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C. Gopinath

NOT A day goes by without another titbit of Enron's malfeasance appearing in the front pages of all the newspapers. Just last week, a former Vice-Chairman committed suicide. According to employees, he was one of the `good guys'. Enron, the US energy multinational, filed for bankruptcy protection in December 2001. As the Enron story unravels layer by layer, it has exposed several fault lines in the free market/capitalist system of the variety practiced in the US. But the lessons being drawn and the solutions proposed are debatable.

Take the role of the auditors. Arthur Andersen, the auditors for Enron, is under fire arising out of a conflict of interest situation. The questions being asked are whether it did a bad job in not spotting the bad accounting practices and the company's overstatement of profits, or whether it was complicit in the accounting gimmickry. In either situation, it has egg all over its face. Full-page advertisements released by the company in major newspapers sound hollow. The fact that the staff were shredding several documents related to their audit is being seen as evidence of their guilt. (Enron's accounting staff had also been shredding documents before they were stopped.)

Arthur Andersen derived $25 million (Rs 120 crore) towards audit fees and $27 million (Rs 134 crore) towards consulting contracts. This is a clear conflict of interest since an auditor is supposed to provide an independent view of a company's accounts. So, the solution recommended is that auditors should not be allowed to perform other services that may compromise their independence.

Interestingly, unlike in many countries in Europe, auditors in the US even represent the company in tax matters to the Internal Revenue Service. Now, if they are truly independent of the company, how can they do that? Moreover, the almost automatic renewal of auditing contracts is coming into focus. Perhaps auditors need to be appointed to one term only and should be prohibited from holding consecutive terms. This would enable a new firm to come in and examine whether the previous auditors had highlighted problems in the past.

Another fault line that stands exposed is the role of the politicians. Some Senate and Congressional committees are investigating every aspect of the Enron situation. Ironically, Enron has been building connections for many years with liberal donations to both political parties and their elected representatives. Almost every political cartoonist in the US has poked fun at the fact that Enron's contributions to both political parties have been so pervasive that only janitors and maintenance staff in Washington are free from Enron's money and only they can conduct the investigation.

However, this is a fault line in any democratic system. It takes money to fight elections, and more money than a potential candidate has. Although the US has an elaborate set of rules and regulations that has brought fund-raising and political contributions into the open, the fact remains that the giver of money to a candidate expects something in return. So, if Enron gave money to the candidates, they surely expect something in return. After all, are we not driven by self-interest in a free market/capitalist system? So, are state-funded elections the only solution? Very few democratically-elected governments are willing to impose that burden on their budgets.

Another fault line the Enron has exposed is the `expert' business. Our management experts climb to fame by studying a few companies, deriving lessons from them, and touting them around the world. This has been going on for some time. If the company subsequently has as many skeletons as Enron has had, does that mean that the example was wrong? Recall the famous study of excellent companies many years ago. Soon after the publication of that study, some of the companies buckled down, and some even went under. Critics quickly pounced on the study claiming it was faulty.

More recently, Enron was held up as the beacon of innovation in the way the company moved from supplying gas to setting up a trading network. It was said to be the champion of how de-regulation of the energy markets would help everybody. Business Week, the US business magazine, in its December 17 issue decided to go back to those experts who had praised Enron and ask them what they thought of it now! But does that mean that we cannot use corporate examples in building theories? After all, corporations are not frozen in time. Can a corporation that does well in one area and at one point of time not be a valid example even if it fails at a later point of time?

The international business press pounced on Enron as the touchstone for foreign investment in India. Every time the company had a problem with its Dabhol plant, readers would be warned that foreign investors were watching and would take it as a test case of how responsive and friendly the Indian Government was towards foreign investment. With the Enron collapse, a lot of backslapping is now going on about how rotten the company was. But is that a certificate for the convoluted rules and procedures that still strangle the Indian economy?

Or does it mean that a government is free to unilaterally revoke a contract entered into by a previous government? Fortunately, the Indian press has been more mature in not seeing Enron as the typical MNC.

Perhaps a very important lesson that one should not forget is that corporate governance failed in the Enron case. Of course, managers would tend to build their own empires and line their pockets. Theorists have warned us about it for a long time and called it `managerialism'. But that is why we have a board of directors overseeing management. Control is the most basic function of a board. In the Enron situation, the board of directors completely failed to do its job. The board had been seduced by the management into believing its version of the events. Funnily enough, it now transpires that the board voted twice last year to suspend the company's code of ethics so that private partnerships set-up by its employees could be approved as valid Enron investments. Enron's board of 15 is full of people who, even if non-executives, benefited in various relationships with the company that cast doubt on their independence.

In addition, it had a professor of accounting and a dean of a law school who should have been able to see through the company's questionable activities. Did their lavish compensation prompt them to look the other way? But should one bad apple such as Enron result in stifling regulations on how a board should be set up?

A lot of the company's employees are suffering due to the fact that their pension funds were invested in the company's own stock which has collapsed. The former chief executive officer, Mr Kenneth Lay (whom the US President, Mr George W. Bush, affectionately refers to as `Kenny boy') had cleverly cashed much of his own stock much earlier while the rules prevented employees from doing so. The inquiries and the debates are bound to initiate a fresh round of regulations in the economy. And some are sorely needed. What is unfortunate is that regulations made in an environment of crisis and scandal as currently prevails, is usually an overreaction to the situation. And too much regulation only creates more scandals.

(The author is a professor of international business and strategic management at Suffolk University, Boston, US. Feedback

can be sent to cgopinat@suffolk.edu.)

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