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Journal of Corporate Finance 13 (2007) 929–958
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Corporate governance post-Enron: Effective reforms,or closing the stable door?☆

Stuart L. Gillan a,⁎, John D. Martin b

a Finance Department, Rawls College of Business, Box 42101, Texas Tech University,Lubbock, TX 79409-2101, United States

b Department of Finance, Hankamer School of Business, Baylor University, Waco, TX 76798, United States

Received 30 March 2005; received in revised form 26 March 2007; accepted 29 March 2007Available online 29 May 2007

Abstract

We examineEnron's collapse to provide insights as to the efficacy of recent governance reforms. In doing so,we explore two main issues. First, if recently mandated governance changes had been in place earlier, wouldthey have constrained actions by Enron's management? Second, and more generally, which of the recentgovernance changes might act to constrain governance failures going forward? Although many aspects ofcorporate governance failed at Enron, the firm's viability ultimately rested on an inherently risky businessstrategy, a strategy that the board and others apparently failed to understand. However, it is not apparent thatincreasing board independence would have changed Enron's strategic direction, or prevented the firm'scollapse. From this perspective, many recent reforms, including thosemandating specific board structures likelymove firms away from their optimal governance structure and are tantamount to closing the stable door after thehorse has bolted. We assert that, ceteris paribus, stronger internal controls coupled with reduced potential forconflicts of interest on the part of the external auditor might have constrained management's ability to hide thefirm's true financial condition and are likely to constrain aspects of fraudulent behavior going forward.© 2007 Elsevier B.V. All rights reserved.

JEL classification: G3; G32; G33; G38Keywords: Corporate governance; Financial distress

☆ We gratefully acknowledge the helpful comments of an anonymous referee, Vladimir Atanasov, Scott Bauguess,Jennifer Bethel, Charlene Budd, James DeLong, David Haarmeyer, Steven Helm, Vince Kaminski, Roger Lowenstein,Douglas Ramsey, Mike Stegemoller, Tracie Woidtke, and participants at: the University of Kansas conference on corporategovernance, the University of Alberta conference on financial reporting, the 2003 European Financial ManagementAssociation (Dublin, Ireland), and seminar participants at the Texas Tech and the University of New Orleans.⁎ Corresponding author. Tel.: +1 806 742 3901; fax: +1 806 742 3197.E-mail address: [email protected] (S.L. Gillan).

0929-1199/$ - see front matter © 2007 Elsevier B.V. All rights reserved.doi:10.1016/j.jcorpfin.2007.03.008

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930 S.L. Gillan, J.D. Martin / Journal of Corporate Finance 13 (2007) 929–958

1. Introduction

On December 2, 2001 Enron Corp., the nation's 7th largest corporation and six-time winner ofFortune Magazine's most innovative company award, declared bankruptcy. Enron's shares closedthe day at less than a dollar, down from $83.13 just eleven months earlier. Enron's collapse, alongwith other failures around the same time, provided the basis for numerous corporate governancereforms including the Sarbanes–Oxley Act of 2002 (SOX). The efficacy of those reforms,however, has been the subject of much debate. While some suggest that many of the changes arebeneficial (Chhaochharia and Grinstein, in press), others contend that the costs outweigh thebenefits (e.g., Linck et al., 2006; Zhang, in press).1 Moreover, recent calls by privately fundedgroups such as the Committee on Capital Markets Regulation support easing regulatoryrequirements for firms listed in the U.S.

We use Enron's collapse as a lens to focus on the potential efficacy of recent governancereforms. In doing so, we address two main issues. First, to what extent might recent governancechanges have affected actions by Enron's management had they been in place earlier? Second,and more generally, which of the recent governance changes might act to constrain governancefailures going forward? Our analysis of Enron is based on more than four thousand pages of textfrom congressional testimony, an internal Enron report, and documents arising out of federalinvestigations and lawsuits. This material provides a unique opportunity to piece together whatled to Enron's collapse, and to provide insights as to how recent reforms might have changed theactions of the board, management, and external auditor.

We emphasize three of the major governance changes initiated following Enron's failure: 1)enhanced board independence, 2) the strengthening of internal control systems, and 3) restrictionson the provision of non-audit services by external auditors.2 These are among the changes cited asboth potentially most effective by proponents of improved governance, and as the most costly bythose seeking to roll back reforms. We also consider aspects of the external governanceenvironment not emphasized in the corporate governance literature. In particular, we highlightthat the undeveloped nature of deregulated markets in which Enron operated affordedmanagement the flexibility to manipulate the firm's performance.3

Enron's collapse arose within a system of corporate governance— internal and external to thefirm — that failed to discipline Enron's management. Enron either circumvented oversight byexternal monitors, or external monitors were slow to react to warning signs at the firm. Similarly,internal oversight by Enron's board was lacking. The board waived the firm's code of conduct topermit related-party transactions (RPTs) with the firm's Chief Financial Officer (CFO) that placedEnron in economic jeopardy. The board was also unaware of the gains the CFO would receivefrom those transactions. However, as noted by Weil (2002, p.2), Enron's failure was a result ofhaving “…bet the farm and lost.” Thus, at a fundamental level there was an apparent failure byEnron's board, and others, to understand the risks inherent in the firm's business strategy.

The remainder of the paper is organized as follows. In Section 2 we review Enron's financialperformance as the firm evolved into an energy trader and merchant banker. Section 3 focuses oninternal governance failures, while Section 4 emphasizes external governance. We conclude inSection 5.

1 See also, for example, Deborah Solomon, At What Price? Critics say the cost of complying with Sarbanes–Oxley is alot higher than it should be, Wall Street Journal, Oct,. 17 2005, R3.2 Healy and Palepu (2003) also provide perspectives on Enron's collapse.3 For a broad overview of governance issues see Gillan (2006).

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2. Enron's rise and fall

Enron was formed in 1985 through the merger of Houston Natural Gas and InterNorth. Almostimmediately Enron struggled to survive the upheaval accompanying natural gas marketderegulation, the nationalization of its Peruvian pipeline assets, and an attempted takeover. Inresponse to these challenges, the firm's business model evolved to focus on two related themes:the acquisition and operation of power plants and electric distribution companies, and tradingoperations in which Enron created markets for trading gas and electricity and financial securitiesbased on those commodities.

In 1990 Enron hired Jeff Skilling who, while at McKinsey, had helped Enron develop its “GasBank” idea calling for the firm to become an intermediary between suppliers and end-users in thenatural gas market. Later, under Skilling's leadership as CEO, the company pioneered the use ofrisk management products and long-term contracting structures in the natural gas industry.Enron's principal innovation in energy markets was to combine financial contracts with contractsfor physical delivery. This innovation was applied to the natural gas and electric power marketsand was being extended to the markets for basic metals, broadband, and pulp and paper at the timeof the firm's collapse. By the close of the nineties it was clear that trading operations had becomeEnron's primary focus and the firm began systematically shedding its physical assets followingwhat it referred to as an “asset light” strategy. From this perspective, Enron's operations mimickedthose of a trading or investment banking firm.4

The new strategy appeared to be a resounding success. From mid-1997 through 2000 Enronposted a compound annual return of 85% compared to only 15% for the stock market as a whole.Of particular note is the firm's stellar performance post-1999 (see Fig. 1). Moreover, during thisperiod Enron made several significant advances including the launch of EnronOnline (EOL), thefirm's energy trading business that became the world's largest business-to-business web site. Inaddition, Enron Broadband, Enron NetWorks (focusing on eCommerce) and Enron EnergyServices (providing retail energy products and services to business customers) were created andappeared to be adding to the firm's bottom line.

With the exception of 1986 Enron reported positive profits throughout its history. Table 1reports Enron's financial performance in Panel A; Panel B reports Enron's restated results relativeto its peers. On an annualized basis between 1995 and 2000 Enron's assets grew 38%, revenuesgrew more than 60%, and earnings grew 12%. The firm's greatest success occurred in 2000 whenrevenues increased from $40 billion to over $100 billion in one year. Much of this increase wasattributable to the creation of EOL and Enron's method of accounting for trading revenues. Enron,following industry practice, reported the total dollar value of its trading volume as revenues andthe cost of filling those contracts as cost of goods sold. Indeed, Enron's line of business reports,excerpted in Table 2, highlight that between 1998 and 2000 Wholesale Services, which housedthe firm's worldwide wholesale energy and commodities businesses including EOL, contributedsome 90% of revenues, and the bulk of Enron's profits (although margins had declined from3.23% in 1998 to 1.79% by 2000).

Despite the appearance of solid performance, beginning in 1997, Enron engaged in related-party transactions (RPTs) with off-balance sheet special purpose entities (SPEs) resulting infraudulent profits, manufactured earnings, and hidden debt. Of note is that Enron's tradingoperations relied on the firm acting as counterparty to trades. Absent a high credit rating, Enron'sability to honor its commitments would be questioned and the firm's ability to trade would be

4 CFO Magazine, Beyond Enron, February 1, 2002.

Fig. 1. Buy and hold returns for Enron and the CRSP Value Weighted Index. Historical returns — November 1984–June2001. Buy and hold returns ¼ ðBHRtÞ ¼ jt

j¼1 ð1þ HPRjÞwhere HPRt is the monthly holding period return for month t.


compromised. Thus, Enron's business model was inextricably linked to its credit rating. The SPEtransactions, however, exposed the firm to contingent liabilities that were either not fully reportedor buried in financial statement footnotes. As potential earnings and credit problems began tosurface, the related-party transactions came under scrutiny. The magnitude of the contingentliabilities was then discovered, and Enron's credit rating was subsequently downgraded. As thefirm's financial viability became an issue, counterparties unwound their positions, refused totransact, and the firm's trading business ground to a halt. Fig. 2 plots Enron's stock price relativeto key events leading up to the firm's bankruptcy filing.

3. Internal governance failures

It has been suggested that conflicts of interest and a lack of independent oversight ofmanagement by Enron's board contributed to the firm's collapse. Moreover, some have suggestedthat Enron's compensation policies engendered a myopic focus on earnings growth and stockprice. In addition, recent regulatory changes have focused on enhancing the accounting for SPEsand strengthening internal accounting and control systems. We review these issues, beginningwith Enron's board.

