NOTES ON ENRON

Death of a Corporation

Idiots v. Crooks

FIRST:

• Let’s Discuss BUSINESS ORGANIZATION.– NOTE: This isn’t in the

book – but it is a sample of Microeconomics and current events – since ENRON is still in the news.

• You will work for one type of organization in your future.

The Three Types of Business Organization

• Sole Proprietorship

• Partnerships

• Corporations

Sole Proprietorship• If you alone own and

control the service.

Opportunity Benefits of Sole Proprietorships

• Owner has direct control

• Small initial investment

• Owner receives all profits

• Owner can dissolve business when necessary.

Opportunity Costs of Sole Proprietorships

• All losses are borne by owner

• Difficulty in raising financial capital– Limited growth potential

• Only one person in authority

• Lack of longevity

• Unlimited liability

Partnerships• A business owned and

controlled by two or more people.• Ben and Jerry were

college buddies that found after certain “experiences” at Berkeley in the 60s – they were really hungry for ice cream.

                                                   

     

REMEMBER!• Partnerships don’t

have to be just two people.

• JC Penney: The man with a thousand partners.• Ben and Jerry today

at a “Legalize Hemp” Festival

• Essay contest and now their company is part of Borden.

Two forms of partnerships• General Partnerships:

Equal decision making.

• Limited Partnerships: Partners join as investors, offering capital, but little, if any, role in decision making.– VENTURE CAPITALISTS

– Famous Dave made great barbecue – but had no sense of business.

– Going broke UNTIL

Willy Theisen

• Founded Godfather’s Pizza in 1973 and made a fortune – sold out the chain to Pillsbury and now is a Venture Capitalist creating partnerships like Famous Dave

Advantages of Partnerships• Two or more individuals

own the business.– Specialization

• Losses are shared by partners.

• More money is available to invest in business

• Sharing management responsibilities

• Taxes are shared by partners

Disadvantages of Partnerships• Division of authority• Unlimited liability.• Difficulty in raising

additional capital.• Lack of longevity.• Legal complications

when there is a change in ownership.

Advantages of CorporationsLimited liability.Easy to raise needed capital.Business owned by a group

of individuals.Responsibilities for running

the business divided among many individuals

Easy change in ownership and business continues as long as it makes profits. – LONGEVITY.

Disadvantages of Corporations• Corporate charters are

$$$• Federal and state

govts. monitor corporations more.

• ***Slow process of decision making.

Corporations• Legally distinct from their

owners and treated as if individuals.– Corporations can

• Own property

• Hire workers

• Make contracts

• Pay taxes

• Sue and be sued

• Make and sell products.

What kind of companies are organized as corporations?

• USUALLY – food, steel, oil companies are corporations.

• Insurance companies, supermarket chains, major companies.

Forming a corporation• When expansion calls

for more than adding more partners.

• GET A LAWYER!

Forming a corporation:• Lawyer applies for a

state license: ARTICLES OF INCORPORATION.

• Reviewed by state officials. If all in order they grant– CORPORATE

CHARTERS

Corporate Structure• The corporate charter

identifies the officers.– Chairman of the board

– symbolic head of the corporation.

– CEO – Chief Executive Officer – the REAL power.

– Martha Stewart – before prison was BOTH Chairman and CEO of her corporation.

Corporate Structure• Board of Directors –

people from inside or outside the company. – Key decision making body.

• Decide on product lines.• Hires / fires corporate

officers to do the day-to-day running of the corporation.

– Sees that boards policies are carried out.

Corporate Finances• Most common way to

raise money is selling STOCK.– STOCK – represents

ownership of the firm.

– Ownership is issued in portions called SHARES.

Corporate finances• If you buy 100 shares

of stock in a company, you own 100 pieces of that company. If that company has a total of 10,000 shares available – you own 1% of the company.

Why own stock?• DIVIDENDS – profits

on your investment.– PREFERRED STOCK

– guarantees dividends.

