Read the definitive Enron book about the financial scandal and Enron's downfall. Book summary of the Smartest Guys in the Room, by Bethany. [PDF] The Smartest Guys in the Room: The Amazing Rise and Scandalous Fall of Enron All e-book all rights stay with the writers, and packages come ASIS. Get Free Read & Download Files Enron The Smartest Guys In The Room Book PDF. ENRON THE SMARTEST GUYS IN THE ROOM BOOK. Download: Enron.
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terday. The scene: the dolder grand hotel, high in the hills above Zürich, Switzerland. It was I was the co-organizer of an impor- tant international monetary. The Smartest Guys in the Room PDF Summary by Bethany McLean & Peter Elkind give an account of the lightning growth and an even quicker. service and publisher of book Abstracts. getAbstract maintains complete editorial responsibility for all parts of this Abstract. The respective copyrights of authors.
Complicated SPE deals allowed Enron to borrow money while keeping it off their balance sheet One-time asset sales were booked as recurring revenue Deals that were actually dead were fictitiously kept alive to avoid a writedown that quarter All this structure became so convoluted that no one totaled up the big picture.
You may eventually deceive even yourself on the true fundamental strength of the situation. Poorly constructed compensation structures that rewarded unprofitable behavior Extending the mark-to-market scheme, deal makers were given bonuses for the deal value when it closed, not on the generation of actual cashflow.
With optimistic projections, deal makers got paid for bad unprofitable deals. Employees got bonuses for short-term stock prices, thus incenting bad behavior to prop up stock price. Senior managers like Skilling got large bonuses for stock performance. This prompted over-optimistic projections to Wall Street, which intensified the speed of rushing into bad businesses Enron Broadband and created end-of-quarter scrambles to make earnings.
Lesson: Make sure your compensation structures align with the fundamental goals of the business, and that there are balancing check points Believable guiding visions These party lines began with good intentions, but as Enron slipped into a gray zone, they helped justify bad behavior.
Enron saw itself as revitalizing an industry populated by dinosaurs and bringing efficiency through privatization and free markets. With a missionary zeal, it charged headfirst into new products. They were just playing the rules of the game. Why stop the party? Furthermore, Enron gave many Andersen accountants cushy jobs.
Bankers who ran bigger deals got promotions. download-side analysts at banks who were supposed to be independent were strongly pressured to give download ratings, since companies would only work with positive banks.
Short sellers were a useful counterforce, since they had a large incentive to expose wrongdoing. Lesson: Correct for your own incentive bias when you analyze a situation. Looking to others believing they had done their due diligence When you have multiple reputable people on board, everyone thinks everyone else has done their diligence. In reality, no one has done their diligence.
Employees thought the board and accountants would keep bad behavior in check, and thought public markets were heavily incented to detect bad behavior. The board trusted the internal risk department, which in reality was a yes-man and thought their only job was to sign off on deals. Assume they have the worst possible incentives to overlook problems. Do your own due diligence from first principles. Big bets on businesses that failed According to the author, the accounting tricks were meant to be short-term bridges to the real new money-makers: Enron Energy Services retail utilities and Enron Broadband.
Complex dependencies that required progressively bigger risks or face complete failure Enron built layers of financial dependencies in a constant push to raise stock prices. In essence, it kicked the can down the road, hoping that salvation would come at some point.
Wall Street expected this to be real recurring revenue, which meant Enron had to book larger deals that had bad long-term prospects to keep up appearances. If Enron ever missed earnings, its stock price would fall. If its stock fell, its SPE deals would unwind since they were predicated on Enron stock prices , causing Enron to have to book massive debt on its balance sheet or issue new shares. This would cause further stock price falls.
This would cause bankruptcy. Take moves to de-risk moment to moment, and take a big write down earlier. Be even more wary if this is an existential risk, since for the sake of staying alive you might take more desperate steps.
An unwillingness to consider the worst case scenario seriously Because of such strong incentive bias, social proof, and self-consistency bias, Enron managers refused to believe that the stock price would ever fall and trigger the nightmare scenario.
Lesson: Seriously consider the worst case scenario, and think about ways that you can mitigate this. Bad appointments to senior managers Generally, promoting people who had the wrong kind of ambition more to themselves than to the fundamental health of the company. Andy Fastow, known for experience creating financial structures rather than financial prudence, was promoted to CFO.
Ken Lay was more interested in being a public figure than in managing the business. The board was weak, filled by Ken Lay with people who had reciprocal relationships with Enron.