3.1. The board of directors

At the apex of internal control systems, corporate boards play a critical role in governance(Jensen, 1993). Despite being ranked as one of the five best corporate boards in 2000 by ChiefExecutive Magazine, we now know that Enron's board did not restrain the firm's managementfrom engaging in risky behavior that led to the firm's collapse. To examine the board's failure wefocus on aspects of board structure, actions, and inactions. We then use this information as a basisfor assessing recent board reforms.

Table 1Enron operating performance: 1985–2000

Panel A. Selected financial performance measures (as originally reported)

Dec-85 Dec-86 Dec-87 Dec-88 Dec-89 Dec-90 Dec-91 Dec-92 Dec-93 Dec-94 Dec-95 Dec-96 Dec-97 Dec-98 Dec-99 Dec-00

Total Sales ($millions) 10,253 7453 5916 5708 9836 13,165 5563 6325 7972 8984 9189 13,289 20,273 31,260 40,112 100,789Gross profit margin (%) 9.1 9.4 12.0 12.2 7.0 6.0 15.3 15.5 13.5 12.9 11.4 8.8 6.9 7.2 5.3 2.8Operating profit margin (%) 5.3 3.5 5.7 5.4 3.4 3.3 9.0 9.8 7.7 8.0 6.7 5.2 3.9 4.6 3.1 1.9Net profit margin (%) 1.2% −1.4% 0.9% 2.3% 2.3% 1.5% 4.3% 5.3% 4.2% 5.0% 5.7% 4.4% 0.5% 2.2% 2.6% 1.0%Net income ($millions) a 125 (108) 54 130 226 202 241 336 333 453 520 584 105 703 1024 979

Total assets ($millions) 9596 8484 9529 8695 9105 9849 10,424 10,664 11,504 11,966 13,239 16,137 23,422 29,350 33,381 65,503Times interest earned 1.56 0.57 0.70 0.71 0.85 1.09 1.35 1.90 2.06 2.53 2.05 2.41 1.89 2.34 1.75 2.23Debt ratio (total liabilities /total assets)

82.1% 83.2% 82.0% 80.0% 80.4% 81.2% 81.5% 76.1% 77.2% 75.9% 76.1% 76.9% 76.0% 76.0% 71.3% 82.5%

Long-term debt / total assets 78.8% 76.1% 78.8% 77.7% 77.1% 74.9% 65.7% 60.3% 68.9% 66.7% 67.8% 67.3% 66.2% 63.3% 60.5% 56.6%

Panel B. Comparison of actual to revised financial statements and peer group ratios b

Dec-97 Dec-98 Dec-99 Dec-00

Actual Revised Actual Revised Actual Revised Actual Revised

Net Income ($millions) 105 26 703 564 1024 635 979 842Net profit margin (%) 0.5 0.1 2.2 1.8 2.6 1.6 1.0 0.8Median peer group net profit margin (%) 5.3 4.6 2.9 4.1

Total assets ($millions) 23,422 22,924 29,350 29,442 33,381 33,272 65,503 64,926Debt ratio (total liabilities / total assets) 76.0% 76.8% 76.0% 77.6% 71.3% 73.8% 82.5% 84.2%Median peer group debt ratio (%) 71.8 75.2 75.1 82.7

Max peer group debt ratio (%) 93.4 94.1 94.2 93.9Min peer group debt ratio (%) 19.8 48.1 57.0 42.8

Panel A reports selected financial performance measures as originally reported by Enron. Panel B reports actual and restated values, along with peer firm comparisons. Gross profitmargin is equal to sales minus cost of goods sold divided by firm sales, operating profit margin is equal to net operating income divided by sales, and net profit margin is equal to netincome adjusted for extraordinary items and discontinued operations divided by firm sales. Times interest earned equals net operating income divided by interest expense. Totalliabilities include both current and long-term liabilities whereas long-term debt includes only those liabilities not due within the year.Source: Enron Annual Reports and Quarter 3 form 10Q filed November 19, 2001.a Before extraordinary items and discontinued operations. However, in 1997 there was a significant contract restructuring charge totaling $463 million (after tax).b Enron's peer group (from the 2001 proxy statement) includes AES Corporation; BG Group plc; Coastal Corporation; Dominion Resources, Inc.; Duke Energy Corporation;

Dynegy Inc.; El Paso Energy Corporation; Level 3 Communications, Inc.; Occidental Petroleum Corporation; PG&E Corporation; and the Williams Companies, Inc.

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Table 2Enron line of business reports for 1998–2000 ($millions)

Panel A. Divisional reporting — distribution of sales, operating income, capital expenditures, and depreciation expensefor 1998–2000

FYR 2000 Sales % oftotal

Operatingincome

% oftotal

Assets % oftotal

Capitalexpenditures

% oftotal

Depreciationexpense

% oftotal

Transportation anddistribution

2742 2.7 565 28.9 8283 12.6 270 11.3 278 32.5

Wholesale services 93,278 92.5 1668 85.4 47,934 73.2 1280 53.8 343 40.1Retail energy services 3824 3.8 58 3.0 4370 6.7 70 2.9 38 4.4Broadband services 408 0.4 (64) −3.3 1337 2.0 436 18.3 77 9.0Corporate and other 537 0.5 (274) −14.0 3579 5.5 325 13.6 119 13.9

100,789 100.0 1953 100.0 65,503 100.0 2381 100.0 855 100.0FYR 1999Exploration and production 429 1.1 66 8.2 – 0.0 226 9.6 213 24.5Transportation and

distribution2013 5.0 551 68.7 7959 23.8 316 13.4 246 28.3

Wholesale services 35,501 88.5 889 110.8 21,185 63.5 1216 51.5 294 33.8Retail energy services 1518 3.8 (81) −10.1 956 2.9 64 2.7 29 3.3Corporate and other 651 1.6 (623) −77.7 3281 9.8 541 22.9 88 10.1

40,112 100.0 802 100.0 33,381 100.0 2363 100.0 870 100.0FYR 1998Exploration and production 750 2.4 133 9.7 3001 10.2 690 36.2 315 38.1Transportation and

distribution1833 5.9 562 40.8 7616 25.9 310 16.3 253 30.6

Wholesale Services 27,220 87.1 880 63.9 14,837 50.6 706 37.1 195 23.6Retail energy services 1072 3.4 (124) −9.0 747 2.5 75 3.9 31 3.7Corporate and other 385 1.2 (73) −5.3 3149 10.7 124 6.5 33 4.0

31,260 100.0 1378 100.0 29,350 100.0 1905 100.0 827 100.0

Panel B. Divisional profitability — continuing divisions (1998–2000)

Business units 2000 1999 1998

NOI/Sales(%)

NOI/Assets(%)

NOI/Sales(%)

NOI/Assets(%)

NOI/Sales(%)

NOI/Assets(%)

Transportation anddistribution

20.61 6.82 27.37 6.92 30.66 7.38

Wholesale services 1.79 3.48 2.50 4.20 3.23 5.93Retail energy

services1.52 1.33 −5.34 −8.47 3.23 5.93

Enron's Line of Business Reports. Panel A reports basic financial performance for Enron's primary business divisions.Panel B reports profitability ratios for continuing divisions. NOI is net operating income. Enron redefined its lines ofbusiness in 1998 such that prior year's line-of-business data are not comparable. These data are “as reported” and do notreflect the revision of 1997–2000 reported results filed by Enron in Q3 2001.


3.1.1. Board composition and committee structureThe independence of the board and its monitoring committees from corporate management are

viewed by many as critical elements of board structure. Taken at face value, Enron's board wasindependent. Of the 14 board members in 2001 only two were company executives (Chairman ofthe Board and former CEO Kenneth L. Lay and President and CEO Jeffrey K. Skilling). Theremaining 12 outside directors included five CEOs, four academics (including economistWendy Gramm — former head of the Commodities and Futures Trading Commission, Robert

Fig. 2. Stock price performance — June 2001 through December 2001.


Jaedicke — a former Stanford accounting professor, a professional investor, and a former U.K.politician. Only three of these directors were viewed as affiliated — Belfer (the former presidentof Belco Oil and Gas which was acquired and became an Enron subsidiary), Wakeham (who alsoacted as a consultant to Enron on the U.K. utility industry), and Winokur (who had businessdealings with Enron).

Enron's audit, compensation, and nominating and governance committees were comprisedsolely of outside directors, and only one affiliated director (Robert Belfer) served on the financecommittee. During the 1990s almost all U.S. listed companies had audit and compensationcommittees, however, less than 60% of large firms had separate nominating committees and fewerthan 25% had corporate governance committees (Gillan et al., 2003). Moreover, in a sample ofS&P 500 firms, Adams et al. (2002) report that less than half (46%) had separate financecommittees.

Furthermore, Enron's audit committee charter was state of the art allowing the committee toretain other accountants, consultants, or lawyers, as it deemed appropriate. In addition, Enron'sfinance committee was charged with monitoring and reviewing executive decisions, manage-ment's financial plans and proposals, changes in risk management policy, the transaction approvalprocess, and the policy for approving guarantees and letters of credit. Thus, Enron's boardappeared to have an abundance of committee oversight, and comprised a set of talentedindividuals with the requisite independence and experience to advise and oversee corporatemanagement (see Appendix A for additional details).