– COMMON STOCK – potential for dividends.

Why own stock?• SOMETIMES can

make more money for you.

• The “fun” of being involved with a corporation or a product.

Benefits for stockholders• Flexibility of

ownership.• Limited liability.

– Can’t be sued for corporate problems.

– If the corporation folds, you only lose what you invested.

– Private assets can’t be seized.

– Coors shareholders can’t be sued by a MAD mother.

The trade-off• Common stock

ownership allows a “voice” on how the company is run.

• Preferred stock does not. • ATT, DISNEY

have had their CEOs replaced by the majority shareholders voting.

IMPORTANT ADVICE TO FUTURE CORPORATE HEADS!!!

• ALWAYS hold or directly control 51% of your company’s stock.

• OR have a lack of control at annual shareholder meetings.

• You can lose your job!• As Steve Jobs

found out!

The corporation raises money• If there are thousands

of shareholders, there is enormous amounts of money through the sale of stock.

• eBay has 6,643,058 shares available.

Other ways corporations raise $$.• Corporate bonds.

– You loan your money to the company.

– You DO NOT own the company.

– Repaid the principal and the interest.

• Principal – the actual money borrowed.

• Interest – the price you gave to that principal.

Example of Corporate Bonds• You hold a 1 year

$1,000 bond. • At the end of the year

you are paid back the $1,000 principal AND the 5% ($50) interest.

Corporate Combinations• Most corporations

seek to expand.– Build new facilities

– Legally combines with another enterprise.

• MERGERS!

Three types of Mergers (corporate combinations)

• Horizontal• Vertical• Conglomerate

Horizontal Combination• Buying up companies

involved in the same industry.

• THINK STANDARD OIL – John D. Rockefeller.• IF on any future test

there is a Standard Oil question – just skip to the horizontal answer.

Horizontal combinations• All the companies

merging do the same thing.

• Standard Oil: all the companies Rockefeller bought, processed oil into gas.• Enron started as a

horizontal combination.

Vertical Combination• A merger between two

or more companies involved in different production phases of the same good or service.

• THINK US STEEL / Andrew Carnegie.

Conglomerates

• Merger of companies producing unrelated products.

• Subsidiaries.• Started in the 1960s.

– Kind of started by Warren Buffet

BERKSHIRE HATHAWAY INC.

Acme Brick Company Johns Manville

Ben Bridge Jeweler Jordan's Furniture

Benjamin Moore & Co. Justin Brands

Berkshire Hathaway Group Larson-Juhl

Berkshire Hathaway Homestates Companies

McLane Company

Borsheim's Fine Jewelry MidAmerican Energy Holdings Company

Buffalo NEWS, Buffalo NY MiTek Inc.

Borsheim's Fine Jewelry MidAmerican Energy Holdings Company

Buffalo NEWS, Buffalo NY MiTek Inc.

Central States Indemnity Company National Indemnity Company

Clayton Homes Nebraska Furniture Mart

CORT Business Services NetJets®

CTB Inc. The Pampered Chef®

Fechheimer Brothers Company Precision Steel Warehouse, Inc.

And ..

• GEICO!

• There is a lot more – but I don’t have room!

Opportunity Benefits of Combinations

• Efficiency – centralized decision making.

• Potential lower costs.• Easier to acquire

financial capital.

Opportunity Costs of Combinations

• Can lead to unemployment (don’t need to double the jobs)

• Reduced competition in the market place. – MONOPOLIES.

Franchises• One company agrees –

for a fee – to let another person or group set up a FRANCHISE.– Have to uphold the

reputation of the parent company.

– Get training and advertising.

Cooperatives• Co-ops – businesses

owned by their members. – Membership gives

privileges.

Cooperatives

Nonprofit Organizations• Does not focus on

financial gain and profits.

• Business organization but pursues other goals.

• Income isn’t taxed.

So What About ENRON?

Enron History

Created in 1985 with a merger between two companies

Houston Natural Gas and InterNorth in Omaha, NE.