They were reassigned to less glamorous parts of the company or publicly humiliated on their failure like Rebecca Mark. Enron partners accountants, bankers who voiced discontent lost the deals.
Enron managers even strongly encouraged the dismissal of employees who added friction to deals. Skilling had a tactic of making people feel dumb for asking questions. Lesson: In your search for the truth, put aside the centering of your ego around being smart. Note how it began with good intentions and a believable vision, then became corrupted by deceptive accounting and a focus on short-term stock prices. Lay served in various roles in gas companies before heading Houston Natural Gas in His vision was to control a large fraction of pipeline which would allow better negotiating leverage.
Larger Omaha company InterNorth, in danger of being taken over by corporate raiders, wanted to defensively increase its size and debt load. Management of the combined entity was tough, riddled with politics. As a public company, Enron was desperate for real earnings.
In , Jeff Skilling, a McKinsey consultant who worked with Enron, envisioned Enron building a futures market, turning natural gas into a commodity then a novel concept. Simplistically, Enron would be the mediator between gas producers and gas downloaders, with Enron earning the spread.
Enron was able to loan gas producers more money than banks, because it knew the clearing price of the gas. So producers signed contracts to supply to Enron, in exchange for upfront money to develop reserves. It could then trade the future contracts, just like oil futures. This was a successful project, prompting a feeding frenzy in developing economies.
Fueled by a compensation scheme that rewarded closing deals and not actually building the businesses, Rebecca Mark globetrotted and closed deals in dozens of countries. The largest scandal was in Dabhol, India. A province struck a deal very favorable to Enron, guaranteeing a long-term download of highly priced energy. The Indian population revolted, seeing it as rapacious globalization. The financing for projects was often unclear, hoping they would come from non-Enron sources.
Sometimes Enron ended up guaranteeing the debt. Enron promised Wall St. This obsession with meeting earnings targets powered the deception. So Lay ousted Kinder who founded Kinder Morgan afterward, still a healthy company today.
Kinder was a voice of reason within Enron, expecting discipline and skeptical of bad deals.
Some suspect Enron could have saved itself had he been appointed CEO. Physical assets were sold off; some physical deals happened primarily to give an input into trading. She decided to download a British water utility, forming Azurix. Thus Enron had the leeway to take on more risk than other companies because it had the right controls in place. RAC also faced strong pressure to close deals to hit quarterly numbers.
Gas trading had become more competitive. Banks were making loans, and downloaders were loath to sign long-term origination deals.
Some earlier deals had turned out unwise and missed projections, requiring writedowns. Deal closings were accelerated, giving away costly long-term concessions to close earlier. Extending mark-to-market throughout the business, including on PE and VC investments.
Earnings projections were reexamined and made more optimistic, squeezing out some earnings. Losses were delayed by pretending dead deals were still alive. Tax avoidance schemes. In effect, all these dealings created fictitious cash flow and profits when they were really dealings with itself — and at some point the house had to collapse.
Trading companies are too volatile to reliably produce increasing earnings. So rather than claiming to be a speculation company, Skilling branded Enron as a logistics company, finding the most cost-effective way to delivery power from any plant to any customer. This provided cover for incomprehensible businesses. Skilling feared that any appearance of losses would shatter the illusion of Enron being wizard risk managers, so fought hard to hide them.
In , the rise of Andy Fastow to CFO brought complicated structured-finance deals that gave Enron cash that could be kept off the books. The goal of these deals was to keep fresh debt off the books, camouflage existing debt, or book earnings or cash flow. They allowed Enron to borrow money while disguising their real debt. In summary, Enron took out large loans and made them appear like cashflow.
So it would take out further loans to pay back earlier loans. This is the corporate equivalent of starting new credit cards to pay back old credit card debt. In reality, Enron gave guarantees to lenders, including guaranteeing a debtlike return while Enron kept the real return.
Further, debt was rarely supported by the true value of the asset, since it was based on unreasonably optimistic assumptions about what would happen. Further, sales of the assets could be booked as operating income.
So it looked like Enron had sold something and booked cash flow. But there was a big wad of additional debt that had to be paid back. So it promised public markets growth of real underlying earnings, but was actually filling it desperately with one-time sale deals. Example: Chewco.
The directors were then paid fees, which were kicked back to Fastow and his family. Minority interest transactions A majority-owned Enron subsidiary Entity A downloadd poorly performing Enron assets. A new allegedly independent Entity B took out a bank loan to download a minority interest in Entity A.
Entity A then loaned Enron these funds. It appeared that Enron received funds from an affiliate, as opposed to from the bank that loaned Entity B.
