Individual Assignment 2

BFF5021 Case Studies in Risk

Management
Reputation risk analysis Enron

Name: Weiyi Xia

Student ID: 26528835
Due date: 08/09/2016
Lecturer: Mr Warren Gillian

Abstract
Reputation risk is that the potential of losing ones reputation given an institutions
business practices, whether true or not, will result in a breakdown in the customer base, costly
litigation or revenue reductions. Human factor, one of major factors in reputation risk, is
related to incompetence, criminal or counter-productive workplace behaviors, negligence and

complacency, as well as custom and practice, all of which significantly influence the
reputation of the organization. The bankruptcy of Enron mainly arose from the human factor
in relation to its weak corporate governance, fraudulent business practices, empty business
ethics, influence of group think as well as a rigorous rank and yank system. Accordingly,
the research provides the recommendations to prevent the scandal, including a need for
significant reforms in corporate governance, a high-quality compliance system with effective
ethics.

Table of Contents
Introduction...........................................................................4
Risk Theme Discussion...............................................................5
Discussion of SUB-theme: Human factor.........................................5
Discussion of Core Case Issues.....................................................6

1.

How much influence should one person have?............................6

2.

Did the business practices provide motive, opportunity and rationale for

fraudulent activity?..............................................................6
3.

Discuss the need for moral/business ethics................................7

4.

Discuss influence and group think....................................7

5.

Discuss HR under rank and yank.......................................8

Identification of case solutions.....................................................8

Conclusion.............................................................................9
Recommendations...................................................................10
References...........................................................................11

Introduction
Reputation risk involves that the possibility or danger of losing the reputation
considering an institutions business practices, whether true or not, will lead to a decline in
the customer base, costly litigation or revenue reductions (Brown, 2007). The loss of
reputation may seriously affect competitiveness, local positioning, the trust and loyalty of

stakeholders, media relations, and the legitimacy of operations, even the license to exist, not
only in the individual organizations, but also an entire industry (Aula, 2010).
The human factor, as one of major factors of the reputational risk, will play an
important role in the organization, in relation to incompetence, criminal or counter-productive
workplace behaviors, negligence and complacency, as well as custom and practice.
According to the Enron Scandal, the human factor is the major factor triggering the
bankruptcy of the company. Firstly, Enrons directors, particularly the CEO, did not establish
a healthy corporate governance to influence the relationship between board and management
to ensure integrity and value-creating decision. Secondly, a variety of business practices by
senior executives were red flag for fraudulent activity, such as Special Purpose Entities
(SPEs) together with opaque financial disclosure. Additionally, the business ethics were
totally destroyed by the senior management with empty values. Moreover, the influence of
groupthink led Enrons groups to make faulty judgments by ignoring the morality and ability,
neglecting contradictory information, and pressuring each other to preserve conformity. At
the same time, the application of rank and yank in Enron threatened severely code of ethics
and created various conflicts of interests.

Risk Theme Discussion

Discussion of SUB-theme: Human factor
The human factor plays an important role in the organization, because the actions,
behavior and decision-making of people will have significant effects upon the reputation of

the company. Giles (2015) shows that the key components of the human factor refers to
incompetence, criminal or counter-productive workplace behaviors, negligence and
complacency, as well as custom and practice. Firstly, incompetence poses a serious threat to
organization reputation, when people are lack of technical skills, conversancy, and
craftsmanship so that they cannot achieve consistency of performance to set up the trust and
confidence of shareholders, who are the foundation for corporate reputation. Secondly,
corporate reputation is extremely affected by criminal or counter-productive workplace
behaviors, including theft, fraud, corruption, collusion, insider trading and conflicts of
interests. Specially, Insider trading involves that people make use of private and pricesensitive information to trade any listed security illegally enriching themselves with greed.
Fraud is also against organizations in terms of losses and reputational damages, based on its
motive, opportunity and rationalization. In addition, negligence and complacency have
adverse impacts upon corporate reputation, as they may increase the possibility of errors,
safety failures, quality defects, truancy and control collapse, then they might decrease
productivity and profit to reduce the value of an organization, therefore, a vicious cycle
occurs to disrupt the confidence of investors, suppliers, customers and employees to danger
corporate reputation. Finally, custom and practice refers to certain actions and behaviors
that are embedded with the tradition and culture of the organization for a long period, in
which managers may turn a blind eye to the practices that seem to be standard and noncontroversial within an organization but they are actually weird, harmful or even scandalous
without formal recognition in policies and procedures to damage corporate reputation.

