Patrick Jankowski is vice president of research for the Greater Houston Partnership. For nearly three decades, Jankowski has watched the ups and downs of the city’s business community. Quite literally, in the case of Enron, whose one-time headquarters at 1400 Smith Street is one block from his office.
“Enron was reporting just incredible profits, incredible growth, and people were trying to emulate the Enron model. They thought that Enron was creating a new game, and everyone wanted to be part of that game. As we’ve seen in hindsight, a lot of the game they were playing, they were playing by their own rules.”
Enron’s financial position was never as good as it looked. The company took on an enormous debt load in the merger that created it. Jeff Skilling appeared to have turned that situation around when he introduced mark-to-market accounting, letting the company book profits from deals immediately.
That led Enron to focus more and more on closing deals, less and less on the operational end of the business. Nowhere was that emphasis brought home more bluntly than in the annual performance review. Former Enron employee Stephen Webster describes the process that came to be known as “rank and yank.”
“You wanted to be in the top, because that’s how you got your bonuses. That’s how you got your stock options. That’s how you got promoted. And if you found yourself at the bottom, you were on your way out, without exception. In the last year I was there, I think the only way I could have climbed to the top of our ranking ladder was to step on my mother to get there. When the competition gets to that level, something just isn’t right anymore.”
It’s important to remember Enron wasn’t acting in a vacuum. These were the years of the dot-com bubble. Bethany McLean, who became well-known for her coverage of Enron in Fortune magazine, describes the situation.
“With the combination of a rising stock market and the proliferation of stock options and a kind of faith among the investor class that good companies were the ones who produced predictable earnings growth every quarter, it’s all a recipe for accounting fraud.”
Strong internal audit controls might have prevented such fraud. They could also have balked many of the questionable and ultimately money losing deals. But such controls were long gone before either Andy Fastow or Jeff Skilling joined Enron.
Back in the late ‘80s, a rogue trading operation in Enron’s Valhalla, New York office nearly bankrupted the company. Enron auditors warned CEO Ken Lay of what was going on in 1987, nearly a year before the scandal broke.
Stephen Arbogast teaches business ethics at the University of Houston’s Bauer College of Business. He says what happened next set the stage for virtually every ethics violation at Enron that followed.
“Ken Lay not only didn’t fire anybody, he called the internal auditors and took them off the investigation, and then he outsourced internal audit to Arthur Andersen. All of these types of things, for anybody that understands basic financial control, are signals by the CEO that we don’t really care how you get results, we simply care that you get results, and if we bend a few rules in the process, so be it.”