3.1.2. Board size and independenceDespite its solid image, Enron's failure calls into question the independence and functioning of

its board and key monitoring committees. To provide further insights on this issue, in Table 3Panel A, we compare the structure, size, and independence of Enron's board with those of peerfirms from 1996 through 2001. Since Enron was viewed by many as having evolved into an

Table 3Board structure 1996–2001: Enron and peers

Panel A: Enron's self-selected peer groupa

1996 1997 1998 1999 2000 2001

Company Size Indep.(%)

D&O Own(%)

Size Indep.(%)

D&O Own(%)

Size Indep.(%)

D&O Own(%)

Size Indep.(%)

D&O Own(%)

Size Indep.(%)

D&O Own(%)

Size Indep.(%)

D&O Own(%)

AES 9 77.8 38.5 11 72.7 34.0 9 55.6 30.1 9 55.6 29.9 9 55.6 24.7 10 50.0 19.7Coastal 12 41.7 16.7 12 41.7 15.6 13 46.2 15.4 11 45.5 10.4 n.a. n.a. n.a. n.a. n.a. n.a.Dominion Resources

(VA)12 75.0 0.1 12 83.3 0.0 12 91.7 0.0 12 91.7 0.0 16 87.5 2.1 13 92.0 2.2

Duke Power 14 57.1 6.9 13 61.5 0.0 15 73.3 3.3 13 76.9 2.7 13 84.6 0.0 12 83.0 0.0Dynegy n.a. n.a. n.a. 10 90.0 8.4 11 90.9 8.4 12 91.6 8.2 13 61.5 9.6 14 57.1 7.4El Paso Natural Gas 7 85.7 3.8 8 87.5 4.3 8 87.5 4.4 8 87.5 5.0 12 83.3 9.4 12 83.0 2.0Level 3

Communicationsn.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. 10 30.0 21.5 10 20.0 19.4 8 50.0 15.5

Occidental Petroleum 14 50.0 1.1 14 50.0 1.4% 13 53.8% 1.5% 12 66.7% 1.4% 11 63.6% 1.3% 11 73.0% 1.7%Pacific Gas and

Electric15 60.0 0.0 16 56.3 0.0 14 64.3 0.0 13 84.6 0.0 11 81.8 0.0 9 78.0 0.0

Williams Companies 13 84.6 1.7 12 83.3 1.8 14 85.7 2.0 12 83.3 2.0 13 84.6 2.0 14 86.0 1.3EnronAt the time 13 61.5 5.6 14 64.3 6.5 17 52.9 4.2 17 52.9 4.8 18 55.6 5.0 14 64.0 3.4Revised for potential

conflicts30.8 28.6 35.3 29.4 38.9 42.9

Mean 12 65.9 8.3 12 66.7 7.1 13 67.9 6.8 12 69.4 7.8 13 66.5 8.0 11 72.0 5.7Median 13 61.5 3.8 12 64.3 1.8 13 64.3 3.3 12 76.9 4.8 12 72.7 3.6 12 75.5 2.1

Panel B: Major investment banking firms 2000–2001

2000 2001

Size Indep. (%) D&O Own (%) Size Indep. (%) D&O Own (%)

Goldman Sachs Group 9.0 44.4 5.4 8.0 50.0 4.5J P Morgan Chase & Co. 15.0 80.0 1.1 15.0 80.0 0.0Jefferies Group 7.0 57.1 13.2 7.0 42.9 13.4Lehman Brothers Holdings 9.0 77.8 11.4 8.0 75.0 9.4Merrill Lynch 11.0 63.6 2.7 10.0 70.0 2.1Morgan Stanley Dean Witter 10.0 80.0 3.2 10.0 80.0 3.0Enron 18.0 55.6 5.0 14.0 64.0 3.4Revised for potential conflicts 38.9 42.9Mean 10.2 67.2 6.2 9.7 66.3 5.4Median 9.5 70.7 4.3 9.0 72.5 3.8

We report Enron's board structure including size, independence (Indep.) and director and officer ownership (D&O Own). Panel A reports on Enron and its self-selected peer firms for the period 1996–2001. Panel B focuses on Enron and a setof investment banking firms for 2000 and 2001.

a To maintain consistency these comparisons involve Enron's year 2000 peer group (2001 proxy) although the peer group changed from year to year. Also, BG Group Plc was a member of the 2000 peer group but is not included herebecause it is a British firm. Coastal Corporation merged with El Paso Energy in 2000.

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investment bank, in panel B we compare Enron's board structure in 2000 and 2001 with that ofinvestment banking firms. Enron's board increased from 13 members during 1996, to a high of 18in 2000, before shrinking to 14 in 2001. The reduction in Enron's board size in 2001 wasconsistent with both best practices and empirical work suggesting that larger boards are lesseffective monitors (Denis and Sarin, 1999; Yermack, 1996). These findings are also consistentwith those of Kole and Lehn (1999) who report that board structures of airline firms slowly evolvefollowing deregulation to look similar to those of unregulated companies. Of note, however, isthat between 1998 and 2001 Enron's board was among the largest relative to both sets ofcomparison firms.

At 64%, the proportion of independent directors on Enron's board during 2001 was close to, butsomewhat lower than that of the comparison firms (72% for Enron's peers and 66.3% for theinvestment banks). Details from subsequent investigations (as reported in Table 4) revealed thatseveral directors who would otherwise be considered independent suffered from potential conflicts ofinterest by way of business arrangements, or the receipt of charitable contributions or consulting fees(notably Gramm, LeMaistre, andMendelsohn). The revised board independence figure of 43% is lessthan that of best practice recommendations and the board independence of comparison firms. This isnot to suggest that board structures are a matter of one-size-fits-all. Nor does it imply that smallerboards or more independent boards are necessarily optimal. For example, one could argue that absentother governance mechanisms, additional inside board members may act as an important conduit ofinformation to outside board members. However, it does suggest that Enron's board was lessindependent than many observers were aware of at the time.

In addition to these potential conflicts, Enron's non-employee director compensation is ofinterest. During 2000, outside board members received average director fees of $79,107 and stockoptions with an estimated value of $270,000 for an annual package valued at almost $350,000.5

This compares to Enron's peer group average of $104,514, in which no firm paid more than$200,000 to its directors. We estimate that the highest director compensation package for theinvestment banking sample during 2000 is approximately $155,000 at Lehman. By any measure,Enron's directors were handsomely compensated, and this level of compensation raises thespecter of whether or not such compensation undermined their monitoring efforts.6

An equity stake also has the potential to provide monitoring incentives for directors. In Table 3we report director ownership for Enron and its self-selected peer firms between 1996 and 2001(Panel A) and for investment banking firms during 2000 and 2001 (Panel B). A comparison of thestock ownership of Enron's directors and officers (D&O) indicates that they owned 5% of thecompany's outstanding shares, which is slightly lower than the average of 7.6% for peer firms and5.4% for investment banks. The peer firm averages, however, are skewed by outliers such thatEnron's director and officer holdings are higher than all but three of its peers and three of theinvestment banks. Using Enron's January 2001 stock price of $83.13 and the directors' beneficialownership reported in the 2001 proxy, we estimate that director ownership ranged from$266 thousand to $706 million. Lay and Skilling had ownership stakes valued at $659 million and$174 million respectively. Although we do not have information on the net worth of individualdirectors, several directors certainly had substantial stakes in the firm. Despite their ownershipstakes, the high director fees and potential conflicts of interest cast doubt on the board'sindependence.

5 The exception to this was Wendy Gramm for whom a trust was created to avoid any appearance of conflicts of interestgiven her relationship with Senator Phil Gramm.6 We abstract from non-pecuniary incentives.

Table 4Financial ties between Enron and board members

Enron engaged in transactions with entities in which a director played a major role• Robert Belfer, board member since 1985 and Chair of Belco Oil and Gas. Belco engaged in hedging arrangementswith Enron beginning in 1996. In 1997 Belco bought Coda Energy, an Enron affiliate. He served on the executive andfinance committees.•Herbert Winokur, on the board since 1985, also served on the board of the National Tank Company. Between 1997 and2000, National Tank recorded revenues of $1,035,000, $643,793, and $370,294 for providing oilfield equipment andservices to Enron subsidiaries. Winokur served on the Finance committee.

Enron made donations to groups with which directors were affiliated• Dr. Wendy Gramm, former head of the Commodity Futures Trading Commission, board member since 1993, wasemployed for some time at George Mason University. Since 1996, Enron and the Lay Foundation donated more than$50,000 to the George Mason University and its Mercatus Center that employed Ms. Gramm. Gramm served on theAudit and Nominating and Governance Committees. In addition, Ms. Gramm's husband (Senator Phil Gramm) receivedpolitical contributions over the period 1989–2001 totaling $97,350 according to the Federal Election Commission data(11/1/01). This total was the second largest political contribution made by Enron to a member of the U.S. congress.• Dr. LeMaistre and Dr. Mendelsohn, on the board from 1985 and 1999 respectively, both served as president of theM.D. Anderson Cancer Center. During a 5 year period Enron and Kenneth Lay donated nearly $600,000, with Enronpledging $1.5 million to the Center in 1993. LeMaistre served on the executive committee and chaired the compensationcommittee. Mendelsohn was on the audit and nominating and corporate governance committees.

Received consulting fees from Enron• John A. Urquhart, director since 1990, and consultant to Enron since 1991. During 2000 he received $493,914 inconsulting fees. Urquhart left the board in 2000 and also gave up his directorship of Enron Renewable Energy Corp. Heserved on the Finance committee.• Lord John Wakeham had been paid a monthly retainer of $6,000 since 1996. Wakeham, board member since 1994,served on the audit, and nominating and corporate governance committees.• Charles Walker, board member from 1985–1999 and partner in two firms that were paid over $70,000 forgovernmental relations and tax consulting services. Enron also contributed up to $50,000 annually to the AmericanCouncil for Capital Formation, a non-profit tax lobbying corporation chaired by Mr. Walker. During his tenure Walkerserved on the finance and nominating and corporate governance committees.

Source: “The Role of the Board of Directors in Enron's Collapse”, Report prepared by the Permanent Subcommittee onInvestigations of the Committee on Governmental Affairs, United States Senate (2002), pp. 54–55.We report financial relationships between Enron and outside board members as revealed in Senate Hearings.


