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sis considered each company in the light of the following issues:
Whether the role of the chairman and chief executive was split;
How long the chairman, chief executive and financial director had been in
place and where they had been recruited from;
The executive remuneration package;
The composition and background of the board;
Information about mergers and acquisitions;
Strategy development and implementation; and
The use of complex financial engineering techniques.

Enron™s failure
Key corporate governance factors “ including its corporate culture “
played an important role in the fall of mighty Enron which was once the
seventh largest corporation in the United States; the corporation named
six years consecutively as the most innovative company of the year by
Fortune magazine.
Part E “ Case Studies of Business Risks

Having regard to sustainable risk management, it is interesting to note that the
report™s findings demonstrated that the four key corporate governance factors
underlying failure are interrelated. This was reflected in the case studies where
it was found that no single issue dominated. The four key corporate governance
issues that were found to underpin failure “ the culture and tone from the top,
effectiveness of the board, effectiveness of the chief executive and internal
controls “ were also significant in the cases of corporate success. Good govern-
ance is seen to add value to an organisation:

Academic evidence suggests companies with better corporate governance will deliver
higher returns. (Philip Coggan, ˜Lombard™, Financial Times, 7 August 2003)

Moreover, this is clear regardless of location, as was seen in the Bangkok Mass
Transit case study (see box below): this is relevant to the conclusions discussed
in Chapter 23 as regards the application of corporate governance principles in
emerging markets.

The Bangkok Mass Transit System case study: a successful company
In the successful companies analysed, a virtuous circle emerges. This is
based upon a decision to take good governance seriously because it is good
for the company rather than necessary to comply with legislation. The
CIMA Report highlighted the Bangkok Mass Transit System in Thailand as
a good example of this: ˜The case of the Bangkok Mass Transit System is
one where, through the awareness of the professional management and the
self-discipline of the shareholders, key principles of good corporate gover-
nance were established well before the subject was widely discussed in
Europe, America or Asia. It is through this early awareness of the import-
ance of corporate governance that the company gained trust and confi-
dence from investors and lenders and hence was able to weather the
financial dark years of Thailand.™

Risk management and the Turnbull recommendations
There is no doubt that the area of risk management is one of increasing concern
to business, regardless of where it operates and its apparent size. It has been
noted in earlier chapters that off balance sheet risks in particular have become
key issues. Moreover there has been a particular push to understand risk man-
agement following the Turnbull Report and the implementation of the recom-
mendations that risk management should be embedded in corporate policy at
board level (see also box below). As a result of supply chain, competition and
related requirements such recommendations have vast repercussions nation-
ally and internationally.
Chapter 21 “ UK corporate governance: reforms in the wake of corporate failures and the Enron case study 539

Risk is part of the entrepreneurial culture needed by any organisation that
wishes to develop, expand and improve. An effective risk management
structure allows an organisation to understand the risks in any initiative
and to take informed decisions on whether and how the risks should be
managed. Risk management is now a practical feature of doing business in
today™s world, just as due diligence should be recognised as another pro-
active tool that is of vital assistance in the management of risk. Nowadays
no matter where an organisation operates “ and whatever its size “ risk
management is becoming an increasingly essential part of today™s business
environment and is of interest to:
CEOs, financial directors, other executive and non-executive directors;
Company secretaries;
Heads of internal audit, risk management or other assurance functions; and
All managers with an interest in risk management.
Risk management should be regarded as an opportunity to improve not
only the management of the particular risk or uncertainty in a specific
project but also the business as a whole.

As is recognised in the UK, controlling risk requires an understanding of the
dynamics of change and a healthy respect for the unexpected. The discipline of
risk management extends to matters such as environmental management (see
Chapters 18 and 19) and provides an armoury of tools and techniques to help
organisations, and the individuals within them, to succeed in a complex world.
Whereas risk management will never be a substitute for prudent judgement, it
can sharpen innate wisdom and improve decision making to help organisations
both survive and thrive. This is very important in the UK in the light of the
Turnbull Report. The date for compliance with Turnbull was 23 December
2000. This has required that any programme should focus on the way to
achieve full disclosure to ensure that risk management processes are embedded
in corporate policy at board level for listed companies. Any additional prac-
tical advice on how to create an embedded and ongoing risk management
process should be valuable. Benchmarking with other companies is a valuable
tool to help in this endeavour.

