[MUSIC] Welcome to the second video of the third week of our course on Unethical Decision Making. In this video we will discuss the Enron scandal through the lens of our concept of ethical blindness. Main goal of this session, in this session you will learn how organizational cultures can drive ethical blindness. Enron was a company that for a few years turned everything into gold, what they touched upon. They were the invincible masters of the universe. They were the most desired employer, year after year. Until they collapsed in a huge scandal of fraudulent accounting in 2001. It is often discussed as a case of a few criminals on the top of a corporation who create a system that is criminal. So called bad apples. You learned from our course so far already that we have a slightly different perspective on unethical behavior. And we would like to share with you some thoughts on how you can interpret the Enron story through the lens of ethical blindness. Enron is the result of a merger of two corporations in 1985. Until the early 90s, Enron is the leading infrastructure producer of the U.S. Their business is to provide pipe lines to move gas across the U.S. So they were the biggest owner of pipe lines ever in the U.S, and they were called the kings of the American pipe line business. Their business model was very simple and very profitable. They were paid to transport energy from A to B. The pipeline business of Enron was heavily regulated, until 1988, when the government decided to deregulate this industry. And from that point on, Enron had two problems. Problem number one, they were still in massive debts because of the merger that they had gone through. And second, because of the deregulation, their profitibiti, profitability shrinked. So they were in search of a new and more innovative business model. Kenneth Lay, the CEO of the company, did what many companies do when they have to change strategy but have no clue of what to do. He called McKinsey. One member of this McKinsey team was Jeff Skilling and he had a fascinating idea. He proposed to turn Enron into a gas bank. What does that mean? Well, instead of just transporting gas from A to B, the new business model was about buying gas, transporting it, and selling it. So Enron could get the control over the whole supply chain of gas in the country. They would charge a fee for the transportation, but they would in addition, charge fees for the selling of the gas. In 1990, Kenneth Lay creates the new division of Enron Finance Corporation, and he hires Jeff Skilling to lead this division. Over time, they increased their power over the market. They bought large parts of the, the gas market and therefore became the dominating actor, not just for the transportation, but also for the buying and selling of gas. And they made superior profits. In November 99, Enron entered in the new economy. You might remember the late 90's, early 2000's are the time of the first wave of the new economy. And they created the E-trading platform and on online. Within a few weeks, this platform became the biggest E-commerce platform that had ever existed in the world. And immediately afterwards, it became a standard for trading platforms online in general. They started to sell all kinds of commodities. They entered the electricity market. And soon after entering this market, they became the biggest energy marketer in the USA. They bought the biggest metal trader in the world. So step after step, Enron turned into one of the biggest corporations in the USA. The share value of Enron grew by 1,400% in ten years. In August 2000, Enron stock hit an all time high of roughly $90. The market was fascinated by the success of Enron. Goldman Sachs called them literally unbeatable in whatever they do. The Fortune Magazine selected Enron to be the most admired and most innovative company in the world. And the CEO of Enron, Kenneth Lay was praised to be an energetic messiah. For quite a while, whatever Enron touched upon became a success story. The time gap between buying and selling energy however, soon became a problem for Enron. because they had to buy it, to invest and to hold the product, until they found a customer. By mid 2000 they were trading several billion dollars every day. So employees were always encouraged to do their own trades, to invent new products, to sell, buy and sell new commodities. By mid 2000, Enron was trading more than 800 different products. The dilemma was that the more successful they became, the more cash they needed to bridge this gap between buying and selling the commodity. So they were exposed to high credit cost. In June 2000 for instance, they needed $2 million just to pay credits to banks every day. Higher credits meant lower profits. Lower profits meant a lower share price. So Enron needed more cash without more debts. Andy Fastow was the CFO of the company. He had an idea how to solve this problem. He created so-called special purpose entities. What is that? These are external partnerships and as external partnerships they could be removed from the balance sheet of the corporation. In order to be entitled to label something in external partnership, a special purpose entity, 3% of the property has to be owned by an external investor. This became a very fascinating tool for the CFO of Enron. He could put the debts of the corporation into these special purpose entities, and thereby remove debts from the balance sheet. Removing them from balance sheet means that the performance of Enron looks much better, and the positive effect of the stock value is easy to imagine. The problem was that the 3% external partner was an Andy Festo himself in most of the cases. So these entities looked like independent, but in reality they were Enron. So Enron continued buying commodities at an ever faster space selling them to customers, but no longer having this problem of the gap between buying and selling, because this was shifted to these outside entities. We don't want to go into the detailed analysis of the fraudulent techniques at Enron, or at the, the criminal behavior of, of the, the accounting specialist in the company. Our focus is, is a different one. But let me just summarize the steps that led to the Enron collapse. There was an increasing scepticism in the market, as it was for all new economy companies from a certain point in time on. On October 16, 2001 the SEC announced that it was investigating the special purpose entities. Roughly man, one month later in November, on November 28 the share of Enron is downgraded to junk status already. So, the value of the company dropped at high speed. On December 2 Enron filed for Chapter 11. So they are bankrupt. The house of card had collapsed. As I said, we are more interested in looking into the culture of this company, to understand how this contagious environment of cheating could emerge. The top [INAUDIBLE] of Enron of course, they were aggressive and greedy individuals. They were driven by self-interest. They were cheating. They were taken by the