, which enabled self- uninformed about key activities and plans of the
interested managers to make profits at the company. The Board not only was well-informed but
Corporation‟s expense. Also, the Board did not build also authorised numerous „hedging‟ transactions that
up an environment in which the external auditor, the were handled by Enron‟s SPEs (Powers, Troubh and
internal audit function, and the whistleblowers could Winokur 2002). The Board, especially Kenneth Lay
operate effectively. (the Chairman and also the CEO), was warned of the
Enron‟s management was greedy and acted in its risk of „accounting scrutiny‟ by performing these
own self-interest, which seriously harmed the transactions at the Finance Committee in May 2000,
Corporation. Of the managers, the role of Enron‟s yet the Board completely neglected „red flags‟ and
chief executive officer (CEO) and chief financial approved a series of hedged contracts with its SPEs 13
officer (CFO) need to be examined. They both that were designed to help Enron avoid reflecting
secured vast sums of money in the form of losses caused by falls in its merchant investments on
compensation whilst the Corporation was in the its income statement (Millon 2003; Powers, Troubh
process of running into difficulties and on the verge of and Winokur 2002; Schwarcz 2002). Moreover, it was
bankruptcy. the Board that allowed Andrew Fastow - the CFO - to
Further, Enron‟s whistleblowers were not establish, and even worse, to become the sole
encouraged to come forward. This can be easily manager of the private equity fund (named LJM
understood as the corporation culture was „lacking in Cayman LP and known as LJM1) to do business with
integrity to a surprising degree‟ due to the senior Enron, which apparently lacks economic substance
executive‟s role in supporting and nurturing (Brooks 2004; Powers, Troubh and Winokur 2002;
wrongdoings (Brooks 2004). For example, it is totally United States Senate‟s Permanent Subcommittee on
implausible that the senior executives did not know of Investigations 2002). He was also approved to
the establishment of „a sham energy trading floor‟ become the general partner of some other partnerships
being „completed with computers, desks, chairs, and that were deliberately set up to make profits at
traders‟ (Brooks 2004). In such a culture, all internal Enron‟s expense. The significant effects of these
corporate governance attributes definitely become breaches on Enron‟s financial position were that debts
weaker. In this instance, the situation had become were moved off Enron‟s balance sheet and earnings
worse because the external auditor simultaneously and cash flows were inflated.
served as the internal auditor and acquiesced with the In addition, the Board also supported an „asset
wrongdoings of Enron‟s management. light‟ strategy, or „syndicating‟ the assets, which
allowed Enron to transfer several billion dollars worth
2.2. The contributing roles of Enron’s of its asset with a slow generating cash flow to its
stakeholders „unconsolidated affiliates‟ and record exorbitant
earnings (United States Senate‟s Permanent
2.2.1. The role of directors Subcommittee on Investigations 2002). However,
such „unconsolidated affiliates‟ did not meet the
The contribution of Enron‟s directors to the requirements for being unconsolidated. Further, the
Company‟s demise can be briefly described as Board was adequately informed of the increases in
unfulfilled fiduciary duties. Generally, directors are
wholly responsible for governing and directing the
13
company‟s affairs in the best interests of the company For example, Enron-Rhythms transactions helped Enron
as a whole and its shareholders (Shailer 2004). keep its loss of $95 million in LJM1, which was unlawfully
Therefore, they are required to act in honesty, treated as an independent controlling partner, to avoid
being consolidated.

