It is suggested that throughout Anglo-American corporations the primary objective for publically owned companies is to maximise shareholder wealth. As a result, managers must continually devise strategies that promote wealth for their investors. However, this if often not the case as outlined by Jensen and Meckling (1976). They believe that ‘managers are “self-utility” maximizers and often look for opportunities to increase their own financial gain at the expense of the shareholder. For example, John Thain former CEO of Merrill Lynch spent $1.22m of shareholder’s investment refurbishing his office for his own personal gains, this form of behaviour is described as ‘Agency Theory’.
It is important that management intention remains aligned to fulfilling shareholder needs. However, where does management draw the line? Should social and ethical principles be abandoned to satisfy shareholder greed? Does law apply to managers that are simply fulfilling their corporate objectives?
Management must ensure they do not abandon the needs of other key stakeholders. A greedy approach to achieve short-term financial gain can often become the long-term demise of a corporation.
In 1985 Kenneth Lay merged the two natural gas pipeline companies Houston Natural Gas & InterNorth to form Enron. According to many financial analysts the company was in quite severe debt. In an attempt to pay their liabilities Lay sold many of Enron’s profitable assets. The CEO then set up several ‘sleeping partnerships’ with companies such as: Enron Oil Trading, Enron Exploration & Enron Cogeneration.
In 1987 Lou Borget head of Enron Oil Trading was convicted of laundering money through bogus foreign accounts. His selfish actions were an example of ‘agency theory’, acting in his own interest and not that of the shareholder. His conviction cost Enron’s shareholders $64m.
In 1990 Jeff Skilling joined Enron, he hired Andrew Fastow a previous employee of the failed Continental Illinois National Bank and Trust Company. In 1996 Fastow begins to create ‘off-the-book’ entities. In an attempt to cover growing debt Enron starts to dispose of their poor performing assets and projects to Fastow’s subsidiaries. As a result, Enron appears to have a more positive balance sheet, hiding their debt and inflating profit. During the 90s the company’s share price rose by 311%.
From 1996-1999 Enron continue to enter into ventures that financially perform poorly creating more debt. As a result, Andrew Stow created LJM, (that stands for Lea, Jeffrey, Michael the names of Stow’s children) a company that is used to purchase Enron’s poorly performing stocks and assets.
Due to their positive appearance, high profits and strong balance sheet the company’s shares hit highs of $90 each during the year 2000.
In 2001 Jeffrey Skilling resigned from his position and sold 450,000 company shares for $33m. Shortly after, the company’s huge debt and unethical accounting principles were uncovered. By November their shares had dropped in price below $1 each, costing shareholders millions in investment. Enron, once valued at $64.3 billion, filed for bankruptcy on December 2nd 2001.
The company were able to hide their huge debt due to a conflict of interest held by their auditors. The firm Arthur Andersen applied reckless standards and did not properly review Enron’s financial performance. This may be due to the influential $25million received annually by the auditors in fees.
The Enron case demonstrates how managers must maintain focus on increasing shareholder wealth whilst in keeping with the law and basing their strategies on achieving long-term financial goals. An emphasis on short-term financial gains can create future problems for organisations.
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