Internal controls
The CIMA Report referred to above showed that internal control weakness is
a logical outcome of various failings in risk management. This is crucial to
sustainability and was clearly demonstrated in the Enron case study (below).
Part E “ Case Studies of Business Risks

For example, Enron™s emphasis on earnings growth and individual initiative
meant that inexperienced managers were allowed too much leeway without the
necessary controls to minimise failures.
As the Enron case study also shows, it is important not to overlook the role
of executive remuneration in a company™s performance. In particular, a poorly
designed rewards package “ including, for example, an excessive use of share
options “ can distort executive behaviour in the direction of aggressive earn-
ings management so that the long-term interests of shareholders are comprom-
ised. As the SERM case studies have also shown there have also been many
well-publicised instances recently where executives have, in effect, been
rewarded for failure. This often causes outrage among stakeholders, affects cor-
porate reputation and impacts on business sustainability.

Aggressive earnings targets: the WorldCom case study
According to the CIMA Report, fraudulent accounting tended to occur
when aggressive earnings targets were not met. This was apparent in the
three highly publicised US cases of Enron, WorldCom and Xerox as well as
Ahold in the Netherlands. WorldCom, the US telecoms giant, became the
world™s biggest bankruptcy case.
In mid-2000, with the telecommunications industry in a severe slump, WorldCom
announced that the company™s results for the second half of the year might fall
below expectations ¦ Thus began the process of managing earnings. In order to hit
the 2000 year-end profit target, reserves were used to cover line charges. The estab-
lishment of these reserves had been questionable at best, and the use of reserves to
cover current expenses was in clear violation of accounting rules. When mid-level
accounting personnel raised objections to this strategy, the CFO assured them that
this was a one-time event that would help WorldCom over a rough place in the road.

Indeed many issues arose about the role of accountants and investment bank-
ing representatives, as well as the unhealthy relationships that were not at all
transparent. It was reported that Lynn Turner, Chief Accountant of the SEC
from 1998 to 2001, who was previously a partner in Cooper & Lybrand, admit-
ted in a television interview: ˜All the Big Five accounting firms helped Wall
Street investment banking firms to engineer hypothetical transactions to make
companies look better than they actually were.™
The general lack of participation, accountability and transparency were
interrelated key concerns that, as seen below, have led to reform. Yet signifi-
cantly it was the complex performance-related culture that also led to dishon-
esty. For example, it was reported in Business Week online:
Enron didn™t fail just because of improper accounting or alleged corruption at the top. It
also failed because of its entrepreneurial culture. The unrelenting emphasis on earnings
growth and individual initiative, coupled with a shocking absence of the usual corporate
checks and balances, tipped the culture from one that rewarded aggressive strategy to one
that increasingly relied on unethical corner-cutting.
Chapter 21 “ UK corporate governance: reforms in the wake of corporate failures and the Enron case study 541

In an article by Professor Jensen and Joseph Fuller of the Monitor Group it was
As the historic bankruptcy case of Enron suggests, when companies encourage excessive
expectations or scramble too hard to meet unrealistic forecasts by analysts, they often
take risky value-destroying bets. In addition, smoothing financial results to satisfy ana-
lysts™ demands for quarter-to-quarter predictability frequently sacrifices the long-term
future of the company. Quarterly reports therefore are the biggest bane of the corpor-
ations. It is the fear of the quarterly results that drives CEOs to inflate earnings.

