Preliminary Lessons From Enron

Judy Olian

( Judy Olian is Dean of Penn State's Smeal College of Business and a leading expert in strategic human resources management .)

Enron filed for bankruptcy protection last week after a stunning downfall from a stock trading high of about $85 a year ago, to less than $1 last week. Enron was the seventh largest corporation in the nation last year, generating $100 billion in revenues. Enron's crash will go down in history. What can we learn?

1. Use "the smell test" when making judgment calls. If it doesn't smell right, it probably is not right. Among the first lapses in reporting practices was Enron's failure to disclose the equity interest of its chief financial officer (CFO) in a limited partnership that benefited from its deals with Enron. The CFO's potential conflict of interest, while known to the other officers of Enron, was not disclosed to Enron investors until much later, after he and the limited partnership had realized significant gains from the Enron deals. These limited partnerships were also a strategy to keep debt off Enron's balance sheet, concealing from investors the true magnitude of Enron's financial instability. There are other corporate lapses of judgment that defy reason, such as Archer Daniels Midlands Co. and the behind-the-scenes price fixing of an additive used in animal feed, or the alleged collusion between the Sotheby and Christie auction houses. Defenders claim that these cases do not constitute clear violations of the letter of the law. Whether or not that's ultimately true, they all fail the simple smell test. Surely these executives should know better and anticipate the serious ethical questions they trigger. In Enron's case, these misgivings prompted the market's flight as it began to distrust the company's numbers, and its underlying valuation.
2. Come clean, quickly. Despite repeated opportunities for Enron (or for that matter, Firestone and Ford) to promptly acknowledge reporting problems, restate earnings, or accept product problems, they filibustered. In all cases, executives deflected responsibility and hoped the problem would disappear. Given media and shareholder scrutiny, that doesn't happen. Tylenol still stands as the gold standard in coming clean, quickly and forthrightly, to address a product problem. In Enron's case, observers point to its risk taking and "anything goes" culture as a source of its problem, leading to exaggerated self-confidence and even arrogance in believing it could bamboozle the analysts raising questions.
3. Excesses are distasteful, and usually signal something rotten. Contrast Warren Buffet's measured reward package and modest operating style with that of Ken Lay (President of Enron), and other senior executives at Enron. Over the years, Mr. Lay earned hundreds of millions of dollars from Enron through salary and option packages, and negotiated a $60 million severance package should his contract be terminated. Only after much public criticism did he agree to walk away from the severance package. And compare the $55 million that Enron's top 500 people awarded themselves just before they filed for bankruptcy last week, with the $4,500 severance check issued to laid off employees. Look at Al Dunlop at Sunbeam, or Jill Barad at Mattel, executives who earned huge rewards as they ran their companies into the ground, and then walked away with multi-million dollar severance packages. Board oversight and management values are highly suspect when excesses of such magnitude are negotiated or tolerated.
   
4. Diversify your employees' options and retirement plans. Protect them against themselves, and against major losses, if company stock constitutes a significant portion of their retirement portfolios. At Enron, employees were locked in until age 54 before they could sell their Enron shares. Of course, the company's rejoinder was that as long as the stock was appreciating as it did, they were doing their employees a favor. Plus, their employees' interests were aligned with the company. Yet executives had greater diversification options than employees, and they were able to unload over the years a much larger percentage of their Enron assets. Today, Enron employees are losing both their jobs, and their retirement savings. It's not uncommon for companies to require concentration of a certain portion of employees' 401k plans in the company stock. The average across 1.5 million plans, according to Hewitt Associates, is that about 30% of 401k assets are locked into company-owned stock. That's a lot less than was the case for Enron employees, but it does represent a doubled risk despite the value of the alignment of employee interests with the success of the company.

The lessons from Enron are just beginning. The accounting profession will likely examine the ramifications of Enron's reporting practices for years to come. For the rest of us, let's not wait to take away a few lessons even before the ink has dried.