3.1.3. Board actions and inactionsAlthough quantitative measures of board independence are important, independence by way of

board actions is also critical. It appears that Enron's board either ignored or failed to react tonumerous warning signs. In particular, Table 5 documents red flags pertaining to the firm's off-balance sheet SPEs, including the board approved related-party transactions with CFO Fastow,and the board's initial failure to implement controls for those transactions. Even when the boardhad explicitly acknowledged the potential conflicts of interest and proposed additional checks onthese arrangements, they failed to fully monitor SPE transactions or determine Fastow'seconomic interest in the SPEs.7

Further, as disclosed in Senate hearings, board minutes indicate that when the first SPE withFastow was approved the board also discussed reorganization plans, a stock split, an increase in

7 Interestingly, the Wall Street Journal, Feb 21, reported that “How much Mr. Fastow made from the LJMs was of littleconcern to top management, says one former Enron executive, because the CFO was the one person who couldconsistently pull “their nuts out of the fire with some fancy transactions. ””

Table 5Red flags

Date Red flag Board actions

1 February1999

Andersen informs audit committeethat Enron's accounting practiceswere high risk and pushed limits

Audit committee recommends Andersenbe reappointed.

2 June 1999 At a special meeting board approves LJM. No internal controls specified.Counter to standard procedures thefinance committee does not review theLJM structure prior to full board review.Conflict of interest provision waived allowingFastow to serve as managing partner of LJM.

3 September1999

Board approved moving $1.5 billion jointventure Whitewing off-balance sheet.Whitewing established December 1997to obtain loans and purchase assetsEnron wanted off its books.

4 November1999

Board approves second waiver forFastow for LJM2.

Internal controls added: Chief Accounting OfficerRichard Causey was required to “approve alltransactions between Enron and LJM.”

5 May 2000 LJM2 update reporting “8 days/6deals/$125 million.”Board approves Raptor 1 to hedgeEnron investments using Enron stock.

6 June 2000 Executive committee approves Raptor II7 August

2000“Project Summer” to sell $6 billion of assets fails.Board approves Raptors III and IV

8 October2000

Board approves third Fastow waiver for LJM3. Internal controls added: Mr. Causey, Mr. Buyand Mr. Skilling will “approve all Enron–LJMtransactions”; audit committee will reviewLJM transactions each February;

Report to board that LJM2 had investedover $400 million in 21 transactions with Enron.

Skilling will review Fastow's “economicinterest in Enron and LJM”;

Board knew that Enron had almost 50% of assets(approximately $27 billion) off-balance sheet.

Finance committee to undertake quarterlyreviews of LJM transactions;Compensation committee asked to undertake a one-off review of Fastow's compensation from LJM.

9 February2001

Revenues jump from $40 billionto $100 billion.

Audit and finance committee each spend15–30 min reviewing LJM transactions.

Audit and finance committees review LJMprocedures and transactions during 2000.

After asking and failing to obtain informationon Fastow's LJM compensation, compensationcommittee Chair LeMaistre lets the matter drop.

10 February2001

Fortune article questioning Enron's valuationand portraying the firm as a black boxthat analysts could not understand

11 April2001

Board informed that 64% of Enron's internationalassets were troubled or not performing.45 million shares of Enron stock were at riskin the Raptors and Whitewing.

Source: “The Role of the Board of Directors in Enron's Collapse”, Report prepared by the Permanent Subcommittee onInvestigations of the Committee on Governmental Affairs, United States Senate (2002).Red flags that Enron's Senate Hearings revealed that Enron's board were aware of in connection with the “asset light”strategy and the SPE transactions.



the company's stock compensation plan, the purchase of a new corporate jet, and a MiddleEastern power plant investment. However, the entire meeting lasted only an hour.8 The evidencealso suggests that the audit and finance committee reviews of SPE transactions entailed 15 to30 minute meetings with Enron's chief accounting officer where they reviewed a one to two pagelist of the transactions, the approximate dollar value of each, and a ten-word or less description ofeach transaction (Senate Board Report p 32). While we do not know if this is typical for boards ingeneral, the board's review of critical transactions appears, at best, cursory.

3.1.4. An assessment of board reformsEnron's board structure differed somewhat from that of other firms and the evidence raises

questions about the board's independence. Indeed, regulatory reforms addressing board issueshave focused heavily on board independence. Stock exchange rules now require that a majority ofthe board be independent, and further, that firms have 100% independent audit, compensation andnominating committees. An added requirement from SOX is that audit committees have at leastone member who is a financial expert. Establishing an independent majority at Enron could havebeen achieved by adding 1–2 new independent directors or replacing 1–2 board members withpotential conflicts of interest. At the same time, however, the board was comprised of directorswho arguably had the skills to monitor management, yet they did not.

What effect might a different board structure had at Enron? Recent evidence questions theextent to which board changes are likely to be value enhancing. Carcello et al. (2006) suggest thatwhile the addition of financial experts to audit committees constrains earnings management so toodo alternate governance mechanisms. Moreover, several recent papers argue that boards evolve asan endogenous response to their environments (Boone et al., in press; Coles et al., in press; Gillanet al., 2006; Lehn et al., 2006). Indeed, Linck, Netter, and Yang (2006) suggest that therestructuring of corporate boards post-SOX has been costly, particularly for smaller firms. Theimplication from this work is that recent reforms mandating board structures are likely movingfirms away from the optimum. With regard to Enron, it is not possible for us to say what wouldhave happened had Enron's board been more independent. We could speculate that changing theboard might have changed board dynamics, processes, and the eventual outcome. However,boards require information on which to act, and it is not clear that changing the board structurewould have changed the information available to the board, or their actions.9 While boardindependence (on paper) can be legislated, board actions cannot.

3.2. Executive compensation

The central functions of the board entail not only the hiring, firing, and monitoring of corporatemanagement, but also providing the appropriate incentives for the management team to act inshareholder interests. To explore this issue further, we focus on Enron's compensation policies.

In many regards Enron's incentive programs appeared innovative and in concert with bestpractices. Compensation was closely linked to shareholder value, and employees had a substantialportion of their compensation at risk. Additional performance requirements — meeting earnings

9 This is consistent with Brickley (2007) who suggests that Ken Lay would not have had detailed information about theSPE transactions.

8 See page 27: Report of the Senate Permanent Subcommittee on Investigations of the Committee on GovernmentalAffairs, The Role Of The Board Of Directors In Enron's Collapse] Rep. No. 107–70, 107th Cong., Sess. (2002)[henceforth “Senate Board Report”].


growth targets, beating an index or peer group, or exceeding the T-bill rate for payouts to bemade— are features that many advocates of compensation policy reform applaud. In some cases,stock option awards provided for accelerated vesting if Enron achieved earnings per share growthtargets. Similarly, although some restricted stock grants “cliff vested” four years from the date ofthe grant, vesting would be accelerated if Enron's shareholder return surpassed that of the S&P500. Indeed, Enron's 2000 annual report stated that the firm was “laser-focused” on earnings pershare. Evidence on compensation structures at the largest 250 industrial companies for 2000suggests that less than a third of firms used performance shares or performance unit plans, andonly 16% used performance-based options (The 2001 Top 250, Frederic W. Cook & Co., Inc).

In Table 6 we compare compensation during 2000 for Enron's CEO, Kenneth Lay, with that ofEnron's peer firms (Panel A) and the sample of investment banks (Panel B). In 2000, Lay received69% of his compensation in the form of incentive pay. Although this is higher than the peer groupaverage, it falls well within the range of Enron's peer firms (from 24% for El Paso to almost 100%at AES). However, Lay's total pay package was almost $31 million — more than four times thecompensation of the average peer firm CEO. Dynegy CEO, Charles Watson, ran a close second

Table 6CEO compensation during 2000: Enron and peers

Panel A. CEO compensation for Enron's self-selected peer group (2000)

Company CEO name Compensation Ratio of incentiveto total

Marketvalue

Total pay Incentive-based

AES Dennis Bakke 6,706,377 6,694,244 1.00 25,348Dominion Resources Thos. Capps 4,959,116 3,094,095 0.62 15,939Duke Energy Richard Priory 5,365,418 3,954,274 0.74 31,441Dynegy Charles Watson 24,690,047 23,136,547 0.94 13,306El Paso William Wise 13,974,828 5,459,940 0.39 16,758L-3 Communications Frank Lanza 1,256,858 500,000 0.40 2566Occidental Petroleum Ray Irani 8,989,841 6,485,304 0.72 8957PG&E Robert Glynn Jr. 2,416,889 1,471,803 0.61 7742Williams Keith Bailey 3,839,777 2,878,311 0.75 17,573

Median 6,035,898 4,707,107 0.68 14,623Maximum 24,690,047 23,136,547 1.00 31,441Minimum 1,256,858 500,000 0.39 2566

Panel B. CEO compensation for investment banking firms

Goldman Sachs Group Henry Paulson Jr. 25,348,846 24,717,925 0.98 36,724J P Morgan Chase & and Co. William Harrison Jr. 57,228,690 56,176,190 0.98 59,194Jefferies Group Frank Baxter 4,478,369 3,739,000 0.83 766Lehman Brothers Holdings Richard Fuld Jr. 34,426,506 33,662,796 0.98 12,034Merrill Lynch David Komansky 36,332,255 35,602,316 0.98 54,913Morgan Stanley Dean Witter Philip Purcell 42,887,400 41,972,222 0.98 71,729

Median 35,379,381 34,632,556 0.98 45,819Maximum 57,228,690 56,176,190 0.98 71,729Minimum 4,478,369 3,379,000 0.83 766

Enron Kenneth Lay 30,904,588 28,365,721 0.92 61,422

Total CEO Pay includes salary, bonus, other compensation, and incentive pay. Incentive pay is defined as the sum ofOption-Grant Value (based on Black–Scholes and 70% of the option life), Restricted Stock Grants, and Long-termIncentive Payouts. All values are obtained from the Execucomp database. Panel A reports compensation for Enron's self-selected peer group, while Panel B reports compensation for a set of investment banking firms. Enron comparison data isincluded at the bottom of the table.


with a total compensation package valued at some $25 million. It appears that Lay's totalcompensation was similar to that of the investment banks, although slightly less incentive-based.

Enron's compensation program provided executives with powerful incentives to increaseearnings and the company's stock price. However, if bonuses are based on performancethresholds, managers might manipulate earnings to achieve them (see Murphy, 1999; Healy,1985). This prompts several questions. Did Enron's compensation policies align employee andshareholder interests, or did they lead to a focus on short-term stock prices? Could the potentialpayoffs from meeting earnings and share price targets explain the willingness of uppermanagement to turn a blind eye to the financial reporting practices and SPE transactions initiatedby Fastow in 1997? The answers to these questions are not clear. Such questions do, however,suggest that, like other aspects of governance, compensation policy is not a matter of one size fitsall. And, while by no means definitive, claims of a link between compensation structure andincentives to manipulate are consistent with recent large-sample evidence linking fraud andshareholder lawsuits to compensation structures (Burns and Kedia, 2006; Denis et al., 2006;Johnson et al., 2003).

