Organisational Governance and Performance Management
Workbook 1
Tasks for submission via Turnitin (maximum 1000 Words)
1. Consider the corporate governance failure of parmalat described by Solomon (pp XXXXXXXXXXand list the 3 major corporate governance failings identified.
2. What mechanisms, if in place that at that time, may have assisted in avoiding the parmalat failure
3. Do you think that the roles of non-executive directors, auditors, the internal audit committee and the board of directors are all equally important as mechanisms of ‘Good’ corporate governance? If not, which mechanism do you consider the most important? Discuss your answers.
Paul Preo
ajensky | School of Science and HEalth
Organisational Governance and Performance Management
Workbook
1
Tasks for submission via Turnitin (maximum 1000 Words)
1.
Consider the corporate governance failure of parmalat described by Solomon (pp. 38
-
40)
and list the 3 major corporate governance failings identified
.
2.
What mechanisms, if in place that at that time, may have assisted in avoiding the
parmalat failure
3.
Do you think that the roles of non
-
executive directors, auditors, the internal audit
committee and the board of directors are all equally important as mechan
isms of ‘Good’
corporate governance? If not, which mechanism do you consider the most important?
Discuss your answers.
Organisational Governance and Performance Management
Workbook 1
Tasks for submission via Turnitin (maximum 1000 Words)
1. Consider the corporate governance failure of parmalat described by Solomon (pp. 38-40)
and list the 3 major corporate governance failings identified.
2. What mechanisms, if in place that at that time, may have assisted in avoiding the
parmalat failure
3. Do you think that the roles of non-executive directors, auditors, the internal audit
committee and the board of directors are all equally important as mechanisms of ‘Good’
corporate governance? If not, which mechanism do you consider the most important?
Discuss your answers.
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Chapter 2
The Impact of Corporate Governance
Weaknesses and Failure
Aims and Objectives
This chapter examines the impact of weaknesses and failures of corporate governance on
companies and on society. In this chapter, we examine the Enron saga and the case of the
'European Enron' , Parmalat, in order to highlight the consequences that arise from the failure of
corporate governance mechanisms. We then discuss the corporate governance failures in the
anking sector that led to the recent cu
ent global financial crisis, reflecting on mistakes made and
making recommendations for the future . The specific objectives of this chapter are to:
appreciate the importance of effective corporate governance and the consequences of weak
corporate governance;
consider the factors that led to the collapse of Enron;
explain why the case of Enron has encouraged corporate governance reform worldwide;
examine the case of the 'European Enron' , Parmalat;
discuss the corporate governance failures and weaknesses that have led to the collapse of the
world's banking sector;
highlight the need for ethical conduct and culture within corporations.
Introduction
The previous chapter defined corporate governance and introduced a number of theoretical frameworks
that have been used to analyse corporate governance issues. This chapter now provides a detailed case
study of the collapse of Enron, in order to enhance the reader' s appreciation of why effective corporate
governance is essential to successful business and social welfare. The Enron saga presents a poignant
28 FRAMEWORKS AND MECHANISMS
illustration of what happens when corporate governance is weak and when checks and balances are
ineffective. Both Enron and Parmalat illustrate the problems associated with attempting to control
human nature, or at least human nature at its worst. However good corporate governance is from a
cosmetic point of view, and however good a company' s apparent financial performance, if there is
unethical behaviour at the highest level, little if anything can avoid eventual disaster.
The collapse of Enron
On 2 December 2001 Enron (one of the 10 largest companies in the USA) became a household name -
and probably in most households in most countries around the world - when it filed for Chapter 11
ankruptcy (a type of court protection giving the company management time to make a
angements with
their creditors). In the following months, more and more evidence emerged of corporate governance
weaknesses and fraudulent activity. Countries across the world have been unsettled and distu
ed by the
shock of this event and are now examining their own corporate governance systems in micro-detail,
looking for similar weaknesses and potential Enrons. 'Enronitis' has spread across the globe like a lethal
virus, infecting every company and every shareholding institution, wo
ying even the smallest share-
holder and unnerving the financial markets. In this case study we examine the downfall of Enron in
detail, looking at the reasons for the collapse and commenting on the corporate governance problems that
were rife within the company.