Ostensibly, the value and earnings of the assets would pay back the debt. However, if the assets were insufficient to pay back, Enron would issue stock or pay cash.
These guarantees made the arrangement much more like a loan than a true equity download. This would later cause trouble when the assets kept falling in value. The entity would pay Enron upfront for these future deliveries, with money it obtained from a lender. The lender would then agree to deliver this commodity to Enron; Enron would pay a fixed price for these deliveries over time. In reality, the entity was set up by the lender.
Take the commodity out it just circles from Enron to entity lender to Enron , and you have a pure loan with interest. Enron was perennially short on cash, so instead of using operating cash flow to pay them back, it used fresh prepays to replace earlier ones. Contrary to popular belief, many of these deals were not secret, but rather publicly revealed and boasted about.
Banks participating in the deals earned large fees. All these machinations were meant as temporary measures while Enron bet big on its next two major businesses. Both of them, however, sustained massive losses.
Enron could then sell directly to businesses and homes. In the few hotspots it could work in, Enron campaigned aggressively to recruit consumer households to sign up, promising lower utility costs.
However, the local suppliers fought back, pulling their political strings and running ads against the big guy coming into town. This was enticing — a big company spends millions a year for light, heating, and cooling. This new TCV became the working metric of the day.
Never mind the fact that TCV bore no relation to revenue or profits — it merely represented the cost of all the utility needs a customer had outsourced to EES. As usual, Enron deal makers were given bonuses on total TCV and the projected profitability of the deal which were wildly optimistic. Naturally a lot of bad deals were signed very quickly. Enron Broadband In , Internet stocks were overheated. Skilling promised such large returns to Wall Street that the division was strongly pressured to make deals happen.
The larger vision was that broadband might ultimately become a tradable commodity, like natural gas or oil. However, physical technicalities got in the way. In one sense, internet pipes were parallel pipes that never intersected.
Enron promised that it was inventing new routing technology that would enable, but it never made it out of the lab. This would turn bandwidth into a commodity that would cut into their control of markets.
Enron even began partnering with Blockbuster to build content streaming services. The reality of execution was difficult. Streaming from the Internet to the TV required expensive special boxes. And incumbent DSL providers controlled access to the last mile and were tough in negotiations.
The trials were tiny — households involved — and the ultimate real sales from this were laughable, in the dozens of dollars. Even though the failed deal should have been written down, Enron reasoned that it should actually be a gain — Enron would no longer have to share the proceeds! Unfortunately, both bets were off the mark. Enron spent billions on unprofitable projects.
This put Enron in an impossible position — having spent all that money and raised expectations, there was no room for failure. He also invited select Enron lieutenants and friends to participate — ultimately, they would get an x return.
But they all stepped out of the way for their own reasons: Enron employees were worried about being berated by Fastow and having their ratings punished. The board was comforted by assurances that all deals would be reviewed by the Chief Accounting Officer, and Fastow could be removed at any time. In reality, the CAO was a rubber stamp. LPs wanted access to Enron deals, and Fastow made clear that participation in his private fund was required to stay in his good graces. Why would Enron do such bad deals?
The deals were structured in a way that implied the fundamental belief that Enron stock would never fall. Meanwhile, the energy traders were making lots of money in the volatile markets. In the early inefficient markets, traders used fundamental research to make smart trades — like finding dam water levels to estimate future water prices or using weather to estimate fuel prices.
Money came so easily they were bewildered.
They made even more when they launched Enron Online — a virtual trading floor for energy futures. Enron served as the marketmaker, representing both sides of the trades.
This dramatically increased the capital requirements the danger will become apparent later. Its dominant position, as well as proprietary info on what outside traders were doing on their platform, allowed Enron to possibly manipulate markets to move prices in its favor. The regulatory change: California opened electrical grids to competition in a market, where electricity had previously restricted it to certain providers with controlled costs.
Utilities had to sell off their generating facilities and download power on the open market. But the regulation was partial — price caps were instituted; rates to consumers were fixed; and utilities were precluded from longer-term agreements that might have allowed hedging and reduced spikes in prces.
The rules allowed market manipulation: Energy producers kept power plants off to spike prices. Electricity rates were tied to the price of natural gas, which Enron was also in a natural position to control.
The utilities then had to hustle to find last-minute power at high prices. Enron submitted schedules reflecting illusory power demand. Enron would sell power as reserves without actually having it. Ultimately utilities were forced to pay far more for power than they could collect from customers, who were still paying regulated rates. One incumbent went bankrupt.