There are also reasons to question how actively the board monitored compensation polices andpayments. For example, the compensation committee approved a $4 million credit line for Lay,which was later increased to $7.5 million. When questioned during Senate hearings,compensation committee members indicated that they were unaware that from October 2000to October 2001, Lay used the credit line to obtain over $77 million in cash from the company, orthat he repaid the loans using Enron stock (effectively selling stock back to Enron). In addition,although the finance committee requested information on Fastow's SPE compensation (from thechair of the compensation committee), when the information was not provided by Enron's seniorcompensation officer, the matter was dropped. Subsequent estimates in Powers, Troubh, andWinokur (2002) suggest that Fastow gained at least $30 million from one of the SPEs alone, alarge amount compared to his estimated $6 million stock ownership (based on insider holdingsdata). Finally, during 2001, based on year 2000 performance, Enron executives were paid some$430 million under the annual bonus plan. Another $320 million was paid under the performanceunit plan for a total cash payout of $750 million. Enron's net income for 2000 was only$975 million. In Senate testimony, board members indicated that they were unaware of themagnitude of these bonuses. Overall, the evidence suggests another board failure, this time in thearea of compensation policy.

3.2.1. An assessment of compensation-related reformsWhile SOX mandated accelerated reporting requirements for insider sales (particularly sales

back to the company) and prohibited corporate loans to insiders, few other requirements relate toexecutive compensation. However, FASB now requires the expensing of option-based com-pensation and recent rule-making at the SEC has enhanced executive compensation disclosures.With levels of options granted and outstanding declining (e.g., 2005 Equity Stake, Pearl Meyer& Co.) it is possible that recent reforms have led to some firms constraining their use of option-based compensation. However, it seems unlikely that such reforms directly affect the incentivesthat individuals have to commit fraud or the likelihood of fraud detection.

3.3. Key internal control problems at Enron

Related-party transactions and SPEs are widely used, both in the U.S. and internationally.Indeed, these related- and internal-capital market transactions may allow management to avoid


the problems associated with markets that are subject to thin trading or price distortions. However,they may also afford managers the ability to manipulate market prices, transaction values, andcorporate performance, particularly when it is difficult to verify transaction values. The evidenceon this issue is mixed. Cheung, Rau, and Stouraitis (2006) examine such transactions in HongKong firms, while Jian and Wong (2003) study Chinese companies. Both sets of authors findevidence suggesting that related-party transactions are used to facilitate expropriation. However,in a study of U.S. firms, Gordon and Henry (2004) find that concerns about earnings managementare confined to cases where the RPTs take the form of corporate loans.

At Enron, from 1997 forward off-balance sheet financing and related-party transactionsbecame increasingly important elements of the firm's business strategy and capital structurepolicy. Although it is not clear to what extent other firms used similar accounting procedures,experts who testified during Senate hearings were unaware of other firms with off-the-booksactivity as extensive as that at Enron (Senate Board Report p. 39). Several factors characterize thecontroversy over Enron's use of SPEs: First, several large SPEs were run not just by relatedparties, but by Enron employees who reported to Fastow in his capacity as CFO. Second, severalSPEs did not meet the requirements for off-balance sheet reporting. Rather, the assets andliabilities should have been consolidated and reported in Enron's financial statements. Third, theborrowing ability of some SPEs was linked to the value of Enron shares. Fourth, in several casesEnron had guaranteed SPE debt. The extent of these guarantees was such that Enron's debtobligations were greater than many observers were aware of. Finally, the SPEs required theboard's approval of a waiver of the firm's code of conduct to allow Fastow's participation.

Moreover, the evidence is consistent with SPEs being used to manipulate earnings for the firmand extract rents, particularly for Fastow, rather than to enhance corporate value. One function ofthe SPEs was to “create prices” that would be used to revalue Enron assets. For example, SherronWatkins' memo to Ken Lay indicated that prices realized from the sale of “dark fiber” to an SPEwere used to inflate the value of Enron's remaining dark fiber assets (i.e., marking theseinvestments to market).10 Although we do not know to what extent estimates were used to valueother merchant assets, or if those sales were to related parties, we do know that merchant assetsales had a significant impact on reported profits. For the years ended 1998 through 2000 Enronreported that $628 million, $756 million, and $104 million of its pre-tax profits came from gainsfrom the sale of merchant assets and investments (footnote 4 of the 2000 10 K). These valuesrepresent 89.3% of pre-tax reported net income for 1998, 84.7% for 1999, and 10.6% for 2000.

Another purpose of these SPEs was to “hedge” Enron's earnings from possible declines in thevalue of merchant investments. For example, Enron had $300 million of gains in RhythmsNetConnections stock which could not be realized due to a lock-up agreement. Under mark-to-market accounting, these gains had been booked as earnings thus, to avoid reporting possiblelosses, Enron contracted with SPEs to offset value declines in Rhythms NetConnections stock. InMay 2000, a report to the board's finance committee indicated that during the fourth quarter of1999 alone, one SPE produced over $2 billion in funds flow for Enron, over $200 million inearnings, and in “8 days/6 deals/$125 million”. Moreover, during 2000 and the first nine monthsof 2001 the SPEs contributed almost $1.1 billion to Enron's earnings by offsetting losses onmerchant assets (Powers et al., 2002, pp 128).

Also of note is that, the SPE assets were effectively unrealized gains on Enron stock (Benstonand Hatgraves, 2002) and the “hedge” for declining investment values involved transferring these

10 The Financial Collapse of Enron, Hearing before the Subcommittee on Oversight and Investigations, House ofRepresentatives Committee on Energy and Commerce, 107th Cong., Hrg. No. 107–89 (February 14, 2002) page 119.


unrealized stock gains back to Enron (thus violating Generally Accepted Accounting Principles(GAAP) rules that prohibit firms from booking increases in the value of their own stock as profit).When Enron's stock price declined so too did the value of SPE assets. This in turn triggered SPEdebt covenants, the realization of Enron's contingent liabilities, and ultimately the firm's default.Rather than using RPTs and SPEs to benefit the firm, they were used to manipulate, misrepresent,and enrich Enron employees, particularly the firm's CFO.

3.3.1. An assessment of internal control related reformsFASB Interpretation 46 (FIN 46) clarifies the accounting for, and arguably increases the

transparency of, SPE transactions. However, it is not apparent that these changes would havealtered events at Enron. Indeed, under the accounting rules in place at the time, several of Enron'skey SPEs should have been consolidated. Also at issue is that these were related-partytransactions. And, although footnote 16 of the 2000 10 K filing revealed that Enron had enteredinto transactions with limited partnerships managed by a senior Enron officer, it was not revealeduntil much later that these RPTs hid significant liabilities, included buy-back agreements (whichinvalidated the notion that these were arm's length transactions), and valued assets at unrealisticprices. As a result of regulatory reforms, it has been mandated that such transactions be subject toapproval of the audit committee and review by external auditors. In addition, the SEC has recentlyproposed enhanced disclosure of related-party transactions. Again, however, board approval andauditor reviews of these transactions took place at Enron, yet concerns that those reviews raisedwere not acted upon.

Several other components of SOX are relevant in this context. First, under Sections 302 and906, CEOs and CFOs must certify the financial statements. Empirical evidence to date suggeststhat the market reacts favorably to CEOs and CFOs “swearing by the numbers” (Chang et al.,2006). Second, under Section 404, management must assess and report on internal controls.Finally, under Public Company Accounting Oversight Board PCAOB Auditing Standard No. 2,the external auditor must opine on management's assessment of internal control systems(discussed below in Section 4.4). Many suggest that Section 404 is particularly costly and thataspects of this provision should be rolled back. Survey evidence from a random sample of Fortune1000 firms suggests that, during 2005, Section 404 compliance costs were approximately 0.24%of revenues for smaller firms, and 0.05% for larger firms. By 2006 these had declined to 0.09% ofrevenues for smaller firms and 0.02% for larger firms. Although it is difficult to quantify thebenefits of increased scrutiny of internal controls, the number of significant deficiencies andmaterial weaknesses reported at the firms surveyed declined by between 25% and 50%,suggesting a strengthening of internal control systems and oversight at these firms.11

4. External governance failures

As a public company, Enron was subject to external sources of governance including marketpressures, oversight by government regulators, and oversight by private entities includingauditors, equity analysts, and credit rating agencies. In this section we recap the key externalgovernance mechanisms, with emphasis on the role of external auditors.

11 Charles River Associates International (now CRA) “Sarbanes–Oxley Section 404 Costs and Implementation Issues:Spring 2006 Survey Update,” http://www.s-oxinternalcontrolinfo.com/pdfs/CRA_III.pdf.

http://www.s-oxinternalcontrolinfo.com/pdfs/CRA_III.pdf


4.1. External markets and deregulation

Several authors suggest that product market competition imposes discipline on managers, andthat managers who operate in developing markets might not be subject to such disciplines. Forexample, Zingales (1998) reports that product market competition and debt are associated withfirm survival after trucking industry deregulation; Parrino (1997) finds evidence that CEOturnover is higher at firms in industries where products are similar; Fee and Hadlock (2000) reportincreased executive turnover at newspaper firms operating in competitive environments.