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making use of „prepay‟ transactions, of which typical examples of unresolved conflicts of interests
prepayments were wrongly treated as a trading that had long existed in Enron and enabled self-
liability and cash flow from operations, instead of interested managers to make huge profits at their
debt and cash flow from financing (Roach 2002). company‟s expense14.
By reviewing such facts, there is little doubt that
Enron‟s Board knew about, and officially approved Inadequate oversight of key business transactions
of, the application of high risk accounting practices, and executives’ compensation
specifically billions of dollars in off-the-books
activity, which aimed at significantly improving its In addition to the issue of inappropriate conflicts of
financial position as concluded by the Permanent interest, the Board also failed to fulfil its
Subcommittee on Investigations (2002). responsibility for adequately overseeing
compensation. Firstly, compensation of the CFO from
Failure to avert conflicts of interest the partnership was mandated to be reviewed by
Enron‟s Compensation Committee; even so, there had
Enron‟s directors must be responsible for their been no review conducted until the time when the role
permission for Enron‟s CFO to establish and manage of CFO in LJM was publicly known (Powers, Troubh
partnerships that ultimately brought them millions of and Winokur 2002). Based on the interview
dollars by engaging in self-dealt transactions with conducted by Dr. LeMaistre, a member of Enron‟s
Enron (Emshwiller and Smith 2001; Kranhold and Executive Committee, Fastow‟s compensation from
Schroeder 2002). The conflicts of interest were clearly LJM was incredible - 45 million dollars (United
shown when the CFO was approved to become the States Senate‟s Permanent Subcommittee on
sole manager and also the general partner of LMJ1, Investigations 2002). Despite realising the danger to
allowing him to make millions of dollars by Enron‟s shareholders of Enron-LJM transactions with
performing Enron-Swap Sub transactions (Powers, the involvement and ownership of Fastow, the Board
Troubh and Winokur 2002). Surprisingly, it is failed to exercise adequate oversight over those
difficult to understand why Enron‟s directors would transactions. Hence, if the Board had adequately
believe the CFO‟s claim, with his role as the general reviewed and overseen Fastow‟s compensation and
partner of LJM1 that owned part of Swap Sub, that properly controlled Enron-LJM partnership
there was no benefit when he entered into transactions, hundreds of millions of dollars may have
negotiations on the Enron-Swap Sub negotiations. stayed with Enron‟s shareholders instead of flowing
The failure to avert conflicts of interest can be to Fastow and his associates (United States Senate‟s
understood by taking the Corporation‟s culture into Permanent Subcommittee on Investigations 2002).
consideration - a cut-throat culture pitting one Moreover, there is evidence that the Board
employee against another (Fusaro and Miller 2002). poorly governed the executives‟ compensation.
In this sense, it is possible to argue that Enron‟s Enron‟s executives were not only granted large salary
culture was a risk taking one placing too much packages, but were also awarded with huge annual
reliance on Andrew Fastow. Consequently, this is and special bonus plans (United States Senate‟s
why he profited from his schemes. The failure may Permanent Subcommittee on Investigations 2002). It
have been due to the Board having this same conflict is also worth acknowledging that executive stock
of interest, with the view to sharing in the profits from option granting is one of management‟s economic
these schemes, given that the self-deal transactions incentives to practice earnings management, and this
with Enron earned Fastow millions. has been documented in the audit literature (Healy
When it comes to the case of Chewco, though, and Wahlen 1999; Said 2003). Surprisingly, the Board
Enron‟s directors chose alternative oversight of Enron did not take any action when witnessing a
measures for conflicts of interest relating to the large number of stock options distributed to Enron‟s
proposed role of Fastow in Chewco, and the conflict executives and the huge amounts they earned from
of interest still remained. In fact, the appointment of exercising stock options grants15. Although there is no
Kopper, who was at that time an Enron worker, as the consensus on the relation between executive stock
manager of Chewco did not comply with Enron‟s option compensation and the future performance of a
Code of Conduct of Business Affairs, which requires
that his role and his participation in Chewco must be
14
approved by the Board (Powers, Troubh and Winokur The LJM partnership was reported as a highly profitable
2002). Further, as the person working for the CFO in venture with a 69 per cent rate of return in the first year of
the finance area, his role in Chewco, as the sole operation and transacted business basically only with Enron.
person dealing with this partnership and having Therefore, profits of LJM, ultimately, profits of their
complete authorisation over this partnership owners, were made at Enron’s expense (United States
transaction, induced him to act in the best interests of Senate’s Permanent Subcommittee on Investigations 2002).
15
the CFO rather than Enron‟s shareholders. For example, in 2000, Lou Pai exercised stock options
Briefly, the role and benefits of Fastow and and quilted the company with more than $265 million in
Kopper in LJM partnerships can be regarded as cash, and Kenneth Lay gained $123 million from exercising
a portion of its stock option.

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firm as well as management earnings (e.g. Core et al., Directors may have been beneficial for the company.
1999; Henry, 2003; Jensen and Meckling, 1976; On the other hand, the corporate governance literature
Rạgopal and Shevlin, 2002; Yermack, 1995), the has also reported that auditor objectivity is likely to be
Board should have considered the executives‟ high impaired by the economic bond between the external
compensation driven by stock option compensation auditor and its audit client (Brandon, Crabtree and
packages as a red flag for fraudulent financial Maher 2004; Frankel, Johnson and Nelson 2002; Hay,
reporting. Even worse, its executives earned $750 Knechel and Li 2006; Krishnan, Sami and Zhang
million in annual bonuses when the Corporation‟s 2005). This economic theory is generally applicable
total net income for 2000 was $975 million. A to outside directors serving on the board. The
significant figure was Kenneth Lay‟s total evidence as to Enron‟s economic bond is that certain
compensation package in 2002 of over $140 million, Enron board members had financial ties with Enron
which was ten times higher than the average payment (United States Senate‟s Permanent Subcommittee on
of CEOs in U.S publicly-traded corporations (United Investigations 2002). Thus, it is reasonable to suggest
States Senate‟s Permanent Subcommittee on that the independence of Enron‟s Board of Directors
Investigations 2002). was impaired, ultimately contributing to the
ineffective oversight over management activities that
Due care and outside directorship lead to Enron‟s demise.