The Enron case study
As has been indicated Enron was one high profile failure in a series of inter-
nationally reported corporate failures which also included WorldCom and
Marconi. Moreover these were not isolated cases. They all had several reasons
for failure. Yet if there is one lesson to be learned from them it is that as part of
its risk management an organisation cannot have a box ticking approach to cor-
porate governance. Indeed Enron had ticked every box and the chairman of its
audit committee was a person of irreproachable reputation and no less than the
Dean of Stanford Business School. Despite other key case studies, It is through
the penetrating analysis of Enron that an opportunity to make change in the
world of corporate governance occurred in most jurisdictions.

The rise and fall of mighty Enron
Enron was founded in July 1985 as an interstate and intrastate natural gas
pipeline company with InterNorth acquiring Houston Natural Gas (HNG).
InterNorth was renamed as Enron Corporation by Kenneth Lay, CEO of
HNG who became CEO after the merger. Initially the business of Enron was:
* To transmit and distribute electricity and gas within the US; and
* The construction and operation of pipelines, power plants and other
infrastructure internationally.
The growth of Enron
In 1989 Enron started trading natural gas commodities and went on to
become the largest natural gas trader in North America and the UK. In
1994 it began trading in electricity and became the largest trader of elec-
tricity in the US. In 1997 Enron further diversified its business by entering
into the trade of weather derivative products, coal, pulp, paper, plastics,
metals and bandwidth. Enron™s wealth kept growing and it was named the
most innovative company by Fortune Magazine from 1996 to 2001. This
was the peak period when its executives behaved as superstars and hob-
nobbed with the people in power. It was reported that its offices were so
opulent that they were cause of envy for even the cream of the financial
world. This was the time when it was considered one of the hundred best
companies to work for in America.
Part E “ Case Studies of Business Risks

The fall of Enron
In 1998 Enron ventured into the water sector by creating Azurix
Corporation, which ultimately failed, and in April 2001 the decision to sell
its assets was announced. Meanwhile EnronOnline, which was launched
in November 1999 and facilitated buying and selling worldwide through
web transactions, was a huge cash drain for Enron. Its major weakness
was that it allowed transactions with Enron only. Enron™s wealth shrank as
the major source for generation of cash, its pipeline service, had already
shut down.
Enron in fact became rich primarily through creative accounting. This
fact became evident when the financial statements for the last five years
were revised on 8 November 2001 stating the loss of $586 million. After
only 11 days the third quarter earnings were restated. It was disclosed that
an attempt to restructure obligations worth $690 million was made. On
28 November 2001 Dynegey Inc., which was purchasing Enron, backed
out and the share value plunged below $1. Enron collapsed and finally
analysts announced that Enron™s bankruptcy was likely. The inevitable
happened and the mighty Enron filed for bankruptcy in December (see
http://www.scripophily.net/encorlarbusf.html accessed on 15-5-06, http://
en.wikipedia.org/wiki/Enron accessed on 15-5-06 and http://business.
guardian.co.uk/story/0,3604,1496488,00.html accessed on 15-5-06). Enron™s
Auditors, Arthur Andersen, formerly one of the big five group of auditors,
were convicted by jury on account of obstruction of justice as they destroyed
the documents relating to Enron™s audit (though the Supreme Court of US
reversed the conviction in July 2005 and ordered retrial on the ground of
flawed instructions to the jury by the judge: too late to save the company).
The superstar executives of Enron faced civil and criminal trials. For
example, Jeffrey Skilling, former CEO, faced 35 charges, including conspir-
acy and fraud.
The prosecution alleged that Skilling attempted to fool investors
into thinking that Enron was a healthy company while he and other Enron
executives lined their pockets. In their view a web of complex and
self-serving financial frauds had been weaved by the executives. Kenneth
Lay, the former chairman who has since died, faced seven counts of
fraud and conspiracy. The prosecution alleged that Lay perpetrated
Skilling™s scheme as Enron tumbled toward bankruptcy. Enron was the
first to fall in the wave of corporate crimes that shook the US after the
The world started assessing the reasons for the fall of Enron, not only
the US, where Enron was based, but also other countries like the UK. They


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