Enron's wholesale operations, the major component of the firm's business, operated in newlyderegulated energymarkets, and Enron held a dominant position in those markets. Three aspects ofEnron's position in these markets are particularly relevant. First, by 2001 EOL was the largestplayer in gas and electricity trading, accounting for approximately 38% of natural gas and 17% ofelectric power marketed in the U.S.. Second, EOL was acknowledged as a major source of pricediscovery and price formation for the markets in which it operated. Finally, Enron traders hadaccess to proprietary information on price, volume, and the identity of those transacting. Thisinformation, which was not available to other market participants, afforded Enron traders acompetitive advantage. Indeed, investigation of Enron's trading practices concluded that “….thereis now evidence that Enron in fact likely exploited this advantage to manipulate prices, particularlyin California and the Western markets” (FERC staff memo Nov 12 2002, page 21). Superiorinformation, Enron's role as a counterparty to its transactions, and the nascent nature of thesemarkets afforded Enron traders the opportunity to manipulate prices. From this perspective, Enronoperated in an environment absent from true market pressures. Indeed, FERC investigations foundthat American Electric, Dynegy, and Williams Cos. had all disclosed that their traders providedinaccurate information to energy industry publications that compile and publish price indices.

However, Enron allegedly “gamed” the system in other ways to add to the firm's bottom line.For example, accounting rules gave trading firms discretion in valuing long-term gas and powercontracts and allowed immediate recognition of expected future revenues. Indeed, as reported bythe Wall Street Journal,

12 PowGreedBarrion

In December 1999, LawrenceWhalley, then president of Enron's trading unit, asked a groupof subordinates to “find” $9 million in additional profits to help the company meet end-of-year goals.12

Critical to this process was that Enron recorded assets and liabilities arising from its trading andmerchant operations at market values rather than historical cost. Under historical cost accounting,if asset values drop, losses are reported only upon sale (unless the assets are permanentlyimpaired). With mark-to-market accounting, losses flow through the income statement regardlessof whether or not the assets are sold. Far from controversial, this practice was consistent withGAAP and was standard practice for equity and bond trading desks, especially in banks and otherfinancial institutions. Mark-to-market accounting appears to enhance transparency concerning thevalue of assets and liabilities. However, absent market values, the requisite valuations involveestimates that are subject to potential manipulation. While weak internal controls might contributeto potential manipulation, at Enron a lack of vibrant product markets also contributed to the firm'sability to misrepresent transaction values, and thus the firm's financial condition.

er Outage: How Energy Traders Turned Bonanza Into an Epic Bust — Unleashed by Deregulation, Industryand Deceit Undid the Nascent Market — ‘Shut Up and Delete This’, Paul Beckett and Jathon Sapsford and Alexeiuevoin, The Wall Street Journal, 31 December 2002, A1.


4.2. Government regulators

At the time of the firm's collapse, Enron was engaged in a wide range of activities includingenergy production and the trading of energy-related commodities and derivatives. As such, manyof its activities were potentially subject to oversight by the Commodities and Futures TradingCommission (CFTC) or the Federal Energy Regulatory Commission (FERC). The CFTC'sprimary mission is to ensure that the commodity futures and options markets operate in an openand competitive manner, while the FERC regulates the interstate transmission and market forenergy products. Of course, the primary source of federal oversight for publicly traded firms is theSecurities and Exchange Commission (SEC). We discuss each of these in turn.

4.2.1. CFTC and FERC oversightThere is a paucity of material pertaining to the CFTC's role in Enron's collapse. It appears that

this is primarily due the agency's limited oversight of the firm. Indeed, throughout the 1990sEnron, and other energy firms, followed a strategy of aggressive lobbying to avoid regulatoryoversight from the CFTC or to gain exemptions allowing them to avoid compliance with theCommodity Exchange Act (CEA). Indeed, the CFTC issued Enron exemptions from the CEA forderivatives on energy products in April 1993. As a result, the bulk of Enron's activities were notsubject to CFTC oversight. Interestingly, during this period, Wendy Gramm was the Chair of theCFTC. She joined Enron's board in 1993.

A post-mortem of the FERC's oversight of Enron identified several occasions when theregulator had sufficient information to raise suspicions about the firm's operations but failed to doso. An investigative committee concluded that more vigilant and aggressive action by FERCwould have limited some of the abuses that appear to have occurred, particularly in the context ofapparent price manipulation by Enron energy traders. A complication in the relationship betweenthe FERC and Enron was the fact that FERC was charged with overseeing the deregulation ofmuch of the energy business and Enron was a chief actor in carrying out that deregulation. Theinvestigating committee concluded that FERC “was no match for a determined Enron and has yetto prove that it is up to the challenge of proactively overseeing changing markets.”13 It is worthnoting that, once again, Enron aggressively lobbied to avoid FERC oversight of many of itsoperations.

4.2.2. SEC oversightThe SEC plays an essential role in corporate governance in two ways. First, the SEC

establishes requirements related to what types of information public companies must disclose andworks to assure compliance with these regulations by reviewing company filings. Second, theSEC enforces the law by bringing legal action against those firms and individuals that it believeshave committed financial fraud.

The alleged failure of the SEC has arisen primarily with regard to its inability to detectproblems with Enron's filings. Although it is not the SEC's task to identify fraud, it has beenacknowledged that, at the time, the SEC was understaffed, under-resourced, and barely able tokeep pace with reviews of new registrations.14 Moreover, Enron aggressively sought exemptions

13 Senate Committee On Governmental Affairs, Staff Memorandum, November 12, 2002, Committee Staff Investigationof the Federal Energy Regulatory Commission's Oversight of Enron Corp. (page 115).14 Senate Committee On Governmental Affairs, Staff Memorandum, October 8, 2002, Financial oversight of Enron: TheSEC and private sector watchdogs, page 10.


from SEC oversight. For example, the SEC provided administrative relief to Enron fromcompliance with the Investment Company Act, and Enron had successfully argued for exemp-tions from the Public Utility Company Holding Act. Absent such exemptions, Enron would havebeen subject to greater regulatory scrutiny and potentially greater discipline with regard to thefirm's utility and investment activities.

4.2.3. An assessment of changes for government regulatorsWhile little in the way of direct regulatory reforms have affected the CFTC and FERC, it is

clear that the oversight expectations of these agencies has increased dramatically. Moreover, inthe aftermath of Enron's collapse, the CFTC and FERC (in some cases jointly with theDepartment of Justice) have pursued actions against Enron, former employees, and others in theindustry for alleged manipulation of natural gas prices. In addition, the CFTC charged that EOLoperated as an illegal futures exchange and offered to trade illegal agricultural commoditiesfutures contracts. Similarly, in September 2004, FERC required that Enron disgorge $32.5 millionof “unjust” profits for violating its market-based rate authority (Collins, 2003).

Not surprisingly, the primary focus of post-SOX reforms has been on the SEC and theestablishment of the PCAOB as a means of overseeing the audit profession. The SEC's fundingwas increased dramatically, and the agency has stepped up its oversight of filings with the SOXrequirement that public company financial statements be reviewed by SEC staff once everythree years. The agency has pursued legal action against numerous individuals and firms, isworking to enhance financial reporting and disclosure practices, and is conducting investigationsinto different aspects of financial reporting and corporate governance.

4.3. Private sector oversight: equity analysts and credit rating agencies

Private sector oversight by equity analysts and credit rating agencies has also come undercriticism. We focus first on equity and then credit analyst failings and reforms.

4.3.1. Equity analystsEnron's failure also highlighted potential conflicts of interest on the part of Wall Street

analysts. At issue is that the investment banking business is driven by the fees derived from clientfirms. Further, analyst compensation was linked to the investment banking business that theyhelped generate. Consequently, negative analyst recommendations would almost certainlydecrease the likelihood that the client would return with more business and adversely affectanalyst compensation. Interestingly, of the 15 sell-side analysts that followed Enron, 13 had buyor strong buy recommendations on August 7, 2001. Moreover, as late as November 8, 2001 —more than 3 weeks after the company announced the $1 billion charge to earnings and thedisclosure of Enron's related-party transactions with partnerships headed by Fastow — 10 out of15 analysts rated the stock a buy or a strong buy.15 Overall, the Senate investigation concludedthat the analysts failed to provide accurate and unbiased analyses of Enron and the value of itstock.16

15 See “The Watchdogs Didn't Bark: Enron and the Wall Street Analysts, Hearing before the Senate GovernmentalAffairs Committee, 107th Congress, S. Hrg. 107–385 (February (202) at 127 (Chart entitled “Enron StockRecommendation by Broker, August 2001 through December 7, 2001).16 Senate Committee On Governmental Affairs, Staff Memorandum, October 8, 2002, Financial oversight of Enron: TheSEC and private sector watchdogs, page 89.


4.3.2. Credit rating agenciesCredit rating agencies serve as independent sources of information regarding the

creditworthiness of public companies and the debt they issue. Particular concern with regardto monitoring by the rating agencies came when Enron filed for bankruptcy just days afteragencies lowered the firm's credit rating from the lowest investment grade rating to junkstatus.

Although credit analysts had been assured no write-down was imminent at the time ofSkilling's resignation in August, in early October the ratings agencies were informed of the$1 billion charge to earnings, and the $1.2 billion reduction in shareholder's equity. On October17 the Wall Street Journal reported Fastow's participation in the SPEs. On October 22 Enrondisclosed that the SEC had initiated an investigation, and on October 24 Fastow was placed onleave. Within 5 days, S&P and Fitch placed Enron on watch for a downgrade, while Moody'sdowngraded Enron to a lower investment grade. A series of subsequent downgrades took place,with the November 9 rating change by S&P triggering a $690 million obligation to one of Enron'sSPEs. However, it was not until the collapse of merger talks with Dynegy that Enron's rating waslowered to junk status. This in turn triggered a covenant that made $2.4 billion of debt payableimmediately. The ensuing credit crisis left Enron's management with no choice but to file forbankruptcy. In an ironic twist, a functioning governance mechanism— the covenants designed toprotect SPE bondholders — triggered the bankruptcy filing.

On balance, the Senate investigation found that the credit rating agencies failed to detectEnron's problems, or at least, did not react to them until it was too late. Moreover, the raters didnot ask sufficiently probing questions and did not adequately consider the effect of accountingirregularities and complex financing structures on the long-term health of the firm. In short, theinvestigation concluded that the ratings agencies “…did not exercise the proper diligence.”Whilethe evidence also suggested that the ratings agencies were given misinformation as to Enron'sfinancial condition, a major element of the governance system failed.

