Enron Corporation and Agency Theory

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Table of Contents

Introduction
Agency theory
Limitations to agency theory
Enron case
Presumed priority of shareholders interests
Conclusion
References

Introduction

Enron Corporation was an American company that used to manufacture diverse products and provide services. It was based in Houston, Texas. According to Fusaro & Miller (2002), the story of this company is considered to be “the most spectacular and scandalous business failure in history”.

Before it became bankrupt in 2001, the company had employed about 22,000 people. Enron was among the leading company in products such as gas, paper, pulp, electricity and many more. Its revenue hit the $ 101 billion mark by the year 2000 but unfortunately met its death a year later (Deakin and Konzelmann, 2003).

The downfall came as a surprise to many, since it had been named as the most innovative company a while ago. It was realized later that financial situation and success had been sustained by mere acts of corruption in form of accounting fraud. This got the name the “Enron scandal”.

Since then, the company has served as an example of a company run through corruption and fraud (Salter, 2008). This paper will use Enron as a case study while addressing how it upset the tenets of agency theory and looked at the presumed priority of shareholders’ interests above those of other stakeholders.

Agency theory

The classic definition of agency theory proposes that a company can be regarded as a network of contracts between the holders of resources. This relationship occurs when one or more people, known as principals, hire other people to do particular tasks and leave the decision-making process to the agents. Some examples of such a relationship are the manager and stakeholder, and the relationship between stockholders and debt holders (Jesen and Meckling, 1994).

Agency theory depicts the issues that occur in these relationships and they are referred to as the agency conflicts. These are the conflicting interests of the agents and their principals. Such things have a negative effect on the business ethics and on corporate governance (Fischer and Lovell, 2006).

This also has a negative impact on the economy since there is an agency cost, which is the cost incurred in order to sustain an efficient agency relationship. Such costs may come in form of the management performance bonuses that are meant to give encouragement to the managers to behave in such a way as to favor the shareholders.

Limitations to agency theory

One assumption to the agency theory is that whenever the principal-agent goal is not congruent, then the behavior that instills the self-interest of the agent in utilizing to the maximum results in the maximization of wealth by the principal. Another limitation is that the compensation incentives that are meant to align the agents and the principals are likely to spur the agents to maximize their utility and consequently maximize the wealth of the company.

Another limitation to agency theory is that there is the lack of empirical support for such a relationship among principals and agents. This leads to the coming up of two different responses. One of them is that the research that would come up in the future should change and perform a better job in terms of measuring the variables at the agencies. The second thing would be to focus more on the process rather than the issues to do with the structure. In other words, they would require the use of longitudinal studies (John, 2007).

Enron case

The Enron case was that of bankruptcy and this occurred in October 2001. It was additionally attributed as the largest audit failure in American. In 1985, Kenneth Lay formed Enron. This happened after there was a merger between InterNorth and Houston Natural gas. Later on, a certain manager was hired and that was the beginning of Enron’s downfall. This was because he hired a group of employees (executives) who could cleverly use the loopholes in accounting to provide incorrect financial reports.

This is whereby the company could hide its huge debts and avoid reporting failed projects. The CEO and other executives made a lie out of the BODs of Enron and at the same time insisted that Andersen should ignore it. The shareholders lost billions of dollars when the stock price came down so bad. The cause of all this was the lack of transparency and accountability when it came to the financial statements (Fox, 2003).

Presumed priority of shareholders interests

The theory of shareholder primacy asserts that the interests of the shareholders should be put as the first priority. This gives the shareholders the power to directly intercede in the decision making process in the corporations and this includes amending some corporate charters (Smith, 1998).

Conclusion

Enron was one of the leading companies that supplied a variety of products in America but failed due to some bad managerial practices that included corruption. The corrupt leaders violated the agreement between the shareholders and disregarded the priorities that should govern such relationships.

The shareholders ended up in losing billions on investments that has never yield any fruits. Bad leadership is to blame for the death of a great corporation that served the people with goods and services. The shareholders, who formed the larger part of the community, were the ones that suffered most for the mistakes made by others.

References

Deakin, S & Konzelmann, S 2003, ‘After Enron: An age of enlightenment?’, Organization, vol. 10, no. 3, pp. 583-587.

Fischer, C & Lovell, A 2006, Business ethics and values, London, FT.

Fox, L 2003. Enron: The rise and fall, John Wiley & Sons, New York.

Fusaro, PC & Miller, RM 2002, What went wrong at Enron: everyone’s guide to the largest bankruptcy in U.S. history. John Wiley and Sons, New York.

Jesen, E & Meckling, W 1994, The nature of man, Harvard University Press, Harvard.

John, F 2007, ‘Professor Bebchuk’s brave new world: A reply to the myth of the shareholder Franchise’, Virginia Law Review, Vol. 93, no. 1, pp. 773-787.

Salter, M 2008, Innovation corrupted: The origins and legacy of Enron’s collapse, Harvard University Press, Harvard.

Smith, D 1998, ‘The shareholder primacy norm’, Journal of Corporation Law, vol. 23, no. 1, p. 296.

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