You don’t have to know all complex details in book, but general outline and some details, and link them to bur. concepts. Don’t get lost in E. case details or too intimidated by them. Keep in mind big picture and how bur. concepts fit & know bureaucratic concepts from Part 1 of class….
Key overarching issues:
Fraud – esp. financial / accounting
Mark to Market Accounting
Stock Price Obsession
Key Bureaucracy Conceptual Issues present in the Enron Story, to keep in mind as read:
Social Construction of Profits & Efficiency (Sjoberg)
Bureaucratic Secrecy (Weber, Sjoberg)
Market manipulation (Sjoberg)
Lack of Oversight
Key features of Ideal type of Bureaucracy (Mills & Simmons; Weber):
Div. of Labor (specialized knowledge), Hierarchy, Written records, Technical Expertise (qualified for position), etc.
Hierarchy in Enron dysfunctional, not work, on one takes responsibility
Div of Labor – various parts of Enron—Traders, Gas Bank, Originators (deal-makers), Gas Pipelines, Intl. (power plant / energy) projects, Azurix (water), Finance, Broadband, Retail Energy services (Cal., etc.), etc.
Network of Organizations affects an Organization (Mills & Simmons, ch 1)
Disadvantages of Bureaucracy: goal displacement, empire building, secrecy, etc. (Mills & Simmons)
Gender inequality and bureaucracy (Mills & Simmons)
Showed parts of video based on book “The Smartest Guys in the Room,” esp. re rise of Enron, Skilling, Mark-to-Market Accounting, & Enron PR for Wall st.
Mark-to-Market accounting (Ch. 3) [Sjoberg’s Social Construction of Profit fits this perfectly…]
Gas Bank & Gas Trading (Ch. 3)– Enron’s first big innovations that changed nat. gas industry…
Oil trading scandal – what was it and what did it foreshadow for Enron’s future? (Ch.2 ). Lots of Bureaucratic secrecy here… a well as Social Construction of Profit (Sjoberg)
Pressure on Enron to Meet Wall Street Expectations (see esp. ch. 7)(of bank and investment analysts, of large investors -- organizational network) 15% profit goal per year, plus quarterly reports. Use of financial manipulation to falsely construct profits (Sjoberg on Social Construction of Profits)
“Deal –making culture” of Enron & foolish incentive structure – Make any deal, even abd one, get contract signed, Key role of Mark-to-Market accounting. Give deal-maker full apy and bonus when? Rebecca Mark and Enron I=nternaitonal as classic example of pitfalls of this approach—Ch. 6.
Balance Sheet basics (assets & liabilities)
& need for moving some assets& liabilities off balance sheet – to hide debts (liabilities, or assets about to become liabilities) and create cash flow (sell assets)
Enron needed independent 3rd party to buy assets from Enron to create cash SPECIAL PURPOSE ENTITIES (SPE’s) created to do this. % funding from Enron vs. % $ from “independent investors” to qualify as seprate organization, not part of Enron, so could take /purchase things off Enron’s books / balance sheet, and provide income via these sales.
See esp. Chs. 11 & 13, and a bit in Ch. 7)
Hid Enron’s debt—moved it off-balance sheet-- $38 BN by the end in late 2001. (ch. 11)
[Sjoberg’s Social Construction of Profit fits this perfectly…]
Securitization & SPE’s (ch. 10 & 11) – bundling “assets,” even questionable ones, to sell for cash – e.g., E. contract for 10 yrs of Nat gas service that e. has booked profits on for $10 MN – E will sell it to 3rd party (e.g., an SPE) for discount, say $9 MN and get all cash now, not have to wait 10 yrs for $10 MN [& might be worth less than $10 MN in end, so E has removed risk].
Enron key themes: Deal makers & originators (of contracts), traders, financial wizards, conflcit of interest, Div. of Labor, Hierarchy(?), Technical expertise 9esp.. in trading and finance), Mkt. Manipulation, Network of Orgs. affect an organization.
Importance of E’s investment banking fees (+$50 MN / year) in luring big banks to make crazy loans and enable E’s fiancial deception. (Banks want investment services fees from E, so make lots of loans to keep E happy & hten E use them for investment deal services.) (Ch. 11)
Special Purpose Entities (SPE’s) & E. ownership part & independent ownership part, what qualified SPE as “independent” so it could take assets and liabilities “off balance sheet” for E.
Again, Balance Sheet & Assets / Liabilities diagram, and where SPE’s help out (Ch. 11, 13, and others later…esp. ch 18, 19, 21)
Wall Street Expectations for E. Profits / earnings – quarterly and annual pressure to “beat the number” (Wall. St. expectations) -- & link to E. Stock price… (ch. 15)
Accounting Manipulation to create false profits [Social construction of Profits—Sjoberg]
Pre-pays—how they work, and how corrupted by Enron. Sales actually loans (income actually debt) (ch. 11)
E—Sell questionable / dodgy assets to SPE for cash
SPE – 3 % “indep.” investors, 97% E. stock investment
Trouble getting 3%, so Fastow creates own equity fund LJM1 &2 (gets banks to invest in order to get E. business in future).
Big conflict of interest for Fastow – whose interest does he represent E’s (as CFO of E.) or LJM’s as CEO of that equity fund? LJM makes many MNs$ of E deals…. E gets cash from SPE’s, all underwritten by banks and assumption that E stock price won’t go down – Been going up a lot since 97, so… (E. stock is collateral for most SPE funds / loans from banks)
Arthur Andersen conflict of interest (ch. 10) – dual rolre (& income from) acting as Enron’s annual auditor vs. on-going “business consulting”
Again, some key bureaucracy concepts:
Hierarchy (& lack of responsible one), Division of Labor, Written records,
Market Manipulation, Soc. construction of profit, Bureaucratic Secrecy,
Net of orgs. affect an Org., etc.
Org Network – Enron, Investment Banks (2 parts: analysts recommending E stock as strong buy, & lenders/service providers—raking in banking fees & amking loans to Enron – banks not get latter if analysts not recommend E stock to investors, corruption & conflict of interest) –See esp. ch. 15
Rating Agencies (supposed to rate Enron debt and investments, assess as high or low risk, affect cost of borrowing $ for Enron and how investors feel about Enron) -- See esp. ch. 15
Business Press –CNBC, Wall St. Journal, etc. Influenced judgements of investors. –See esp. ch. 15
Large institutional investors & their staffs – manage large blocks of capital (like retirement funds for govt. agencies), make key decisions about whether or not to invest in Enron. –See esp. ch. 15
How Enron Fooled Analysts about its Energy Services contracts & trading (fake tour of “trading “war room”—Ch. 12
Problems with Cal. Retail Energy contracts (with UC and Cal State system, etc.) (ch. 12)
Showed parts of video “Smartest Guys in the Room” – Everybody loves Enron and Love for Sale – how Enron generated lots of false impressions about itself to drive up stock price and why so many people and organizations bought into it. (see esp. Ch. 15)
Water Venture Azurix (Ch. 16) -- How Enron got into water business, then many problems, esp. in developing countries (e.g., Buenos Aires deal)
Enron Energy trading in deregulated California Market (Ch. 17)… Cali. Deregulation partial & flawed from E point of view. How E. manipulated market in Silverpeak case & others Death Star, and Ricochet / “megawatt laundering”? Cali. Energy Crisis & hardships & E. attitude & profits.
[Also, see other factors in crisis (power plants sold & taken off-line, weather.]
Ruthless traders as heart of Enron culture & tough to control—their viewe of Market vs. reality of their attempts to manipulate it -- See ch. 14