4.3.3. An assessment of analyst changesIn response to potential conflicts of interest on the part of equity analysts, the failure

of IPOs, late-trading, and allegations of insider trading that also occurred around the timeof Enron's collapse, there has been a dramatic change in the regulatory environment forequity analysts. In particular, the so-called “global settlement” with investment bankingfirms resulted in fines of close to $1.5 billion, a de-coupling of analyst compensation from theinvestment banking business, and the provision of independent research reports to investors.

There have also been moves to enhance competition in the credit ratings industry by allowingmore entities to be “nationally recognized statistical rating organizations,” or NRSROs. Indeed,since 2003 Dominion Bond Ratings Services and A. M. Best have been recognized as NRSROs,arguably increasing competition in the ratings arena. Moreover, some ratings agencies, notablyMoody's, now explicitly consider aspects of corporate governance in their ratings process.Finally, the Credit Rating Reform Act of 2006 has been passed with the objective of enhancingthe quality of credit ratings and investor protection.

4.4. Private sector oversight: external auditors

Among the most important sources of external oversight are the independent auditors.However, as we will see in the following sections, they too appeared to be compromised asmonitors.


4.4.1. Auditor effectivenessAuditor effectiveness hinges on the auditor's ability to be an independent gatekeeper. The

independence of Arthur Andersen, Enron's auditor, has been questioned on at least three grounds.First, because accountants rely on repeat business, simply accepting the audit engagement maycompromise auditor objectivity and independence (O'Connor, 2002). The conventional counterargument is that auditors would not risk their reputation on a single client's indiscretions for themodest fees involved (Coffee, 2002). Yet, evidence from the 1990's suggests that auditors haveknowingly certified fraudulent accounts, even though the financial gains appear to be dwarfed byreputation loss (Prentice, 2000).

Second, for two years Andersen served as Enron's internal and external auditor. Essentially,when Andersen performed the external audit it was reviewing its own work. In addition,Andersen advised Enron on the structure of many of its SPEs, received consulting income fordoing so, and then audited transactions between Enron and the SPEs (Powers et al., 2002). Third,during this period audit firms routinely earned consulting income from their audit clients. Thisraised questions as to whether or not the magnitude of consulting fees, relative to those receivedfor audit services, might compromise the integrity of the audit.

In Table 7 we report information on fees paid to external audit firms for Enron and its self-selected peers, and a sample of investment banking firms during 2000 (the first time such

Table 7External auditor fees 2000: Enron and peers

Enron's self-selectedpeer group

Audit fees Financialinformationdesign fees

Other fees Totalnon-auditfees

Total fees Ratio: non-auditto total fees

AES $ 4,861,897 $ 155,020 $ 7,464,526 $ 7,619,546 $ 12,481,443 0.61Dominion Resources 2,295,000 – 2,516,000 2,516,000 4,811,000 0.52Duke Energy 3,373,051 – 11,796,608 11,796,608 15,169,659 0.78Dynegy 3,198,500 – 4,119,500 4,119,500 7,318,000 0.56El Paso 1,920,000 – 4,018,000 4,018,000 5,938,000 0.68L-3 Communications 755,400 – 1,691,000 1,691,000 2,446,400 0.69Occidental Petroleum 3,886,500 – 6,725,308 6,725,308 10,611,808 0.63PG&E 3,100,000 – 11,300,000 11,300,000 14,400,000 0.78Williams 4,400,000 – 21,400,000 21,400,000 25,800,000 0.83

Average $ 3,087,816 $ 7,892,327 $ 7,909,551 $ 10,997,368 0.68Maximum 4,861,897 21,400,000 21,400,000 25,800,000 0.83Minimum 755,400 1,691,000 1,691,000 2,446,400 0.52

Investment banking firmsGoldman Sachs Group 9,463,000 – 2,346,000 2,346,000 11,809,000 0.20J P Morgan Chase & Co. 21,300,000 11,100,000 73,100,000 84,200,000 105,500,000 0.80Jefferies Group 271,124 – 399,461 399,461 670,585 0.60Lehman Brothers Holdings 5,500,000 – 6,309,000 6,309,000 11,809,000 0.53Merrill Lynch 20,115,000 6,746,028 32,837,413 39,583,441 59,698,441 0.66Morgan Stanley

Dean Witter14,500,000 – 22,700,000 22,700,000 37,200,000 0.61

Average $ 11,858,187 $ 2,974,338 $ 22,948,646 $ 25,922,984 $ 37,781,171 0.57Maximum 21,300,000 11,100,000 73,100,000 84,200,000 105,500,000 0.80Minimum 271,124 6,746,028 399,461 399,461 670,585 0.20

Enron $ 25,000,000 $– $ 27,000,000 $ 27,000,000 $ 52,000,000 0.52

Fees paid to external auditors by Enron and peer firms for audit and non-audit services. We include in the table the identityof the external audit firm, audit fees, fees paid for information system design (where disclosed) non-audit fees, total non-audit fees, total fees, and the ratio of non-audit to total fees.


disclosures were required).17 Enron's 52% ratio of non-audit fees to total fees paid to auditors(a common measure used in practice to detect potential capture of the audit firm) comparesfavorably with the peer firm average of 68%. However, this measure masks the economicsignificance of the Andersen–Enron relationship. Focusing on the dollar amounts in Table 7indicates that during 2000 Enron paid Arthur Andersen total fees of $52 million including$25 million for the audit, $14 million for work arguably connected to the audit, and $13 millionfor other consulting (including $5.7 million related to SPEs (Powers et al., 2002). The total feesare almost five times the average for Enron's peers, and higher than all but two of the investmentbanks.

These fees made Enron one of Andersen's largest clients, and the largest for the Houstonoffice. The evidence also suggests that Andersen partners outside the Houston office decided tokeep Enron as a client despite determining the firm to be high risk— a decision that might havebeen motivated by profit given their expectation that Enron would be a $100 million client inthe near future (WSJ, C1, January 18, 2002). The potential conflict of interest as a result ofreceiving large consulting fees may have contributed to failures by Andersen to pursue itsmisgivings about many of Enron's transactions. For example, apparently Andersen employeeshad serious concerns about Fastow's involvement in the SPEs as the following e-mail excerptreveals:

17 EnrDominComm

Setting aside the accounting, [the] idea of a venture entity managed by CFO is terriblefrom a business point of view. Conflicts of interest galore. Why would any director in hisor her right mind ever approve such a scheme? (Andersen internal email, Exhibit 55,Senate Subcommittee report)

The magnitude of these concerns was apparently not communicated to the audit committee.Interestingly, Andersen developed a risk profile analysis of accounting and disclosure judgmentsthat placed Enron in the “high risk” category in 11 out of 14 areas. At the same meeting,handwritten comments on meeting materials by an Andersen representative indicated that some ofEnron's accounting practices “push limits” and were “at the edge” of acceptable practice. Despitethese concerns, Enron was given an unqualified audit report and Enron's audit committeerecommended the adoption of the financial statements to the full board.

4.4.2. An assessment of audit changesAs noted in the discussion on regulatory changes, the audit profession is now subject to

oversight by the PCAOB. Furthermore, SOX has reinforced earlier SEC promulgations that theexternal auditor be appointed by, and report to, the audit committee of the board. Finally, thepractice of audit firms providing consulting services to their audit clients has all but ended.These moves are likely to mitigate many potential conflicts of interest on the part of externalauditors.

In addition, under SOX 404 auditors are charged with certifying internal control systems andidentifying material internal control weaknesses. In this context, the associations betweenFastow and the SPEs he set up at Enron would have been red-flagged as material weaknessesand been publicly disclosed much sooner. Enhanced internal controls and auditing procedures

on's peer group (from the 2001 proxy statement) includes AES Corporation; BG Group plc; Coastal Corporation;ion Resources, Inc.; Duke Energy Corporation; Dynegy Inc.; El Paso Energy Corporation; Level 3unications, Inc.; Occidental Petroleum Corporation; PG and E Corporation; and the Williams Companies, Inc.


may have also identified potential problems in Enron's trading operations. We cannot say whatactions Enron employees would have taken given these reporting requirements, but the factremains that external auditors are now subject to less pressure from losing consulting fees andthat new rules mandate enhanced disclosure for and auditor review of related-party transactions,SPEs, and internal control systems. As such, our priors are that the reduced potential for conflictof interest on the part of the external auditor, coupled with enhanced internal controlrequirements, are potentially among the most beneficial in terms of detecting and preventingfraud.

At issue is whether or not the benefits of such changes outweigh the costs. As discussed earlier,it has been suggested that reforms associated with auditor attestation of internal controls areamong the most costly to firms. For example, survey evidence suggests that during 2005 averageSOX 404 compliance costs ranged from 0.24% of revenues for smaller firms to 0.05% for largerfirms (dropping to 0.09% for smaller firms and to 0.02% for larger firms by the second year ofcompliance). However, as noted by Turner (2006) the Foreign Corrupt Practices Act of 1977mandates that companies have adequate internal controls to ensure the accuracy of their booksand records and financial reporting. From this perspective, it may well be the case that some firmswere not compliant with current regulations and thus SOX compliance cost estimates areoverstated. Moreover, SOX compliance cost estimates do not appear to be prohibitive for manyfirms By comparison, Bebchuk and Grinstein (2005) estimate that between 2001 and 2003aggregate compensation for the top 5 executives at S&P 500 firms averaged close to 10% ofearnings. This is not to suggest that current SOX requirements should be left unchanged, norshould it be viewed as an argument against attempts to improve compliance efficiency, and thusreduce compliance costs. It does, however, suggest that claims of the onerous cost burden ofcompliance and calls for a wholesale rollback of 404-related reforms should be viewed withcaution.

5. Conclusion

Multiple corporate governance mechanisms, both internal and external, failed to constrain theactions of Enron's management team. In particular, Enron's board failed to oversee managementand apparently did not understand the risks inherent in the firm's business strategy. It also appearsthat several board members and the external auditor faced potential conflicts of interest thatattenuated their role as monitors. Further, the board, analysts (credit and equity), external auditors,and federal agencies failed to identify problems at Enron or did not respond to obvious signs thatthere were problems at the firm. Finally, Enron's role as a dominant player in nascent andinefficient markets, afforded the firm's management the opportunity to manipulate prices, assetvalues, and thus the firm's financial position.

