College of Business Administration

Article Reprints:

Rondal R. Sims & Brinkmann, Johannes

Enron ethics: Culture matters more than codes. Journal of Business Ethics, Jul 2003.Vol. 45, Iss. 3; pg. 243

At first sight, Enron looks like a mega-size illustration of the bad apple and/or the bad barrel disease and, hence, looks like good marketing for the business ethics business (which almost has a vested interest in such scandals and other bad examples). The problem is, however, that Enron looked like an excellent corporate citizen, with all the corporate social responsibility (CSR) and business ethics tools and status symbols in place.

Enron Ethics (an ironic expression which is used now and then, see e.g. the headings of Tracinski, 2002 or Berenbeim in Executive action no. 15, Feb. 2002) reads like the new catchword for the ultimate contradiction between words and deeds, between a deceiving glossy facade and a rotten structure behind, like a definite good-bye to naive business ethics. Enron ethics means (still ironically) that business ethics is a question of organizational "deep" culture rather than of cultural artifacts like ethics codes, ethics officers and the like. With this as a backdrop, the paper will describe and discuss how executives at Enron in practice created an organizational culture that put the bottom line ahead of ethical behavior and doing what's right. More specifically, the paper first provides a brief background on Enron and its rise and fall. Next, the paper systematically uses Schein's (1985) five primary mechanisms available to leaders to create and reinforce aspects of culture (i.e., attention focusing, reaction to crises, role modeling, rewards allocation and criteria for hiring and firing) to analyze the company's culture and leadership that contributed to it's ethical demise and filing for bankruptcy. It is our contention, that with such a point of departure one will be better prepared for a necessary discussion in our field of how to prevent an "instrumentalization" of ethics and CSR for mere facade purposes (this theme deserves and requires a paper on its own, at least).

The culture history of Enron

The Enron case is not least a good illustration of continuously updated case presentation and case discussion in the Internet age (which could deserve a paper on its own, too). Business school researchers, teachers and students alike can easily keep themselves busy for days just with sorting, structuring, checking and summarizing all the ingredients and pieces of the Enron story found on the Internet. One possible way of organizing and limiting such a task is departing from or even staying with the websites of traditional mass media such as CNN (see e.g. cnn.com/SPECIALS/2002/enron/), the Wall Street Journal, Financial Times, or of the main stakeholders such as the victims' enrongate.com or the remainders' enron.com. Most tempting for business ethicists is of course a closer look at the websites of the business ethics business (see e.g. http://www.msnbc.com/modules/enron/, businessethics.ca/enron/, caseplace.org, enronguide. com, all with lots of further links) and as the up-dated and earliest of all the academic articles and papers we can expect in the future Tonge et al., 2003; Petrick and Quinn, 2002; Cohan, 2002). In spite of (or because of ) such an abundance of available information1 we choose to tell the story once more, as a culture history in our own prose, as a background for the following illustration of how Schein's organization culture approach can lead to a better understanding of the Enron case.

Background

A company with humble beginnings, Enron began as a merger of two Houston pipeline companies in 1985. Although Enron faced a number of financially difficult years, the company managed to survive. In 1988, the deregulation of the electrical power markets took effect, and the company redefined its business from "energy delivery" to "energy broker" and Enron quickly changed from a surviving company to a thriving one. Deregulation allowed Enron to become a "matchmaker" in the power industry, bringing buyers and sellers together. Enron profited from the exchanges, generating revenue from the differences between the buying and selling prices. Deregulation allowed Enron to be creative - for the first time, a company that had been required to "operate within the lines" could innovate and test limits. Over time, Enron's contracts became increasingly diverse and significantly more complex. As Enron's products and services evolved, so did the company's culture.

In this newly deregulated and innovative forum, Enron embraced a culture that rewarded "cleverness". Deregulation opened the industry up to experimentation and the culture at Enron was one that expected employees to explore this new playing field to the utmost. Pushing the limits was considered a survival skill.

Enron's former President and Chief Executive Officer (CEO) Jeffry Skilling actively cultivated a culture that would push limits - "Do it right, do it now and do it better" was his motto. He encouraged employees to be independent, innovative and aggressive. The Harvard Business Review Case Study: Enron's Transformation (Bartlett and Glinska, 2001) contains employee quotations such as ". . . you were expected to perform to a standard that was continually being raised . . .", "the only thing that mattered was adding value", or ". . . it was all about an atmosphere of deliberately breaking the rules . . ." (Bartlett and Glinska, 2001). A culture that admires innovation and unchecked ambition and publicly punishes poor performance can produce tremendous returns in the short run. However, in the long run, achieving additional value by constantly "upping the ante" becomes harder and harder. Employees are forced to stretch the rules further and further until the limits of ethical conduct are easily overlooked in the pursuit of the next big success (Josephson, 1999; cf. also similarities found in the culture at Salomon Brothers in the early 1990s, see Sims, 2000; Sims and Brinkmann, 2002).

A lot of smoke and mirrors

Enron's spectacular success, and the positive scrutiny the company was receiving from the business press and the financial analysts, only added fuel to the company's competitive culture. The business community rewarded Enron for its cleverness (and even its ethicalness) and Enron's executives felt driven by this reputation to sustain the explosive growth of the late 1990s, even when they logically knew that it was not possible. A negative earnings outlook would have been a red flag to investors, indicating Enron was not as successful as it appeared. If investors' concerns drove down the stock price due to excessive selling, credit agencies would be forced to downgrade Enron's credit rating. Trading partners would lose faith in the company, trade elsewhere, and Enron's ability to generate quality earnings and cash flows would suffer. In order to avoid such a scenario at all costs, Enron entered into a deceiving web of partnerships and employed increasingly questionable accounting methods to maintain its investment-grade status. Enron executives probably felt that they were doing the right thing for their organization.