Horizontal merger between two gas pipeline companies.

BTW:

• BAD feelings about Enron in Omaha!

• Ken Lay of Enron promised to keep Omaha as a central headquarters for Enron.– Broke the promise in

six months and moved everything to Houston.

Enron History

• Branched out of the natural gas business into power plants, pipelines for gas and energy.

• Ken Lay CEO and later Chairman

• Jeff Skilling came in and took the company into conglomerate enterprises.

Enron

• By 2000, Enron was the SEVENTH largest corporation in the country and a darling of Wall Street with great earnings report.– They sell energy – so

how could they go wrong?

• A needed good!

So, what went wrong?

• It is still being sorted out.

• Problems with people not talking.

• Evidence was destroyed.

• Political pressure not to investigate too much????

So, what went wrong?

• Primary question: Were they idiots or crooks?

• Brian Cruver’s story is about his time at Enron – about the last six months of the company and his observations.

What happened at ENRON?

• Enron branched into operations they didn’t really “know” about.– Didn’t have a

corporate board that was based on knowing the business world.

In just 5 years Enron branched into fields like:

• Oil & LNG Transportation • Broadband • Petrochemicals* • Plastics* • Power* • Principal Investments • Pulp & Paper* • Risk Management for Commodities • Shipping / Freight • Steel* • Streaming Media • Water & Wastewater • Computer Chips • Weather Risk Management

No one really was an expert in any of these fields …

• If mistakes were made – they simply went to find another business to get into.

Management Problems

• Managers that weren’t managing their people.

• Personnel afraid of the reviews that “automatically deployed” the lowest 15% based on peer reviews.– No one wanted to make

anyone mad at them!

– Lack of accountability.

Management Problems

• “No bad news” the Enron motto.

• Falsifying reports that might make “unfavorable” news about the people or company.

• Enron = power + success

Yes! It is True!

• Enron employed a number of people solely on their looks.

• People think beauty = success.

• STRIPPERS were hired to work in the offices.

Cooking the Books

• Andy Fastow CFO (Chief Financial Officer) cooked the books.

• As bad deals kept happening a corporation has two choices:

Cooking the Books

• Revealing the bad deals.– Makes the value of the

stock go down.

– People lose their jobs.

• Hide the debt– Keep the stock price

up.

– People keep their jobs.

Virtual Assets

• Fastow’s creation.• What does VIRTUAL

mean?• What does assets

mean?

Virtual Assets

• For years, no one questioned the term.

• They were counting on deals to pay off before they actually paid off.– Example: Living like you

already have a million dollars because you know someday you will win the lottery, since you buy a ticket a week.

Virtual Assets

• The SEC and Wall Street demand a balance sheet that when a company says “We made 100-billion in profits” – that it is true.– Arthur Andersen

Auditors come in.

Buying off the auditors

• Enron executives “bought off” the Arthur Andersen Company to keep the lie of profits based on “virtual assets” going. – Note how that info is just

“slipped in” to Brian Cruver’s training.

– They also helped shred evidence about who knew what and when.

Enron Image

• If people saw Enron employees living well – it gave the impression that the company was doing great.– Encouraged

employees to live beyond their means???

Political Influences?

• The movie brings up the connections to George Bush and Dick Cheney – and there are legitimate questions there.

• But Enron was also contributing to both sides of the aisle.– Note Mr. Blue’s insider

trading.– Note the news flashes of

helping politicians.

Ken Lay’s Role in Enron

• He encouraged the employees to buy the stock.– Creating demand to bring

the price up.

– But he sold his stock when the price went up.

– His son was short-selling Enron.

• Betting the stock would go down in value and collecting a payoff.

Characters to know:

• Ken Lay– Founder of Enron

– Chairman and CEO

Jeff Skilling

• CEO of Enron• ARROGANCE in his

management style and encouraged it in the company.

Andy Fastow

• CFO

“Mr. Blue”

• Real life name: J. Clifford Baxter.