hubris of being above the ruins. That was affecting many companies of the new economy of that time. They were bad apples probably in the strict sense. But we will not understand the Enron scandal if we just look at these people at the top and zoom into their character deficiencies. What is interesting in the Enron case, is their large scale of divine behavior, that has taken the whole organization across all levels of hierarchy. The whole barrel was rotten. Not just some apples. Many people in many places at Enron got corrupted. They tried us. Amazingly, they came from top universities. Enron hired mainly from Harvard and Wharton. They never dreamed of becoming criminals. But the atmosphere of Enron may have, might have pushed them towards a behavior that they did not expect to get entangled with when they started to work for this company. So what are it, did it mean to work for Enron? The Enron hype is strongly connected to the overall new economy hype of the late 1990s. There was a debate on old economy versus new economy. Old economy meaning, slow, bureaucratic, big corporations. New economy meaning innovative, high-speed startups. And Enron was an example of how you could turn an old economy corporation into a new economy model. And the broadly shared impression of that time, the mood was that something very exciting is happening right now. And the rules that we have learned and applied in the past, don't count any more. Rules are for the old economy. The new economy is making its rules on the way up to these new type of organizations. So, the behavior of Enron managers was, was pretty much in line with the overarching ideology of deregulation, rule breaking, transformation, new economy. Markets are perceived as good. Governments as, as a problem. The shareholder value ideology, we will talk about that at a, at a later point in time in our course. The shareholder value ideology, dominated the belief system at Enron. Skilling Jeff Skilling once said, we are doing God's work. So we are representatives of a God like mechanism, that promotes the common good for everyone through our own self interested behavior. This was the spirit of deregulation. The spirit of profit maximization that has caught the early 2000s. Enron created its own reality. Building on the high press of being superior. We are up here, everyone else is down there. This is another citation from Skilling. Tom Wolfe in his, in his novels calls this kind of behavior the Master of the Universe behavior, or attitude. But the reality, it reflects exactly the values and beliefs that characterize the society or the economy. At that point in time, in general. So Enron was from that point of view not an exception. They were pretty much the rule of the belief systems of their time. What we believe as clearly wrong, Enron managers might have perceived as clever. You beat the system. You tried to beat the system. Cleverness is probably the term that describes best the overall culture at Enron. It is a culture of the company that we would like to analyze next, to, to show you that there is this hubris of the overall societal context, but there's also the cleverness that drives the organizational context, towards what we would call ethical blindness. As I mentioned, Enron was hiring just graduates from top business schools in the US. And they were hired basically as traders. They were in their early 20s. They were embedded in a, in a context of entrepreneurial aggressiveness of competition. Of creative destruction. Of fast growth. Of you can do what you want as long as you bring in trades. There were flat hierarchies, few layers between the top managers and the traders. There was a meritocratic system. Instead of being promoted or being rewarded because of your seniority, you were rewarded because of the trades you brought in. High bonuses. High stock options for young traders, based on success, based on deals. The objective was to bring as many deals as possible at an ever higher speed. The young traders, which only loosely controlled. They had a large space of making their own decisions. Even for big projects. They were inexperienced. And you can imagine what happens if you give broad decision making freedom to people who have not much experience. The reward system at Enron was as I said, to, to pay according to the trade that you bring in. They created a kind of governistic culture around the traders. And this governistic culture is pretty much manifesting in the reward system that you had in one, in the evaluation system. How did it look like? The evaluation system at Enron? There was a group of 20 managers, who evaluated their peers every year, according to their performance. The Enron traders were categorized into mainly two groups. The high performers, and the low performers. The high performers, 5% of the traders overall, they received huge bonuses and Ferraris partly. When, when bonus day came, Ferraris piled up in front of the headquarter. The low performers. Roughly 15% of the traders were fired the same day. So, what do you do if you want to survive in such an environment? You better don't make problems. You do whatever is expected from you, you don't criticize your superiors. You bring in business. Because you know when bonus day comes, you might be humiliated. And just imagine, put yourself into the shoes of one of these traders. You come from a top elite business school. You are trained already that you are the best and brightest. You work for the company that is perceived as the business model of the future. Do you want to be fired after six months because you are a low performer? You cannot afford to do this. This would be the end of your career. At least you might perceive this as the end of your career. This is Darwinism. It's struggle for survival in a very aggressive context. So if we, if we want to understand this corporation, there're a few conclusions that we can draw in the context of our concept of ethical blindness. The Enron scandal is not simply the result of the criminal behavior of a few people at the top of the company. It is not the result of the behavior of so called bad apples. There're bad apples, they drive the corporation into this direction, but you only understand it, if you look at the whole culture of the organization. It became contagious. The deviant behavior of the top leaders. So the culture of the corporation was characterized by a dangerous mix of cleverness, arrogance, vanity, aggressiveness, greed, and fear. If you create such a culture, you're promoted with your evaluation system, your bonus system your career path. Then you should not be surprised to get out something as Enron. And in addition, this culture of greed and cleverness is embedded in a particular historic moment. The, the history of the internet bubble of the early 2000s, in which everyone was convinced that now the whole economy is changing and turning into something completely different. This culture led to a systematic rule breaking on all levels of the organization. [MUSIC]