From this perspective, the in-depth focus on Enron's collapse supports the view that corporategovernance is not a matter of “one-size-fits-all.” A natural extension of this view is that, whilesome reforms will likely make it more difficult for fraud to occur, others are akin to closing thestable door after the horse has bolted. Indeed, we assert that increased board independence asprescribed by new governance standards would likely not have altered the outcome at Enron, andsuch changes are unlikely to prove beneficial in preventing Enron-like governance failures atother firms. In contrast, we contend that enhanced oversight by independent auditors, morestringent internal control systems, and the associated reporting requirements are potentially themost beneficial of recent reforms. Of course, we cannot say what actions Enron's managementwould have taken in the face of stronger internal controls and enhanced auditor independence. In


addition, we cannot say what actions management teams bent on fraudulent behavior will taketo circumvent new regulations. However, all else equal, it seems reasonable to assume thatmanagerial actions are subject to more constraints in the face of enhanced internal controls andauditor oversight.

Also at issue are the relative costs and benefits associated with recent reforms. While theevidence on this issue is mixed our analysis, in conjunction with evidence from large samplestudies, suggests that changing board structures likely imposes net costs on firms. And, whilewe contend that enhanced internal controls and audit oversight are potentially beneficial, thecosts of these changes remain the focus of ongoing research. More generally, the costs andbenefits of different governance mechanisms, their relative efficacy, and the way in whichthey interact are important issues that researchers and policy makers must continue toaddress.

Appendix A. Enron's board of directors

This table provides details of Enron's Board as of the 2001 Proxy Statement. The tablereports director name, year of appointment, number of years of board service, committeemembership (where “c” designates the committee's chairperson). The Notes columnprovides detail about each director's classification as executive, independent, or affiliated,employment history, and their stock ownership (amount and value) as reported in the 2001proxy.

Panel A. Board membership in 2001

Name
Yearappt.
Years servicedeparture)

Age(2001)

Audit
Comp Nom Exec Fin Notes
Robert A.Belfer

1983
19 65 y y • Affiliated Outside Director(business dealings) • Shares owned: 8,491,829;Value: $ 705,925,745 • Oil and gas investor. • Former President and Chairmanof Belco Petroleum Corporationa wholly owned subsidiaryof Enron (resigned 1986). • Director of EOTT Energy Corp.(the general partner of Enronsubsidiary EOTT EnergyPartners, L.P.), NAC Re Corporation,and Smith Barney World Funds Inc.
Norman P.Blake, Jr.

1993
9 59 y y • Independent Outside Director • Shares owned: 24,611;Value: $ 2,045,912 • Chairman, President and CEO ofUSF&G Corporation (since 1990)property and casualty insurer. • Former Chairman and CEO ofHeller International Corporation,subsidiary of The Fuji Bank,Ltd. of Tokyo, Japan • Director of Owens–CorningFiberglass Corporation.

Appendix A (continued )

Name Yearappt.


Age(2001)

Audit Comp Nom Exec Fin Notes


Ronnie C.Chan

1996
6 51 y y • Independent Outside Director • Shares owned: 19,199;Value: $ 1,596,013 • Chairman of Hang LungDevelopment Group, a publiclytraded Hong Kong based companyinvolved in property developmentand investment, and hoteldevelopment and management. • Founder and managerMorningside/Springfield Group,which invests in private industrialcompanies internationally. • Chairman of Springfield Bankand Trust Limited of Gibraltar. • Director on the boards ofStandard Chartered Bank PLC andJusco Stores (Hong Kong) Co., Ltd.
John H.Duncan

1985
17 73 y c • Independent Outside Director • Shares owned: 954,692;Value: $ 79,363,546 • Investor (since 1990). • Director of EOTT Energy Corp.(the general partner of EOTT EnergyPartners, L.P.— an Enron subsidiary),Texas Commerce Bank NationalAssociation and King Ranch, Inc.
Wendy L.Gramm

1993
9 56 y y • Affiliated Outside Director(Charitable/Political Contributions) • Self employed consultant oneconomic issues. • Former Chairman of the CommodityFutures Trading Commission • Director of IBP, Inc., State FarmInsurance Co. and the ChicagoMercantile Exchange.
Robert K.Jaedicke

1985
17 72 c y • Independent Outside Director • Shares owned: 57,087;Value: $ 4,745,642 • Professor (Emeritus) of Accountingat the Stanford University GraduateSchool of Business inStanford, California. • Served as Dean at the StanfordUniversity Graduate School ofBusiness from 1983 until 1990. • Director of Homestake Mining Co.,Boise Cascade Corporation, WellsFargo & Company, California WaterService Company, GenCorp, Inc.and State Farm Insurance Co.
(continued on next page)


Name Yearappt.


Age(2001)



Kenneth L.Lay

1985
17 58 y • Executive Director • Shares owned: 7,930,897;Value: $ 659,295,468 • Chairman of the Board andformer CEO of Enron. • Also served as President ofEnron (1989–1990). • Director of Eli Lilly and Company,Compaq Computer Corporation,Enron Oil & Gas Company, EOTTEnergy Corp. (the general partner ofEOTT Energy Partners, L.P.) andTrust Company of the West.
Charles A.LeMaistre

1985
17 77 c y • Affiliated Outside Director(Charitable Contributions) • Shares owned: 56,287;Value: $ 4,679,138 • President of The Universityof Texas M. D. Anderson CancerCenter in Houston, Texas.
JohnMendelsohn

1999
3 64 y y • Affiliated Outside Director(Charitable Contributions) • Shares owned: 5563;Value: $ 462,452 • President of the University ofTexas M.D. Anderson Cancer Center. • Former Chairman of the Departmentof Medicine at Memorial Sloan–Kettering Cancer Center in New York. • Director of ImClone Systems, Inc.
Jerome J.Meyer

1997
4 (Retired2000)
63
y y • Chairman and Chief ExecutiveOfficer and a director of Tektronix,Inc., an electronics manufacturer • Director of Esterline TechnologiesCorporation and AMP, Incorporated.
Paulo v. FerrazPereira

1999
3 46 y y • Independent Outside Director • Shares owned: 3195; Value: 265,600 • President and Chief OperatingOfficer of Meridional Financial Group,Managing Director of Group Bozano • Former President and ChiefExecutive Officer of the State Bankof Rio de Janeiro.
Frank Savage
1999 3 62 y y • Independent Outside Director • Shares owned: 4005;Value: $ 332,936 • Chairman of Alliance CapitalManagement International • Director of Lockheed MartinCorporation, Alliance CapitalManagement L.P., LyondellChemical Corp. and Qualcomm Corp.


Name Yearappt.


Age(2001)



Jeffrey K.Skilling

1997
5 47 y • Executive Director • Shares owned: 2091,529;Value: $ 173,868,806 • President and CEO (former COO)of Enron Corp. Former CEO andManaging Director of EnronCapital & Trade ResourcesCorp. (“ECT”).
John A.Urquhart⁎

1990
12 (Retired2000)
71
y • Former Vice Chairmanof the Board of Enron • Shares owned: 57,087;Value: $ 4,745,642 • President of John A.Urquhart Associates, a managementconsulting firm (since 1991). • Formerly Senior Vice Presidentof Industrial and Power SystemsGeneral Electric and Executive VicePresident of General Electric'sInternational and Power Systems.Sectors. (1982–1990) • Director of Aquarion Company,TECO Energy, Inc., Hubbell, Inc.and The Weir Group, PLC.
JohnWakeham

1994
8 69 y c • Affiliated Outside Director(Consulting) • Shares owned: 20,987;Value: $ 1,744,649 • Retired former U.K. Secretaryof State for Energy and Leaderof the House of Lords. • Former member of Parliament(1974 –1992) • Had once managed a large privatepractice as a chartered accountant.
Herbert S.Winokur, Jr.

1985
17 57 y c • Affiliated Outside Director(Business Dealings) • Shares owned: 119,755;Value:$ 9,955,233 • President of Winokur & Associates,Inc., an investment and managementservices firm, and Managing GeneralPartner of Capricorn Investors,L.P. and Capricorn Investors II,L.P., private investment partnershipsconcentrating on investments inrestructure situations. • Former Senior ExecutiveVice President and Director ofPenn Central Corporation. • Director of NAC Re Corporation,NHP, Inc. and DynCorp.


Appendix B. Enron's board committee structure in 2000

Committee name
Key mandate Stated activities Members
Audit andcompliance

Oversee Enron's financial reportingprocess and internal controls

Met 5 times
Chan Review: Gramm • Scope and results of the audits Jaedicke • Notice and application of
accounting principles
Mendelsohn
• Effectiveness of internal controls
PereiraWakeham
Compensation andmanagementdevelopment

Establish compensation strategy andensure effective compensation ofsenior management.

Met 10 times
Blake • Monitor and approved awards
earned under Enron's executivecompensation program

Duncan

• Monitor employee benefitprograms

Jaedicke

• Review matters relating tomanagement development andmanagement succession

LeMaistreSavage

Nominating andcorporategovernance

Oversight for making or evaluatingrecommendations regarding

Met 3 times
Mendelsohn
• Board size
Meyer • Recruiting and recommending
board candidates
Gramm
• Monitoring Corporate GovernanceGuidelines for revision and compliance

Wakeham

• Monitoring Enron's social andenvironmental performance• Performing periodic evaluation of

director independence and performance.
Executive All of the powers of the Board
of Directors, except where restricted byEnron's bylaws or by applicable law.

Met 7 times
BelferDuncanLayLeMaistreSkillingWinokur
Finance
Monitor Enron's finance activities. Met 5 times Belfer Review management's financialplans and proposals including:
Blake

• Equity and debt offerings
Chan, • Changes in stock dividends
and the equity repurchase program
Meyer
• Changes in the riskmanagement policy

Pereira

• The transaction approval processand the policy for approval of guarantees

Savage

• Letters of credit
Urquhart • Letters of indemnity Winokur. • Other support arrangements.
Recommend actions with regard theretoto the full board

Source: Enron proxy materials.


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