Corporate governance failure and corporate collapse can happen in the strongest company. Investors,
employees and creditors can be seduced by a company's reputation and success and can throw caution to
the wind. If economic agents were rational, as they should be according to economic and finance theory,
this sort of blindness could never happen. But it does. Investors do not always behave rationally, and
human behaviour and psychology are factors that are difficult to incorporate in a finance model or an
economic theory. Polly Peck and Coloroll were cases of i
ational behaviour in the UK in the 1980s,
when investors missed vital information in the accounts of these companies, pertaining to huge
contingent liabilities. As soon as this information became public knowledge, both companies collapsed
(Smith, T., XXXXXXXXXXWe first consider the way in which Enron built up its glittering reputation and the
success that it encountered before crashing in such a monumental fashion .
• • J:l
Enron was a Houston-based energy company founded by a
illiant entrepreneur, Kenneth Lay. The
company was created in 1985 by a merger of two American gas pipeline companies. In a period of
16 years, the company was transformed from a relatively small concern, involved in gas pipelines, and oil
and gas exploration, to the world's largest energy trading company (The Economist, 28 November 2002).
Deregulation of the energy market in the USA allowed utilities to choose their energy supplier. The
1980s saw deregulation of the market for natural gas in the USA, and deregulation of the wholesale
electricity market followed in 1992 (The Economist, 26 Fe
uary XXXXXXXXXXDeregulation had a far-reaching
THE IMPACT OF CoRPORATE GovERNANCE WEAKNESSES AND FAILURE 29
impact, allowing energy providers to diversify into other areas of the industry and become more
competitive. Deregulation of energy in the UK had a similar effect, forcing providers to compete on price
in order to attract supply contracts. One of the effects of deregulation was to create a market in energy
trading, similar to a futures and options trading floor, where deals were struck between suppliers and
clients on a continual basis.
nlitt~rin~ succe&s
Enron's success was phenomenal. By 1998 it had eight divisions, including Enron Energy Services
(EES) and Enron Capital & Trade (ECT). In 1994 ECT sold $10 million of electricity. By 1997 the
company was selling $4 billion, which constituted almost a fifth of the North American wholesale
market. Yet it only produced a small proportion of this itself. In 1998 Enron held $23 billion in assets (see
The Economist, 26 Fe
uary 1998, for these and other figures). In January 1998 Enron sold a 7% share of
EES to two pension funds for $130 million. From 1990 Enron's total return to shareholders ran far in
advance of the index. In July 1998 Enron announced a $2.3 billion takeover of Wessex Water in the UK.
Indeed, Rebecca Mark, then in charge of Enron's new water business, commented that they intended to
e one of the two or three dominant players in the business (The Economist, 30 July XXXXXXXXXXIn 1999
Enron's sales reached $40.1 billion. By 2000 the company's revenues reached over $100 billion
(The Economist, 8 Fe
uary XXXXXXXXXXIn Fe
uary 2001 the company's stock market value was $60 billion
(The Economist, 29 November XXXXXXXXXXEnron became famous for its dexterity in handling risk
management derivatives, as well as for its abilities in the area of commodity trading derivatives.
Indeed, the company was proud of having ' invented' weather derivatives in 1997 (The Economist,
15 June XXXXXXXXXXAnother area where Enron was praised for its innovation and success was in Internet-
ased business. At the end of 1999 Enron launched its Internet-based trading platform, EnronOnline.
The venture was massively successful, with 5000 trades taking place online every day, valued at about
$3 billion (The Economist, 28 June XXXXXXXXXXHowever, the chief executive of Enron, Jeffrey Skilling,
dismissed this success by saying that the Internet business was just a better form of telephone, which was
the way the company did business successfully before.
Towards the end of its life, Enron had transformed itself from an energy company to a predominantly
financial and energy trading company, trading financial derivatives as well as energy contracts and
effectively running a gas pipeline on the side (The Economist, 29 November XXXXXXXXXXSuccess was so great at
Enron that the words over the door as visitors entered the Houston headquarters were changed in 2001 from:
The world's leading energy company
to:
The world's leading company
This sort of self-confidence and pride is a clear example of counting chickens before they are hatched, or
pride coming before a fall.
30 FRAMEWORKS AND MECHANISMS
1= wor
An article in The Economist (26 Fe
uary 1998) raised queries as to the permanency ofEnron's success