Review: Smartest Guys in the Room, pt2

What are the enduring lessons we can learn from Enron?

1.) Management is just as important as leadership. Ken Lay had a great vision for what was possible, but consistently abrogated his responsibility to manage his subordinates. Rich Kinder helped restrain the organizational climate for a while, but once he left, Skilling couldn’t match his ability to manage.

2.) Don’t believe the hype. Everyone cheered Enron all the way up to 2000, and yet within two years, the entire thing collapsed like a house of cards. Writer Toni Mack correctly identified the double-edged sword that mark-to-market accounting presented way back in 1993, and yet this quiet warning sign was overpowered by bullish voices for seven years.

[Toni Mack article]

Most recently, crypto-currency has been an investing fad – one that has even enticed some of my friends to dally (and lose money) in the market. Not me -- what I witnessed more than 20 years ago is that when *everyone* is excited about something, it’s simply not for me. Unless cryuptocurrencies were somehow part of an index fund, I have lost no money in the cryptocurrency bubbles.

3.) The long-term is more than just a series of short-terms. Enron’s mark-to-market accounting required ever-greater deals to continue dazzling investors. At some point, though, Enron simply ran out of good deals that they could reliably deliver on. Yet the nature of their business was “like running downhill with arms flailing” – hoping that you reach the bottom before you collapse.(p285) The internal system that Enron set up, though, ensured they could never stop running.

4.) “You can act within the rules and still commit fraud.” When Andrew Fastow broke ethics rules as Enron’s chief financial officer, he did so with the knowledge and consent of Kenneth Lay and the corporate board.

“Every single deal I did at Enron was approved by the accountants at Enron, the outside auditors, the internal attorneys, the outside attorneys and the board of directors. How can you get approval from all of those people and still commit fraud?” he said. Perhaps it was not “full” knowledge that went with the consent, but Fastow’s point remains – those with a responsibility to challenge unethical behavior refused to do so out of self-interest.

This is true not just within the corporate world, but also in government, as seen in the Trump administration. Was it illegal for him to hire his children to work for him? No. Was it illegal for him to maintain business interests at odds with his governmental responsibilities? No. Was it illegal for him to withhold his tax returns, despite having committed to do so? No. But all of these represent ethical breaches which his supporters were content to overlook.

When Trump broke ethics rules as president, he did so with the consent of his supporters, and the wider American public who accepted his behavior as a part of a false dichotomy -- they might not agree with him, but compared with Democrats, he was “the lesser of two evils.”

5.) [A] bad company corrupts good character (1 Cor 15:33). At Enron, incentives tied performance-led executives to falsely evaluate the profitability of various projects. Under mark-to-market accounting, this was legal, but it led people to present a distorted picture of business conditions. And those with a vested interest in success used cognitive dissonance to justify looking the other way.

Fastow explained in 2016, “What I am talking about are people who technically follow the rules but undermine the principles of those rules. The way I looked at it, if there is complexity and ambiguity, it gives me greater latitude to do what I want to do. Never when I did these transactions did I think about the ethics.” [Source]

Similarly, one of the things I saw in the Army was how desire for the perception of success can lead people (myself included) to take ethical shortcuts, call it “feeding the beast,” and then justify it by saying “everyone else is doing it.” Leonard Wong wrote a white paper on this in 2015 for the Army War College.

This mindset took root not just in Enron, but the entire industry. And yet, the vast majority of stakeholders – by adopting a narrow, legal definition -- felt they had done nothing wrong.

“The larger message was that the wealth and power enjoyed by those at the top of the heap in corporate America – accountants, bankers, executives, lawyers, member of corporate boards – demand no sense of broader responsibility. To accept these arguments is to embrace the notion that ethical behavior requires nothing more than avoiding the explicitly illegal, that refusing to see the bad things in front of you makes you innocent, and that telling the truth is the same as making sure no one can prove you lied.” –p406

In 2001, the end of the 1990s bull economy deflated a number of unrealistic expectations, but at Enron, there was no correcting the level of rot in the corporate culture. For that reason, I think Dynegy was better off for having pulled out of its last-minute deal for Enron's acquisition.

I’m not “glad” that Enron went bankrupt; but I can’t argue they didn’t deserve it.