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C. Gopinath

EVERY time you turn a stone, another worm creeps out. That seems to be the story of the Enron debacle. Not a day goes by without a new expose of wrong doing in the company that one begins to wonder if there is anything in our systems and structure of an enterprise that can prevent such a catastrophe.

A lot of attention in this regard has been placed on the accounting and auditing issues. The auditors, Arthur Andersen, on whom the general public relied on for accurate information clearly failed in their job. There has begun a debate on the need to revise rules and regulations so that the auditors are held more accountable.

Another group that has let the public down is the analysts who work for stock brokerage houses. Even when the problems of Enron were beginning to be highlighted by newspapers, out of 17 analysts who follow Enron, 16 had `strong buy' or `buy' recommendations and one had `hold.' These are so-called experts who are knowledgeable about the firm and the industry and they failed in their duty.

Both auditors and analysts are external to the company. One group internal to the company on whom sufficient attention has not been focussed is the Board of Directors. Management theory tells us that the board performs three roles: Control (overseeing the functioning of the corporation and its management), service (being a link between the corporation and its external stakeholders), and strategy (providing a direction for the enterprise into the future). Of these three roles, control is the most basic and traditional role that provides the raison d'etre for a board.

The widely dispersed nature of the ownership (stockholders) of a joint stock enterprise requires the owners to repose their authority on the Board to oversee the corporation and ensure that the owners' interests are protected. This is where the Board failed.

In a feeble effort at damage control, the board constituted a Special Investigation Committee (SIC) of three directors that released its report on 1 February. The first mea culpa has emerged in their report where they say, `Oversight of the related- party transactions by Enron's Board of Directors and management failed for many reasons.'

As compensation, each company director receives an annual fee of $50,000 (Rs 24 lakh). Apart from that, they also receive annual awards of stock and stock options. In 2000, this package for each director was worth $836,517 (Rs 4 crore). Perhaps as an act of contrition for a job badly done, six of the directors have announced their intention to resign.

Governance failures

Getting down to the details of governance, we can focus on five issues.

Chairman and CEO: It is considered good practice to separate the roles of the Chairman of the Board and that of the CEO. The Chairman is head of the Board and the CEO heads the management. If the same individual occupies both the positions, there is too much concentration of power, and the possibility of the board supervising the management gets diluted.

In Enron, Mr Kenneth Lay was both the Chairman and CEO. For a brief while the two positions were separated when Mr Jeff Skilling functioned as CEO, and when he resigned in August 2001, Mr Lay again took on both roles. His recent claim that he did not know too much of the details of the accounting falsification that was going on is, at best, disingenuous.

Audit Committee: Boards work through sub-committees and the audit committee is one of the most important. It not only oversees the work of the auditors but is also expected to independently inquire into the workings of the organisation and bring lapses to the attention of the full board. The Enron audit committee failed in this regard.

In the words of the Special Investigating Committee: "The Board assigned the Audit and Compliance Committee an expanded duty to review the transactions, but the Committee carried out the reviews only in a cursory way." The Chair of the Audit Committee since 1985 was Mr Robert Jaedicke, a former accounting professor and Dean of Stanford University Business School. (Normally, it is good for this position to rotate every three or four years.) He was there because audit committee's are required to have as its members, persons who are financially literate.

Mr Jaedicke, in addition to not using his expertise to perform his role as Chair of the committee, seconded the motion in the board to suspend the `Code of Ethics' of the company in order to allow an employee to set up a special partnership. (Audit committees normally oversee compliance of such a code.) Setting up that entity amounted to a conflict of interest and was specifically prohibited by the company code.

Mr Jack Welch, the legendary former Chairman of GE, commented recently in a television programme that suspension of a code of ethics is unheard of. I would go a step further and say that it is the corporate equivalent of the `insanity defense' that we see in criminal cases. Apart from Mr Jaedicke, the audit committee comprised of five persons, three of whom reside outside the country.