Partnerships

Partnerships can be an easy and efficient way to raise money. However, in an effort to continue to push the value envelope Enron took partnerships to a new level by creating "special purpose vehicles" (SPVs), pseudo-partnerships that allowed the company to sell assets and "create" earnings that artificially enhanced its bottom line. Enron exaggerated earnings by recognizing gains on the sale of assets to SPVs. In some cases, the company booked revenues prior to a partnership generating significant revenues. Project Braveheart, a partnership Enron developed with Blockbuster was intended to provide movies to homes directly over phone lines. Just months after the partnership was formed, Enron recorded $110.9 million in profits prematurely, these profits were never realized as the partnership failed after only a 1,000-home pilot.

In a success culture like Enron's such behavior represented a way of least resistance. Enron employees with a self-image of being the best and the brightest and being extremely clever do not make business deals that fail. Therefore booking earnings before they are realized were rather "early" than wrong. The culture at Enron was quickly eroding the ethical boundaries of its employees.

Keeping debt off the balance sheet

The SPVs not only allowed Enron to boost earnings, but the SPV's also allowed the company to keep debt off its balance sheet. A highly leveraged balance sheet would jeopardize its credit rating as its debt-equity ratio would rise and increase its cost of capital. To avoid this, Enron parked some of its debt on the balance sheet of its SPVs and kept it hidden from analysts and investors. When the extent of its debt burden came to light, Enron's credit rating fell and lenders demanded immediate payment in the sum of hundreds of millions of dollars in debt.

This can be read as another example of ethical erosion. Enron's decision makers saw the shuffling of debt rather as a timing issue and not as an ethical one. Clever people would eventually make everything right, because the deals would all be successful in the long run. Moving debt was as easy as pre-dating a check, and would harm no one, and therefore was not an ethical issue.

Partnerships at "arm's length"

Each questionable partnership decision carried additional cleverness burdens. In order to keep information from the public, Enron had to guarantee that the Securities Exchange Commission (SEC) did not consider its partnerships as Enron subsidiaries. If the partnerships had been classified as such, in-depth disclosure and stricter accounting methods would have been required. In order to prevent potential SEC skepticism, Enron enlisted help from its outside accountants and its attorneys (Arthur Andersen, and Vinson &Elkins). The accountants and attorneys all referenced the Financial Accounting Standards Board (FASB) rule that holds that partnerships are not considered subsidiaries as long as 3% of their equity comes from outside investors and they are managed independently of their sponsors. This is commonly known as being at "arm's length". Enron crafted relationships that looked (legally) like partnerships, although they were (in practice) subsidiaries. A closer look at the partnerships would have revealed that the outside investments came from companies (like SE Thunderbird LLC) that were owned by Enron.

Conflicts of interest

Although the partnerships were classified as partnerships according to the FASB rules, Enron officials obviously had close ties with them. This raised the question about conflicts of interest. Andrew Fastow, Enron's former Chief Financial Officer (CFO), ran or was partial owner of two of the most important partnerships: LJM Cayman LP and LJM2 Co-Investment LP. Michael Kopper, a former managing director at Enron, managed a third partnership, Chewco Investments LP.

The culture of cleverness at Enron started as a pursuit of excellence that devolved into the appearance of excellence as executives worked to develop clever ways of preserving Enron's infallible facade of success. Although Enron maintained that top officials in the company reviewed the dealings with potential conflicts of interest, Enron later claimed that Fastow earned over $30 million from Enron with his companies. At some point in the bending of ethical guidelines for the good of the company, Enron's executives also began to bend the rules for personal gain. Once a culture's ethical boundaries are breached thresholds of more extreme ethical compromises become lower.

The self-reinforcing decline of Enron

In the long run, Enron's executives could not "rob Peter to pay Paul". Even if the Enron culture permitted acts of insignificant rule bending, it was the sum of incremental ethical transgressions that produced the business catastrophe. Although Enron's executives had believed that everything would work successfully in the long run, the questionable partnerships left the company extremely vulnerable when financial troubles came to light. As partnerships began to fail with increasing regularity, Enron was liable for millions of dollars it had not anticipated losing. Promises began to come due and Enron did not have the ability to follow through on its financial obligations.2

The financial implosion

The partnerships that once boosted earnings and allowed Enron to prosper became the misplaced card that caused the Enron house to collapse. The stability of Enron's house of cards had been eroded by the very culture that had allowed it to be built. Enron was forced to renounce over $390 million in earnings from dealings with Chewco Investments and JEDI, another partnership. The company was also forced to restate earnings back to 1997, and the restated earnings totaled only $586 million, a mere 20% of the initially reported figures. The very results Enron had sought to prevent - falling stock prices, lack of consumer and financial market confidence - came about as a direct result of decisions that had been driven by Enron's culture.

The Enron case of ethical failure consists of more than a series of questionable business dealings. When strong company leadership would have been needed the most, Enron's leader left the company. In August of 2001, Jeffery Skilling resigned as President and CEO of Enron and sold shares of his company stock totaling $66 million dollars. Only two months later, Enron restated earnings, stock prices dropped and the company froze shares in an attempt to help stabilize the company. Enron employees, who had been encouraged to invest heavily in the company, found themselves unable to remove and salvage their investments. The company culture of individualism, innovation, and aggressive cleverness left Enron without compassionate, responsible leadership. Enron's Board of Directors was slow to step in to fill the void and individual Enron employees for the first time realized all of the ramifications of a culture with leaders that eschew the boundaries of ethical behavior.

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