Discussion of Core Case Issues

1. How much influence should one person have?
OConnor (2003) thinks that directors, particularly the CEO, should have influence in
setting the tone in the board, by monitoring firm performance, providing advice and

guidance, as well as serving a relational function. Specially, the CEO has to play an essential
part in establishing the healthy corporate governance. True corporate governance is about
creating a culture of positive relationship between board and management in order to ensure
integrity and value-creating decision (Ide, 2002). Nevertheless, Heath and Norman (2004)
show that the scandal of Enron arose from a breakdown of the governance relationship
between the shareholders, the board, and the senior executives, because the senior executives
in Enron were able to work against the interests of the shareholders by information
asymmetries and conflicts of interests on the board.
2. Did the business practices provide motive, opportunity and rationale for fraudulent
activity?
A large number of business practices in Enron were red flags of fraudulent activity.
The application of Special Purpose Entities (SPEs) provides a cradle for fraudulent activity
in Enron. Actually, SPEs are legal structures to bridge the gap between lending money for
exploration and reaping the rewards from production. However, Andrew Fastow and Arthur
Anderson made SPEs structure increasingly complex to hide massive debt and risks in
relation to contracts off the balance sheet. For example, Fastow formed a new partnership
with JEDI by a new structure named Chewco, which was so complex that Arthur failed to
disclose the financial arrangements clearly. Furthermore, it was found that there were
considerable opaque financial disclosures in Enron, particularly in the off-balance sheet
transactions with huge risks and debt (Bone, 2009). For example, Arthur Andersen verified
the SPEs noted in 1999 Annual Report, which was considered as fundamentally
inadequate and nearly impossible to understand; Fastow suggested a new SPE (LJM I)
with a high level of internal risks and the conflicts of interests, to hedge its exposure about
investment in a dot.com company for keeping the debt off Enrons balance sheet, therefore,

there was only $34 billion were on-balance sheet items from a total of $51 billion asset in
June 1999.
3. Discuss the need for moral/business ethics
Generally, Enrons code of ethics was about respect, integrity, communications and
excellence. Unfortunately, Lencioni (2002) believed that there were empty values of the
Enrons business ethics, which just created cynical employees, alienate customers and limited
management credibility. Sims and Brinkmann (2003) also found that Enrons leaders broke
critical values to focus on financial measures and partnerships to serve themselves; for
example, on October 16, 2001, Kenneth Lay declared that $1.2 billion of shareholder equity
had been eliminated by terminating a partnership introduced by former CFO Andrew Fastow,
therefore, it allowed the company to buy and sell assets without the debt on its book to keep
Enrons credit clean and the stock price high.
4. Discuss influence and group think
Group think may also trigger the tremendous failure of Enron. OConnor (2003)
describes that group think involves group members follow the leader overestimating the
morality of their behaviors, neglecting or discounting information, pressuring each other to
preserve conformity. Accordingly, groups may increasingly make faulty judgements. With its
early 1990s, Jeff Skillings, an energy consultant in Enron, strongly recommended the assetlight strategy and short-term mentality through the companys human resources practices.
Therefore, around 25 percent of all electricity and natural gas contracts traded internationally
were controlled by Enron through the use of derivatives and other forward contracts by the
late 1990s (Bone, 2009). In addition, deregulation was rooted in Enron to replace the role of
government in production, long-range transmission, and local distribution (Bone, 2009).
Richard Kinder, as vice chairman of Enron in 1988, believed that there were many

opportunities in the deregulation of the gas business, while the executive confab was regarded
as the Come to Jesus meeting to make Enron fall into the void with intermediate activity.
5. Discuss HR under rank and yank
Moreover, OConnor (2003) found that Enron applied the rank and yank system in
which employees evaluated each other, then terminated the employment of workers at the
bottom of ranking performance. Johnson (2003) believed that rank and yank made the
company easier to ignore the companys code of ethics which should have limited conflicts of
interests. Actually, the intense and competitive hiring and retention structure in Enron led to
sabotage, jealousy and borderline accounting practices. Under the rank and yank, the
excelling superstars may take greater risks to keep their current status due to loss frame;
they may tend to be over-confident and self-serving to attribute their failure into bad luck
(OConnor, 2003).

Identification of case solutions

In reality, Enron almost lost its head in response to the immense crisis till the
bankruptcy. As a result of the Enron Scandal, the president George W. Bush signed into the
Sarbanes-Oxley Act in 2002, which mandated new ethics hotlines, codes of conduct, and
stronger internal controls and reporting efforts (Boehme, 2009). It was found that the
Sarbanes-Oxley Act created the Public Company Accounting Oversight Board (PCAOB),
which was responsible for registering and inspecting public accounting firms and for
adopting and changing audit standards; the PCAOB has the power to bring enforcement
actions, in conjunction with the SECs (Donald & Ghoddoucy, 2006). Additionally, Larry
Thompson, the former Department of Justice Deputy Assistant Attorney General, together
with officials at the Securities and Exchange Commissions and U.S. Sentencing Commission,
all of them stressed compliance seriously to implement reasonably effective internal controls
according to the Thompson Memorandum, the Seaboard Report, and Chapter 8 of the

Sentencing Guidelines (Weissmann, 2006). Weissmann (2006) also found that individual
employees, including mid-level executives as well as more notorious CEOs, would be
prosecuted to deter from otherwise stray.