It is argued that the frequency of meetings held by the 2.2.2. The role of executive officers
Board of Directors does not necessarily reflect its
effectiveness and that outside directorships of the The role played by executive officers in contributing
board members may increase oversight of the board to the Enron fiasco is significant. The previous section
over the company because of incentives to protect has exemplified the contributing role of Enron‟s CFO.
their reputation (Song and Windram 2004; Yang Hence, this section focuses on discussing the
2002). However, what occurred in Enron shows the contributing role of the CEO, Kenneth Lay.
need to take these issues into consideration16. As As outlined earlier, the establishment and
discussed earlier, the failures of Enron‟s directors operation of SPEs was to best serve the self-interests
mainly stem from failing to exercise adequate and satisfy the CFO and some other Enron employees,
oversight; therefore, Enron‟s directors should have and ultimately lead Enron to slide into bankruptcy.
spent more time on the significant issues of the However, it is arguable that difficulties arising from
company despite the fact that there is no benchmark the SPEs could have been avoided if the CEO had
for this measure17. The efficiency of the Board of acted in the interests of Enron‟s shareholders. Under
Directors may have been impaired by outside Enron‟s Code of Conduct, the CEO had to examine,
directorship, resulting from time constraints - even approve, and control the establishment and operations
though it is not easy to measure such factors; however of Enron-LJM‟s partnership transactions to ensure
this, still, is an implausible excuse given the many that these transactions were fair to Enron (United
warning signs in this case. States Senate‟s Permanent Subcommittee on
Investigations 2002). What the CEO did was not only
Enron’s Board of Directors’ economic bond to approve the CFO to do business with Enron but
also to improperly control transactions between his
The corporate governance literature has emphasised partnerships and Enron, thus enabling hundreds of
the role of outside directors and documented how millions of dollars of Enron‟s expenses to be
increasing the percentage of outside directors on the converted into his and his associates‟ benefits (United
board and on the audit committee could enhance the States Senate‟s Permanent Subcommittee on
effectiveness of corporate governance (Bhojraj and Investigations 2002).
Sengupta 2003; Davidson, Goodwin-Stewart and Additionally, the CEO also made use of his
Kent 2005; Dechow, Sloan and Sweeney 1996; Klein credit line to draw sums of money ($77 million) from
2002; Peasnell, Pope and Young 2006; Richardson Enron and repay it with Enron‟s own stock (United
2000; Sharma 2004; Yang 2002). Therefore, the States Senate‟s Permanent Subcommittee on
presence of outside directors on Enron‟s Board of Investigations 2002). This action does not only reflect
the Board‟s lack of control over Enron‟s business and
compensation, but also reflects the high level of self-
16
Power, Troubh and Winokur (2000) reported that interest of Enron‟s CEO.
Enron’s Board held five regular meetings per year. The In this context, it could be convincingly argued
United States Senate’s Permanent Subcommittee on that the dual role of Ken Lay, over a long period,
Investigations (2002) documented that Enron’s Board of significantly contributed to the lack of proper
Directors spent relatively little time reading material and governance that ultimately lead the firm to go into
preparing for board meetings (1 to 2 days) and little time in bankruptcy. This conclusion, firstly, is fully supported
attending board meetings (1 to 2 hours). by the recommendation that it would be ineffective if
17
Australian listed companies’ boards hold meetings the company‟s management was dominated by a
between 4 to 10 times per year (Shailer 2004).