An audit committee is almost a `working' committee and needs to meet more frequently than a full board. Having non-residents on the committee hampered its functioning. One of the members, Mr Ronnie Chan, missed 75 per cent of the meetings in 2001.

Independence and conflicts of interest: Good governance requires that outside directors maintain their independence and do not benefit from their board membership other than remuneration. Otherwise, it can create conflicts of interest. By having a majority of outside directors on its Board, Enron followed a good practice. But in the way they behaved, they compromised their independence. Six of the 14 outside directors suffered from serious conflicts of interest:

(a) Mr Robert A. Belfer, Chairman of Belfer Management, bought a stake in an energy company from an Enron partnership, thereby providing funds to start another.

(b) Ms Wendy Gramm (spouse of a Republican Senator) was formerly Chairman of the Commodities Futures Trading Commission of the federal government. Enron's trading in energy derivatives was exempt from regulation by the CFTC.

Shortly after that decision, she quit the commission and joined Enron's board. She is presently Director of Regulatory Studies Program at George Mason University. Enron has donated $50,000 (Rs 24 lakh) to that centre.

(c) Mr John Mendelsohn is the President of the MD Cancer Centre at the University of Texas. Enron and related entities have donated $1.5 million (Rs 7.2 crore) to the Centre since 1985.

(d) Mr William Powers, who also headed the Special Investigation Committee is the Dean of the University of Texas Law School. Enron has given $3 million (Rs 14.4 crore) to the University since he became Dean. The law firm that works for Enron, Vinson and Elkins, has endowed a chair at the Law School.

(e) Lord John Wakeham, a former Minister for Energy in the UK was paid $72,000 (Rs 34.5 lakh) for services as a consultant to Enron's European unit. When he was minister, he gave consent to Enron for building the country's largest power plant at Teeside.

(f) Mr Herbet S. Winokur is also a Director of the Natco Group which is a supplier to Enron and its subsidiaries. He is also Chairman of the Board's Finance Committee which recommended that the board suspend the company's ethics code. The involvement of these Directors resulting in other benefits compromised their independence making one wonder whether they acted in the best interest of Enron.

Flow of information: A board needs to be provided with important information in a timely manner to enable it to perform its roles. A governance guideline of General Motors, for instance, specifically allows directors to contact individuals in the management if they feel the need to know more about operations than what they are being told.

In the Enron situation, the directors are pleading ignorance of the murky deals as a way of excusing themselves of the liability.

The Special Investigating Committee report says: "The board was denied important information that might have led it to action, but the Board also did not fully appreciate the significance of some of the specific information that came before it.' Here is another mea culpa. Moreover, if they did not have sufficient information, they should have gone seeking it. Reports suggest that Enron operated about 3,500 Special Purpose Entities, that is, partnerships that shifted debt and losses off Enron's balance-sheet. If the directors did not understand what was being reported to them, it was their job to educate themselves more about it by asking the right questions and getting more information. This they failed to do.

Too many directorships: Being a director of a company takes time and effort. Although a board might meet only four or five times a year, the director needs to have the time to read and reflect over all the material provided and make informed decisions. Good governance, therefore, suggests that an individual sitting on too many boards looks upon it only as a sinecure for he or she will not have the time to do a good job. Mr Raymond Troubh, one of the directors, is a Director of 11 public companies.

Many successful companies suffer from one or more of the faults described above. When the company performance is satisfactory, we tend to overlook these drawbacks. In Enron's case too many of their faults came together at the same time to cause the company to implode.

The corporate governance model being followed was too weak to prevent the problems from escalating. And this should be a lesson for all of us. Next time we receive a proxy statement from a company in which we hold shares, we must read it carefully.

If we are unhappy with the directors being proposed for election, we must voice our complaint to the company and vote against the slate being offered. If we are suspicious of the company's governance structure, we should report to the stock exchange where the company's shares are traded. As a final resort, we can exit the situation by disposing the stock.

(The author is a professor of international business and strategic management at Suffolk University, Boston, US. His Internet address is cgopinat@Suffolk.edu)

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