What Caused Enron to Collapse?

by Joseph Nicholson; Updated September 26, 2017
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Accounting Problems

The conventional wisdom is that it was "innovative" accounting practices and their consequences that started the tide of losses that brought the energy giant down. Enron collapsed not so much because it had gotten too big, but because it was perceived to be much bigger than it really was in the first place. By decentralizing its operations into numerous subsidiaries and shell corporations, Enron was able to hide huge derivative losses that would have halted its growth much sooner if widely understood. Publicly traded corporations are required to make their financial statements public, but Enron's finances were an impenetrable maze of carefully crafted imaginary transactions between itself and its subsidiaries that masked its true financial state. In other words, losses were held off the book by subsidiary companies, while assets were stated.

Fallout From Fraud

Taken at its word, this rosy scenario made the company the darling of Wall Street, and it was able to borrow almost endlessly and expand into e-commerce and other questionable ventures. Its stock literally soared, which made employee compensation and pensions in the form of stock options seem very attractive. But what were already considered accounting practices on the edge of acceptable standards were eventually revealed to be outright fraudulent. The disgrace drove so much business away from and created such liability for accounting firm Arthur Anderson that it was itself forced out of business. By this time, though, the true value of the company had been revealed and the stock price collapsed, leaving employees with worthless options and pension packages. Of course, executives that understood the real picture sold their shares in advance of the collapsed and waltzed away with billions.

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Management Culture

Of course, the Enron fiasco did not happen by accident. It was facilitated by a corporate culture that encouraged greed and fraud, as exemplified by the energy traders who extorted California energy consumers. Rather than focus on creating real value, management's only goal was in maintaining the appearance of value, and therefore a rising stock price. This was exacerbated by a fiercely competitive corporate culture that rewarded results at any cost. Some divisions of Enron replaced as much as 15 percent of its work force annually, leaving employees to scramble for any advantage they could find to justify their continued employment.

Preferential Treatment

While the internal integrity of the company remained thusly challenged, the facade was the exact opposite. The company leveraged political connections in both the Clinton and Bush administrations, as well as on Wall Street, for preferential treatment and the air of legitimacy that allowed it to perpetrate its frauds. In this context, the accounting practices widely considered the cause of the Enron collapse can be seen as just a symptom of a larger management culture that exemplified the dark side of American capitalism.

About the Author

Joseph Nicholson is an independent analyst whose publishing achievements include a cover feature for "Futures Magazine" and a recurring column in the monthly newsletter of a private mint. He received a Bachelor of Arts in English from the University of Florida and is currently attending law school in San Francisco.

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