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single person without compensation (Auditing and audit department as their reports were based on a
Assurance Standards Board 2006). Further, corporate limited understanding of the business. Therefore,
governance literature also suggests that the separation Enron should have established its own audit
of the role of CEO and chairman enhances corporate department so that the internal audit could have made
governance effectiveness (Johnson and Jianbo 2004; a greater contribution to enhance the integrity of
Organisation for Economic Co-operation and corporate governance. In doing so, internal auditors
Development 2004; Sharma 2004). should achieve the following objectives: overseeing
the effectiveness of internal control, performing risk
2.2.3. The role of whistleblowers assessment and management processes, ensuring
procedural compliance including IT systems integrity,
As noted previously, the culture of Enron was producing audit committee briefs, and getting
dishonest and unethical. Consequently, this culture involved in other corporate governance issues (Leung,
discouraged Enron‟s whistle-blowers to come Cooper and Robertson 2003).
forward. Additionally, within this context, it is not
difficult to understand why some of Enron‟s 2.2.5. The role of the external auditor
employees came forward; however, there was no
action taken to follow this up. Besides the corporate In addition to Enron‟s internal corporate governance
culture, it is also important to note that Enron‟s structure, Enron‟s external auditor, Arthur Andersen,
employees „blew to the wrong people‟, including the also played a key role in contributing to the Enron
CEO and the CFO, who were directly involved in fiasco. The role of the auditor, generally, is to provide
such wrongdoings and acted in their own interests. reasonable assurance that audited financial reporting
Accordingly, although Enron‟s CEO did consult with is free from material misstatement, as well as
the law firm Vinson & Elkins, there was no follow-up truthfully and fairly presented by management. In
action undertaken (Powers, Troubh and Winokur doing so, the external auditor is required to be
2002). In fact, Ms Sherron Watkins, the vice president impartial and free from any financial interest in the
for corporate development at Enron, blew the whistle audit client (Foldvary 2002). With Enron, the external
by writing an „anonymous‟ memo to Ken Lay on an auditor acquiesced in Enron‟s financial reporting and
elaborate accounting hoax at the Corporation and so deliberately withheld information about the
another to the public relations department on how the Company‟s difficulties. Firstly, this could have
CEO should handle the financial mess. Nonetheless, resulted from the economic bond, as discussed earlier.
her whistle-blowing letters were not followed up It is a fact that Arthur Andersen was paid $27 million
(Fusaro and Miller 2002; Zimmerli, Richter and for non-audit services and $25 million for audit work
Holzinger 2007). from Enron, and this firm was attempting to raise its
In order to enhance the effectiveness of whistle- revenue (Brooks 2004). Hence, it is probable that the
blowing as an internal control mechanism, it is quality of Arthur Andersen‟s audit work for Enron
crucially important to create an environment in which was impaired by conflicts of interest between
individuals are able to freely provide upstream protecting its professional reputation by fulfilling its
communication, not only within but also outside the professional responsibilities and being willing to risk
organisation (Hooks et al. 1994). U.S regulators such a reputation as a means of keeping its largest
support this view by stating, in the Sarbanes-Oxley client by acquiescing with Enron‟s management
Act of 2002, that audit committees must establish (Brooks 2004; Foldvary 2002; Lipton 2006; Millon
procedures, referred to as „whistle-blowing systems‟, 2003). Moreover, it is also argued that their
to deal with employees‟ complaints and concerns acquiescence was caused by Arthur Andersen‟s lack
about internal accounting control, and accounting and of competence in detecting extremely complicated
auditing matters, especially questionable accounting financial vehicles designed by its client‟s
and auditing matters ('Sarbanes-Oxley Act of 2002'). management. Regardless of the reasons, Arthur
Andersen failed to produce a quality audit report; and
2.2.4. The role of the internal auditor the action of shredding tons of Enron‟s documents
reflects its failures to fulfil its fiduciary duty.
One of the most important mechanisms in
internal corporate governance is the internal audit. It 3. Conclusion
is important to note that Enron‟s internal auditors
were outsourced from Arthur Andersen for several It is widely accepted that the high profile collapse of
years (Brooks 2004; Smith 2002). The lack of a Enron was caused by numerous factors. Congruent
strong and capable internal audit department also with widely-held perceptions, this paper has found
significantly contributed to Enron‟s collapse because that the deciding factor in Enron‟s demise was the
of the high probability of undetected wrongdoing, corporation‟s allowance of poor governing structures
unnoticed questionable transactions and dealings, and and processes. Specifically in relation to the directors,
earnings management (Smith 2002). Also, outsourced evidence revealed that Enron‟s Board of Directors did
auditors may have influenced the effectiveness of the not fulfil their fiduciary duties towards the