Conclusion
The human factor has significant effects upon the Enrons reputation till the
bankruptcy, regarding peoples actions, behavior, and decision making. Firstly, Enrons
directors, including the CEO, did not take the responsibility of creating a true corporate
governance to ensure integrity and value creation for the stakeholders. Secondly, various
business practices were embedded with fraud, specially related to Special Purpose Entities
(SPEs) with opaque financial disclosures. In addition, Enrons ethics actually existed in
name only due to senior management negligence. Moreover, the group think influenced
Enrons groups to make wrong judgements due to overestimate the groups morality and
ability, ignore negative information and pressure each other to maintain conformity. Finally,
Rank and Yank system also resulted in the collapse of Enrons code of ethics.
A series of measures were taken by the government responding to the Enron scandal.
The U.S. Congress mandated the Sarbanes-Oxley Act in 2002 regarding new ethics hotlines,
codes of conduct, and stronger internal controls and reporting efforts. Moreover, the relative
policies included the Thompson Memorandum, the Seaboard Report, and Chapter 8 of the
Sentencing Guidelines as well as prosecution of individual employees to keep compliance
with reasonably effective internal controls.

Recommendations
According to the Enrons scandal, there are some recommendations in response to the
similar situation. Firstly, it is necessary to establish an effective corporate governance, since
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the Enrons corporate governance is just on paper in line with business practice. Board of
director should pay closer attention to the behavior of management and the way the company
is making money. They also have to maintain a healthy relationship between board and
management in order to maintain the long-term value of the shareholders investments. In
addition, there is an urgent need to build up an effective compliance system in correlation
with effective ethics to prevent a similar scandal from occurring in the first place.
Corporations can perform effective checks on the internal controls to prevent the similar
risks, as government regulators and prosecutors cannot be everywhere to detect breaches of
the law and prosecute all violations.

References
Brown, W. J. (2007). Understanding Reputational Risk: Identify, Measure, and Mitigate the
Risk. SRC Insights, Fourth Quarter. Retrieved from:
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https://www.philadelphiafed.org/bank-resources/publications/src-insights/2007/fourthquarter/q4si1_07
Aula, P. (2010). Social media, reputation risk and ambient publicity management. Strategy &
Leadership, 38(6), 43-49. doi: 10.1108/10878571011088069
Giles, S. (2015). The Business Ethics Twin-Track: Combining Controls and Culture to
Minimise Reputational Risk. Business & Economics, pp. 92-128
OConnor, M. A. (2003). The Enron Board: The Perils of Groupthink. University of
Cincinnati Law Review, 71. Retrieved from: http://ssrn.com/abstract=1791848
Ide, R. W. (2002). Post-Enron Corporate Governance Opportunities: Creating a Culture of
Greater Board Collaboration and Oversight. Mercer L. Rev., 54, 829.
Heath, J., & Norman, W. (2004). Stakeholder theory, corporate governance and public
management: what can the history of state-run enterprises teach us in the post-Enron
era?. Journal of business ethics, 53(3), 247-265.
Bone, J. (2009). The Conflicts of Interests in Financial Services. Corporate Compliance
Insights. Retrieved from: http://corporatecomplianceinsights.com/conflicts-ofinterests-financial-services-enron-economy/
Lencioni, P. M. (2002). Make Your Values Mean Something. Retrieved from:
https://hbr.org/2002/07/make-your-values-mean-something
Sims, R. R., & Brinkmann, J. (2003). Enron ethics (or: culture matters more than codes).
Journal of Business ethics, 45(3), 243-256.
Johnson, C. (2003). Enrons ethical collapse: Lessons for leadership educators. Journal of
leadership education, 2(1), 45-57.
Boehme, D. (2009). From Enron to Madoff: Why Most Corporate Compliance and Ethics
Programs are Positioned for Failure. Rand Conference, Washington D.C.

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Donald, E., & Ghoddoucy, S. (2006). Corporate Governance and Sarbanes-Oxley

Post-Post-Enron an interview with Professor Thomas Joo of UC Davis School of
Law. Business Law Journal. Retrieved from: http://blj.ucdavis.edu/archives/vol-6-no2/corporate-governance-and-sarbanes-oxley-post-post-enron.html
Weissmann, A. (2006). Perspective on Compliance Programs: The Enron Verdict. Law
Journal Newsletters - The Corporate Compliance & Regulatory Newsletter, 4(1).

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