Vicious cycle: because of this instability, power producers began refusing to ship to California. Later the US Energy Secretary imposed a state of emergency, requiring marketers to sell to California. Ultimately Enron lawyers told the traders to stop ethically gray trades. Their hubris in energy trading led them to launch trading ventures in a host of other commodities — steel, paper, lumber, metals, bandwidth.
Skilling thought Enron could be the market maker for everything! None of the others launched to much success. They continued taking progressively riskier positions, breaking the trading limits. As always, mark-to-market became a risk — they made their books look better through optimistic projections.
In , Enron took a large short position on electricity forecasting lower energy prices and less volatility due to the weakening economy and conservation.
With typical Enron hubris, Mark thought water was easy and the incumbents were ancient. They would come in, make large deals, and figure out the details later. They also anticipated privatization of water supply, and a coming water crisis.
Immediately they ran into competition with the two global heavyweights — Vivendi and Suez — who competed aggressively for contracts to service municipalities. Azurix was also in money trouble — the Wessex deal had cost a lot, and Enron saddled Azurix with large debt. Now a public company, Mark stressed the appearance of making big deals to buttress their stock value.
In the few deals that Azurix won, they vastly overbid, largely out of desperation to signal momentum. It became clear Azurix would never make money on that deal.
This later proved wrong. This is a testament to how powerfully its accounting distortions disguised the true nature of the problems brewing. Enron was paraded as a visionary company, building new businesses like Enron Online in the Internet era.
To the public, Enron only ever expressed certainty of being a juggernaut. As we have seen with Enron, leadership in an adhocacy culture is entrepreneurial and idealistic and willing to take risks to achieve its vision for the future Quinn et al. Once hired, management began the multi-dimensional process of acculturation Schein, , p.
In the case of Enron, the acculturation process included the self-enhancing technique of imbuing employees with a sense of confidence in themselves and the organization, noted Amanda Martin in the movie Gibney, There was the reaffirmation that this could be big. These managers had a strong orientation to the compete quadrant of the CVF framework Quinn et al. Revenue goals were a numbers game that was driven by a need to boost quarterly profits. Employees were constantly surrounded by indicators of the financial health of the company from the time they entered the elevator and saw the stock prices posted Gibney, The desire to sustain these rewards encouraged employees to engage in deal making and complicated, questionable accounting procedures that would help the company meet its quarterly earnings, with little concern about how this would impact the long-term financial health of the company.
Enron rewarded increased revenue, which is more easily measured, instead of rewarding profitability, a more desirable outcome Kerr, In this type of environment—particularly when few checks and balances existed—corporate values were stronger than individual standards. Enron retained only those employees who achieved targeted profits Ghosh, , p.
Mirroring his risk-taking behavior at the office in which he placed wild bets on the market, Skilling went on male bonding trips with other managers that involved engaging in activities in which participants sustained injury and risked death.
These trips included bungee jumping, rock climbing, jeep races through the desert, skydiving, and other intense thrill-seeking, risky adventures. There were few women among the leadership team, suggesting the most women were unable to break the glass ceiling and rise to the upper echelon.
The management team was able to create a powerful coalition to support change efforts and induce employees to remove any obstacles to achieving the vision. A culture of change produced a lack of coherent organizational identity. Each model offers a unique vantage point and holds different strengths and weaknesses. Both models converge in suggesting a wide range of skills for managers Mintzberg, , p. An assessment of the managerial competencies of Enron managers depends on the manager—and the model.
The CVF competencies represent management practice and theory and are derived from the research Quinn et al. The CVF, as its name suggests, places greater emphasis on specific values in evaluating managerial competencies.
Although there is convergence between the competencies in these models, their divergence makes these models somewhat less valuable in defining specific skills for effective management. While the models address leadership skills and competencies, neither addresses specific traits or personality characteristics associated with effective leadership.
Inherent traits of effective leaders such as dominance or charisma are identified in the research e. Moving to a broader level, both models offer a much different perspective on Enron, but both identify key weaknesses in the management team that contributed to the downfall of the company.
Mintzberg , p. These managers adopted a managerial posture of connecting externally Mintzberg, , p. The CVF framework offers the same conclusion, but a different perspective. The management team excelled in the external-focused competencies on the compete and create quadrants, with demonstrated weakness on the opposing and competing values aligned with the control and collaborate quadrants.
The strength of this model is that it also allows us to analyze the organizational culture along these same dimensions. Its managerial team did not integrate competing values and demonstrate behavioral complexity that would have made them more effective. Their unitary managerial posture contributed to a myopic vision and fostered a culture that was enormously successful but later became toxic.