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corporation‟s shareholders. These failures were the U.S legislation had no requirement for the
proved by evidence that the Board approved high risk separation of the role of CEO and chairman in the
accounting practices, failed to avert conflicts of company‟s organisational structure (Lipton 2006).
interest, and did not adequately oversee key business However, in terms of expected good corporate
and executives‟ compensation decisions. Moreover, governance, it is believed that the dual role of the
with regard to Enron‟s top executives, this paper CEO should not be permitted in a company‟s
strongly supports the suggestion that executives were organisational structure. Theoretically, it is widely
greedy, as well as acting in their own self-interest so acknowledged that a chairperson is the person who
as to seriously harm Enron‟s shareholders. Enron‟s acts in the shareholder‟s interests. Hence, he or she
CFO proposed (and this was approved) to establish has responsibilities for monitoring and advising
private equity funds in the form of SPEs to make huge executive officers‟ activities with the aim of best
profits at the Corporation‟s expense. Not unlike CFO, serving the shareholders. This could be the reason
Enron‟s CEO did not act in the interests of the why the Organisation for Economic Co-operation and
Corporation‟s shareholders, evident by the fact Development (2004) suggests that the separation of
Fastow was allowed to enjoy vast amounts of profit the role of CEO and chairman enables the board to
by undertaking unfair transactions with Enron that effectively exercise its responsibilities for monitoring
seriously harmed Enron‟s shareholders. In addition, a managerial performance and preventing conflict of
number of Enron‟s employees witnessed the interest. Additionally, in order to successfully fulfil its
wrongdoing of Enron‟s top executives, but only a few function of monitoring management and strategic
came forward. Nevertheless, this situation is guidance, the Organisation for Economic Co-
understandable because the constraints resulted from operation and Development (2005) also recommends
the extremely dishonest culture. Ultimately, the that it is necessary for the board to have the power to
weakness of Enron‟s corporate governance could not appoint and fire the CEO. Moreover, the prevalence
be offset as the corporation‟s whistleblowers‟ system of CEOs contributing to corporate collapses, such as
was improperly maintained. Concerning the audit with Health International Holdings Insurance, has
mechanism, not only did the internal audit not resulted in the necessity to separate the roles of CEO
function properly, but also the external auditor and chairman rather than to formulate a single
acquiesced with Enron‟s management in the structure (Johnson and Jianbo 2004). Further, some
application of questionable accounting and fraudulent research suggests that the duality on the board also
financial reporting because of its economic increases the likelihood of fraud and earnings
dependence on the Corporation. The combination of manipulation (Dechow, Sloan and Sweeney 1996;
all these internal corporate governance attributes Sharma 2004). In addition, the Australian Auditing
resulted in Enron‟s difficulties, and ultimately the and Assurance Standards Board (2006) also notes that
Company went into bankruptcy. ineffective monitoring of management is a
Based on the findings of this paper, the first consequence of domination of management by a
painful lesson drawn from the role of Enron‟s single person without compensation controls.
directors is the failure to avert the serious issue of Therefore, in the case of Enron, it can be logically
conflict of interest. Remarkably, Enron‟s collapse concluded that the dual role of Ken Lay significantly
resulted from manipulation by applying high-risk contributed to the lack of proper governance,
accounting practices, as mentioned earlier and as has ultimately leading the firm into bankruptcy. This case
been widely discussed in the literature. More provokes further research into evaluating the
importantly, these manipulations thrived owing to the effectiveness of the duality of the CEO in the
conflicts of interest existing in Enron - especially in corporate governance mechanism of a firm.
that the CEO gained a massive amount of As for the auditor‟s objective, even though the
compensation and returns by acting in favour of SPEs literature has documented the divergent evidence on
and in his own interests (Schwarcz 2002). Thus, the way that an auditor‟s opinion is affected by
enhancing conflict of interest regulations is one of the economic bonds, many regulations follow the
most effective measures to prevent corporate failure. Sarbanes–Oxley Act (2002) to prohibit or at least to
Secondly, in terms of top executives‟ structure, restrict the auditor to provide non-audit services to its
there are some opponents of the suggestion that the clients. This paper again calls for future research to be
role of the CEO should be separated from the role of carried out to gain further evidence to access
chairperson. For instance, Dalton and Dalton (2005) regulations resulting from corporate governance
note that there is, surprisingly, no evidence in the reforms around the world.
literature demonstrating the superiority of the separate In conclusion, the paper theoretically suggests
structure and encouraging the dual roles of the that a business organization should follow the
chairman of the board rather than making efforts to following corporate governance model to prevent an
advocate for the separate structure. In the same vein, Enron-like collapse happening.

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Table 1. The good corporate governance model for Enron-like collapse prevention

Corporate governance attributes Practicing good governance

- Board structure and processes - Providing effective oversight of the corporation
management actions, such as directly controlling key
business transactions, maintaining regular meetings of
the Boards, carefully designing and governing
executive compensation, establishing proper procedure
for whistleblower protection, and separating the role of
CEO and the chairperson‟s.

- Audit function - Setting up the internal audit department to enhance

the integrity of corporate governance, separating
internal and external audit functions, not paying higher
fees to the auditors for non-audit services than an
audit.

- Stakeholders‟ rights and the corporate culture - Formulating and strictly complying with the
Corporation Codes of Ethics and the Codes of
Conducts.

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