D1: What Has The Case Showed About The Problems of Corporate Control?

Enron Corporate Control
Managerial Economics Professor Howard DAVIES
D1: What has the Enron case showed about the problems of corporate control?
Presenters: Cary Cheung Christie Cheung Rita Chung Ryan Chan
Date: Sept 30, 2002

Presented by: Cary Cheung, Christie Cheung, Rita Chung, Ryan Chan
Outline
Introduction to Corporate Control Background of Enron Corporation The Story of Bankruptcy Reasons for Bankruptcy Problems of Corporate Control Reforms Conclusion
Nominal Corporate Structure

Shareholders Audit Committee Auditor
Board of Director
Senior Manager
Executive Non-Executive Directors Directors
Company Staff
Ownership VS Control?
Shareholders
Senior Manager
Senior managers seek for max profit? Looking for significant discretion? Is there any Control mechanism?
Importance of Corporate Control
Market Corporate Control is the market for voting shares, which give ultimate control value of a firms stock = value of the stream of future profits
Market Corporate Control should prevent managers from being lazy or pursuing objectives other than maximizing the organizations profit
Important and powerful mechanisms
Rise and Fall of an Energy Giant
Lets see Enron case

Shareholders Structure Types
Family-Controlled Single Shareholder hold >20% e.g Cheung Kong Holding Ltd. managed by major shareholders
Other shareholders:
Institutions Corporations Pension funds Charities foundations Small individual investors
Management-Controlled No Single shareholder hold >20% e.g. Enron managed by professional managers
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
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 < Year 2001
Enrons Bankruptcy (1)

Prosperous business performance..
2001
Jul Enron announced a large loss in its quarter statement
Oct
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) Nov Dec Overstated its profits by ~16%
Bankruptcy
Enrons Bankruptcy (2)
Major reason of bankruptcy?

A substantial fraction of Enrons 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

Reason For Bankruptcy (1)

Accounting gimmickry: Unable to spot bad accounting practices and companys overstatement of profits Conflict of auditor: The multiple conflicting roles of auditor Automatic renewal of auditing contracts Affecting 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
Political confusion:
Ironical relationship between governmental monitoring parties and political parties
Source: www.cnn.com / www.businessweek.com


Managerialism
Managers tend to build up their own empires and scarify the profits/benefits of the organization
Conflict of the board

Enrons board of directors fail to control and oversee the management The board had been benefited in various relationship with the company Lack of independence of the board
Source: Professor of international business and strategic management at Suffolk University, Boston, US
Whats Wrong with it?

How can they be fixed?
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

Control and Management Overlapping
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

Failure in Financial management
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

Employee Retirement Schemes
Over 50% of Enrons employee retirement
schemes asset are invested in Enrons share All employee have a common goal to boost the stock price of the company
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 companys auditors Auditors should not be allowed to perform other services that may compromise their independence Managements compensation should be a flat rate
Reform (2)
Corporate governance regulation
Government and Stock Exchanges should tighten regulations and rules to avoid any insidertrading
Limitation of percentage of assets of retirement funds which can be invested in their own company.
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-toread and easy to be understood by shareholders
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
END of D1 Groups Presentation
THANK YOU
Appendix
1. Execution of nominal corporate control 2. Enrons Governance Structure
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
Enrons Governance Structure

L. Brooks
Outside Law Firm

Finan.
SPEs
Reports
Board Ken Lay: Chair; Co-chair ZZZ Audit, Compensation Cees.

Compliance
Guidance
Missing Suspended
Management Lay, Skilling: CEO Fastow, CFO; Koppers Causey, CAO; Buy, CRO Watkins; Kaminsky; McMahon
Company Policies Code of Conduct Internal Audit ? Whistleblowers ?
Consultant: Arthur Andersen
Auditor Arthur Andersen

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Enron Corporate Control

Managerial Economics Professor Howard DAVIES

Date: Sept 30, 2002

Enron Corporate Control

Enron Corporate Control

Nominal Corporate Structure

Executive Non-Executive Directors Directors

Enron Corporate Control

Enron Corporate Control

Importance of Corporate Control

Important and powerful mechanisms

Enron Corporate Control

Rise and Fall of an Energy Giant

Lets see Enron case

Enron Corporate Control

Shareholders Structure Types

Enron Corporate Control

Background of Enron Corporation (1)

Enron Corporate Control

Background of Enron Corporation (2)

Arthur Andersen acts as accountant and consultant Board of director

Employee stock ownership and retirement planning

Enron Corporate Control < Year 2001

Enrons Bankruptcy (1)

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

Enron Corporate Control

Enrons Bankruptcy (2)

Major reason of bankruptcy?

--- investigation by special committee of the Enron board

Reported profit Actual profit

Enron Corporate Control

Reason For Bankruptcy (1)

Enron Corporate Control

Reason For Bankruptcy (2)

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

Enron Corporate Control

Reason For Bankruptcy (3)

Conflict of the board

Enron Corporate Control

Whats Wrong with it?

Enron Corporate Control

Problems of Corporate Control (1)

Enron Corporate Control

Problems of Corporate Control (2)

Enron Corporate Control

Problems of Corporate Control (3)

CFO badly perform his role

Enron Corporate Control

Problems of Corporate Control (4)

Enron Corporate Control

Enron Corporate Control

Enron Corporate Control

Enron Corporate Control

Enron Corporate Control

END of D1 Groups Presentation

Enron Corporate Control

Enron Corporate Control

How is the Corporate control executed?

Enrons Governance Structure

Outside Law Firm

Board Ken Lay: Chair; Co-chair ZZZ Audit, Compensation Cees.

Company Policies Code of Conduct Internal Audit ? Whistleblowers ?