Why Enron Failed

By Suzy Bills

In 2001, Americans were appalled to learn of the unethical practices carried out by leaders and other employees of Enron (as well as its accounting firm, Arthur Andersen). Enron used various methods of deception to appear more profitable than it really was, including through creating off-the-book entities to which Enron transferred its substantial debt (Jennings, 2005). While the company’s stock rose, so did its debt, and company leadership began using insider information and trading millions of dollars in company stock. When the scandal and impending bankruptcy were revealed, the company’s stock decreased from $90 to less than $1, a devastating hit to the financial market and numerous investors and employees (Betz, 2002). While the public was shocked at the numerous unethical financial practices, several organizational behavior theories, when applied to Enron, explain how such unethical activity could be permitted to take place.

Chima (2005) describes organizational behavior as the result of the decisions of those who have obtained decision-making power, with the decisions reflecting the decision makers’ assessment of what is economically and politically beneficial for themselves and the company. Enron’s executives allowed themselves to be motivated much more by what would benefit themselves than what would truly benefit the company. The political model of organizational behavior describes this focus on self-interest (Chima, 2005). Money, greed, arrogance, and hubris led company executives to lose focus on working for the good of the company and to act unethically (Gini, 2004).

Impacts of Company Executives and Managers

Company executives and managers directly impact the ethical direction of a company. When the executives and managers are ethical, employees are more likely to act ethically. Enron’s leadership may have been extremely influential because several exemplified charismatic leadership—especially Jeffrey Skilling and Kenneth Lay—greatly encouraging employees to follow their lead. Managers have the important role of linking shareholders, employees, suppliers, and customers (Premeaux, 2009). The executives and managers also set the informal aspects of the company, such as values, attitudes, interactions, and norms. Some researchers liken the formal and informal aspects of a company to an iceberg. The formal aspects are similar to the 10% of the iceberg than can be seen above the water; the informal aspects compose the real nature of the company—the 90% hidden beneath the water, not easily observed but requiring careful examination and analysis (Wienclaw, 2008).

A company’s moral culture is tied directly to the ethical integrity and quality of the company’s leadership. When a company lacks committed ethical leadership, as did Enron, ethical standards will not be maintained. Because Enron lacked ethical leadership, it experienced a breakdown in its corporate structure and culture (Gini, 2004). Eventually, the entire company collapsed as a result. Enron created a culture obsessed with the bottom line and not with ethical behavior. The company culture demanded conformity and penalized dissent. Consequently, employees adopted and complied with the culture demanded by the company’s leaders (Tourish, n.d.; Gini, 2004). Once leadership has crossed the line to unethical behavior, unethical acts can become accepted, daily activities, and employees have many reasons for remaining quiet (Ignorance Isn’t Bliss, 2007). For Enron’s employees to do more than participate in grapevine conversations about the company’s unethical practices would be a breach of the heavy-handed cultural norms of the company (Werther, 2003).

Signals of Unethical Behavior

Sometimes, signals of unethical behavior are not considered warning signs because the actions are in line with the company’s beliefs and goals. In the case of Enron, warning signals about Enron’s use of unconsolidated affiliate companies for financial purposes were overlooked by the board of directors because the practice was considered one of Enron’s standard business practices. As a result, the board of directors allowed the company to omit from the balance sheet at least $27 billion, which eventually led to the company’s collapse (Choo, 2005). Similarly, the theory of social proof indicates that individuals rely on cues from those around them to determine proper behavior. Leaders, in particular, provide behavioral cues. While Enron did have a code of ethics, the leaders of the company did not abide by the code and did not provide an appropriate example for other employees to follow (Prentice, 2003). The employees used the behavioral cues to shape their own actions, as well as their decisions not to report the unethical acts of other employees.

Further Causes

From a group perspective, the Enron executives and employees were influenced by groupthink. Groupthink involves group members hiding or discounting information to maintain group cohesion. The group members collectively overestimate the group’s morality and ability, ignore contradictory information, and pressure each other to preserve conformity (Choo, 2005). Such was the case with Enron.

Enron’s employee-motivation structure also predisposed the company to unethical behavior. Motivation regards people’s thought processes and needs. When a manager understands what motivates an employee, the manager is better able to reward the employee for behavior that helps the company achieve its goals and objectives (Wienclaw, 2008). Enron misused motivation in order to meet the company’s lofty growth goals. The company hired and promoted individuals who were highly motivated by monetary rewards and promotions. Enron then provided the employees with incentives to take risks and focus on making profits, no matter the means. Enron also implemented a semiannual review system in which 15% of the personnel were rated as unsatisfactory, which essentially ruined their careers at Enron. As a result, the unwritten but essential rule was for employees to do whatever was needed to reach their performance goals (Prentice, 2003).

The unethical behavior was also aided by the numerous layers and specializations within Enron. The organization was sliced horizontally, in that midlevel employees lacked the information provided to the executives, preventing the employees from understanding the overall picture of business operations. The organizational structure also separated employees vertically into traditional divisions, such as legal, financial, and trading, which prevented employees from understanding how each division’s operations combined with the other divisions to facilitate the company’s actions (Werther, 2003).

Enron’s collapse was devastating in many regards. Thousands of people lost their retirement savings, and the energy industry was greatly affected. But perhaps the greatest damage was to people’s trust in businesses and their leaders. The study of Enron shows that a company’s leaders are not always positive influencers who lead the company to do the best good for its stakeholders. The collapse of Enron highlights the importance of analyzing an organization’s behaviors to detect potential unethical acts. The actions of the company executives, the culture established, the employee motivations employed, and the company structure can all provide signals regarding whether a company is ethically sound.

References

Betz, K. W. (2002). Enron’s abrupt crash and burn stuns energy markets. Energy User News, 27(1), 1.

Gini, A. (2004). Business, ethics, and leadership in a post Enron era. Journal of Leadership & Organizational Studies, 11(1), 9–15.

Chima, F. O. (2005). Integrating traditional organizational behavior theories and issues for employee assistance practice. Journal of Workplace Behavioral Health, 21(2), 59–77.

Choo, C. W. (2005). Information failures and organizational disasters. MITSloan Management Review, 46(3), 7–10.

Ignorance isn’t bliss. (2007, August 28). PR Newswire.

Jennings, M. M. (2006). Business: Its legal, ethical, and global environment (7 ed.). Mason, OH: Thomson.

Premeaux, S. (2009). The link between management behavior and ethical behavior and ethical philosophy in the wake of the Enron convictions. Journal of Business Ethics, 85, 13–25.

Prentice, R. (2003). Enron: A brief behavioral autopsy. American Business Law Journal, 40(2), 417.

Tourish, D. Charismatic leadership and corporate cultism at Enron: The elimination of dissent, the promotion of conformity, and organizational collapse. Accessed at http://www.rickross.com/reference/general/general782.html

Wienclaw, R. A. (2008). Organizational behavior. Organizational Behavior—Research Starters Business.

 

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