Dogs Who Turn Into Ducks: Reassessing Enron's Miltonic Fall
by David Friedman, New York.It is by now a cliché that arrogance and myopia contribute to many a downfall, whether the downfall is personal or corporate. "The Smartest Guys in the Room: The Amazing Rise and Scandalous Fall of Enron" (Bethany Mclean and Peter Elkind) proves that point aptly. Hubris and a sincere belief that Enron could do no wrong in the world contributed to an atmosphere of injudicious superiority. Combine that tumultuous atmosphere with ineffective, weak-willed executives and poor business management skills, Enron always was a precarious edifice awaiting its fate.
At least, such is the narrative that the authors offer. They argue that Enron, over the past 15 years, repeatedly found itself in financial trouble, and, rather than come clean to the Street, used financial engineering strategies to make its numbers appear better than they were. This practice arose out of a fanatical devotion to the company's stock price; the company's stock price would not continue to rise if the company missed the Street's earnings expectations for the quarter. Since so much of the executives' wealth was tied up in Enron stock and options, financial shenanigans became a self-fulfilling prophecy. After all, the authors point out, if most of your wealth is tied up in a company's stock, don't you have an incentive to do everything possible to keep its stock at a high level? Certainly, at this point, financial chicanery becomes more attractive than financial fidelity.
Therein lies the fundamental flaw of Enron (as well as numerous other bubble companies): the very compensation scheme created by the company to inculcate a sense of loyalty in its executives created a conflict too gross to manage adequately. The conflict in this instance is, in retrospect, a simple one: executives had all the incentive in the world to keep their company stock at a high level because all of their wealth, and their future wealth, was tied up in the company. Therefore, there was little incentive for them to be straightforward with the Street, or, for that matter, the company's finances. Enron thus became a delusional place where it could do no wrong and its managers were businesspeople par excellence.
All of this is false of course. Enron's managers are human after all, and all humans are susceptible to the foibles and follies of people everywhere; no matter how smart a group of executives, nor the sterling reputations of the schools from which they received their MBAs, absent sound business principles, ignorance becomes bliss and delusion becomes reality.
The authors are at their best when they explain the source of Enron's executives' arrogance, and the consequences for the company of that arrogance. It is important, therefore, to understand the company's hierarchy. The company was run by its founder, Ken Lay. Despite having the title of CEO, he played a role more akin to Chairman of the Board or a statesman: he spent most of his time away from the company, hobnobbing with celebrities and heads of state, and otherwise embodying the rock star CEO mentality. Business is just another form of theater, a la Sean Penn walking down the red carpet at the Oscars. Thus, other executives, from Jeff Skilling, on down, basically ran the show, and their outsized, narcissistic personalities therefore dictated a lot about the Enron culture.
Skilling came from McKinsey, the famous consulting firm full of Harvard and Wharton MBAs. As we all know, people with MBAs from Harvard and Wharton can be very intelligent. But they can also be very arrogant and dismissive of those they consider to be their intellectual inferiors; the authors imply that Skilling demonstrated the worst tendencies of a Harvard MBA, and, absent any checks in his behavior, his arrogance and condescension became the shaky cornerstones of the poorly constructed edifice that became Enron.
The metaphor of a poorly built structure is, at the end, the appropriate one for Enron. Despite the thousands of worker bees carrying out the daily operations of the company, the executives at the top were maniacally focused only on telling the Enron story: manipulating the Street into thinking that Enron was the greatest thing since sliced bread. Their thought was that as long as the stock keeps going up, and the Street believes in the Enron story, then there is no need to make the hard business decisions that are actually quite unpleasant to deal with. Enron had no organization and no comprehension of the risks it faced, either in its daily operations or in its financial engineering. One need not be an architect or engineer to know that structural integrity is important to the sanctity of a building. Such is the lesson we learn from the Enron fiasco: image is nothing when it is created only for the purpose of supplicating the Street and propping up the stock.
Incidentally, the title of this review comes from a reference in the book. The authors quote an accountant who explains that Enron used creative accounting techniques that often hewed to the letter of the law but violated its spirit. Under this logic, if you have a dog, but you paint its fur yellow and paste a beak on it, you technically have a duck, if by "duck" you understand it to mean "an animal with yellow fur (feathers) and a beak." In other words, if a transaction meets the technical requirements for it to be considered, say, revenue, then it need not matter that, in substance, it's not really revenue but debt.
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