Both the CVF and the Mintzberg model offer valuable frameworks for assessing organizations, but each model has strengths and weaknesses. The competing values framework offers a stronger perspective on the overall balance of the organization among four quadrants.
The Mintzberg model offers insight into managerial posture for individual managers and teams. Effective organizational leadership teams are those that have balance among individuals who assume various managerial postures aligned with art, craft, and science, as each managerial posture brings different strengths to the organization.
The CVF emphasizes the integration of competing values for a balanced individual approach to management. Managers set the bar high for goal attainment—and then raised it higher. They achieved incredible productivity from their employees. However, the combination of an externally focused managerial posture Mintzberg, , p. From a managerial standpoint, Enron holds many lessons for organizational development and success.
Enron was led by a team of charismatic leaders who could communicate the need for change and effect change in the organization. Unlike many organizations whose processes and dynamics stifle change and innovation, Enron leadership valued creative, visionary thinkers and entrepreneurial individuals, and the leadership welcomed good ideas and acted on them.
These managers are leading organizations that have been indelibly changed by their own successes in that the original strengths that made the organization successful have become weaknesses which bring the organization down Mintzberg, , p. Enron illustrates the tremendous leadership role that managers have in establishing the culture of the organization and in understanding the mechanisms for how organizational culture evolves.
Currently, many managers deny the existence of a corporate culture in their organizations or view it as something they cannot control, instead of leveraging the opportunity to shape the formal culture of the organization Grey, , p. The experience of Enron emphasizes the need for managers to be reflective practitioners in identifying and analyzing their own managerial style and to seek a balanced approach to management.
Managers, for example, will want to judiciously set challenging goals for employees— but also to develop controls that prevent unethical behavior in pursuit of those goals.
It is imperative that managers are cognizant that the practice of management requires an understanding oneself as well as others and to examine their implicit biases to ensure that they are promoting diversity of thought and perspective and not hiring someone who is exactly like themselves. Managers with a high level of confidence and competence are skilled at being able to work with diverse individuals and to value different ideas and different work styles.
Managers need to exercise care in the goals that they set for employees and the behaviors that are rewarded. While they may be required to follow established performance review mechanisms and models established by the organization, to the extent possible managers can shape behaviors of their employees by judiciously selecting the goals that they will pursue.
Managers also can be cognizant of the tremendous power they have in creating confidence in their employees that they can achieve the goals set for them and fulfill their roles with the organization.
Managers can use their power judiciously and ethically to influence and motivate individuals in their unit. Lastly, while Enron holds many valuable lessons as an organizational success, it ultimately created a toxic culture that encouraged its employees to be dishonest and rewarded greed at the expense of long-term corporate results. The emperor's new clothes. Harvard Business Review, 76 3 , Banaji, M. How un ethical are you? Harvard Business Review, 81 12 , Baumgartner, M. Perceptions of women in management: A thematic analysis of the glass ceiling.
Journal of Career Development, 37 2 , Why the best and brightest approaches don't solve the innovation dilemma.
The Smartest Guys in the Room
Duffy, M. By the sign of the crooked E.
Retrieved from http: Gibney, A. The smartest guys in the room [motion picture]. Grey, C. A very short, fairly interesting and reasonably cheap book about studying organizations 2nd ed. Los Angeles, CA: Hoffman, B.
Great man or great myth? A quantitative review of the relationship between individual differences and leader effectiveness. Journal of Occupational and Organizational Psychology, 84, Curse of the superstar CEO.
Harvard Business Review, 80 9 , Kerr, S. On the folly of rewarding A, while hoping for B. Academy of Management Journal, 18 4 , Kotter, J. Leading change: Why transformation efforts fail. Harvard Business Review Original work published , 85 1 , Mintzberg, H. San Francisco, CA: Drawing how companies really work. Harvard Business Review, 77 5 , Murphy, S. A qualitative analysis of charismatic leadership in creative teams: The case of television directors.
The Leadership Quarterly, 19 3 , Enlightened Leadership. New York, NY: Ordonez, L. Goals gone wild: The systematic side effects of overprescribing goal setting.As usual, Enron deal makers were given bonuses on total TCV and the projected profitability of the deal which were wildly optimistic.
The remarkable similarity among the top management team in personality characteristics, life experiences, and educational background in combination with uniformity in management styles and predominant managerial postures led to a leadership team that was highly imbalanced. Organigraph of Enron.
Enron retained only those employees who achieved targeted profits Ghosh, , p. Meanwhile, 20, Enron employees lost jobs and health insurance. Clair, , p.
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