Did HR fuel the demise of Enron?

Jane Lewis examines the risk-taking, entrepreneurial work culture of the
energy giant and shows how HR played a leading role

Few companies have risen so quickly then burned down with such intensity as
Enron. The collapse of the Texan energy giant, once hailed as a model for all
21st century companies, has shaken America to its roots – some commentators
have even claimed its long-term impact, at least in terms of how the country
views itself, may be stronger than that of 11 September.

This is not just because Enron, thought to owe a staggering $55bn, is the
largest corporate bankruptcy in history; nor because so many thousands of its
employees now face the misery of personal financial ruin. The real point about
Enron is that it is a wound the US inflicted on itself – and there is no
telling where else the gangrene may be lurking. If such a seemingly invincible
powerhouse can be exposed as little more than a house of cards, who will be
next? As one corporate anatomist has remarked, much of the US population is now
suffering a mass epidemic of "Enronitis": a nervous condition brought
on by implausible company accounts.

But as Enron’s leading managers brace themselves for a prolonged circus of
Congressional hearings and investigations, it is increasingly clear that the
cause of the company’s downfall goes much deeper than improper accounting or
alleged corruption at the top. The real problem that hastened Enron’s demise,
claim the many management experts now raking over its ashes, is the very same
risk-taking, entrepreneurial culture that first propelled its high-octane
growth. And if you believe that, says Martin Goodman, a consultant in Watson
Wyatt’s strategic change practice, it is but a short step to concluding that
"ultimately the responsibility must lie with HR".

Who else, he argues, was responsible for framing and policing Enron’s
corporate values, its recruitment policy, and the cut-throat performance
processes that did so much to shape a culture in which the survival of the
fittest, by any means necessary, came to be the paramount consideration?

But, as Goodman is the first to point out, Enron’s HR department, while
clearly responsible, should not bear the full burden of blame. Faced with a
management board that not only condoned the subversion of accepted corporate
ethics, but which often appeared actively to encourage malpractice, the
department’s hands were tied. "You cannot expect people to act in an
ethical manner, if those at the top of the business are not doing so," he
says.

What Enron represents, therefore, is the inherent conflict in the role of
HR: a department responsible for corporate ethics, yet seemingly powerless to
enforce them at the highest level. Above all, the scandal highlights one of the
most fundamental questions that every HR practitioner should examine. Is the
department merely an agent of senior management, or does it have a
responsibility to act on behalf of the interests of the workforce as a whole?
In Enron’s case, as we will see, the path taken by HR was clear-cut. Which way would
you go?

Culture and ethics

During Enron’s glory period (circa 1995-August 2000, when shares hit a peak
of $90), it was often remarked that this was a company in love with itself. CEO
Kenneth Lay was only half joking when he suggested a fitting tribute to the
‘coolest’ corporation on the planet would be to wrap a giant pair of shades
around its Houston HQ.

Enron employees were easily identifiable by their swagger. The rewards for
those who performed well were high: bonus day at Enron became known in the city
as car day because of the lines of shiny new sports cars cluttering up the
streets; its most opulent suburb, River Oaks, looked in danger of becoming an
Enron dormitory town. Anyone working for the company, in whatever capacity, was
considered a person with prospects.

If the city of Houston was impressed by Enron’s freewheeling, sassy culture
it was nothing to the praise lavished by the armies of management experts who
flocked to Texas. As the new economy model took off, Enron seemed to be doing everything
by the book – indeed, from an HR perspective, the company was virtually writing
the book. Enron, said management guru Gary Hamel, had achieved the holy grail
of modern people management: it encouraged a "hotbed of entrepreneurial
activity" in which staff were encouraged to take risks and become career
builders.

Retaining talent was never an issue at Enron because the HR department
modelled itself as a kind of internal employment agency and kept an up-to-date
internal database of CVs that encouraged managers to recruit internally.
"If you make it easy for people to move inside the company, they are less
likely to look outside," said vice-president of HR, Cindy Olson last year.
It was not unusual for high-flyers to change jobs two or three times in as many
years. The point, she said, was to enable entrepreneurs to "build
something of their own within the company".

"Everyone knew," says another executive, that if [CEO Jeff
Skilling] liked you "the leash was very long". But with hindsight,
the downside of this approach is obvious: inexperienced young MBAs were
routinely handed extraordinary authority to make multi-million dollar decisions
without higher approval. And because they tended to move between businesses,
rather than within them, experience was not made to count. "If you move
young people fast in senior-level positions without industry experience, and
then allow them to make large trading decisions, that is a risky
strategy," says Jay Conger, a management professor at London Business
School.

In many ways the culture at Enron could not have been more straightforward:
make your numbers or else – and executives were particularly highly rewarded
for originating money-making ideas. Women did especially well in this
environment: two of Enron’s most profitable trading centres – its weather
derivatives business and online trading division – were begun by ambitious
young female executives who were noisily proclaimed corporate heroines.

The counter-balance to this risk-centric culture was supposed to be a strong
code of corporate ethics, written up in a 61-page booklet and centring on
Enron’s guiding principles of RICE (Respect, Integrity, Communication,
Excellence). These were prominently displayed on wall-posters, key rings, mouse
mats and T-shirts and all employees had to sign a certificate of compliance. In
practice, however, the unrelenting emphasis on profit growth and individual
initiative tipped the culture from one that awarded aggressive strategy to one
that increasingly relied on unethical corner-cutting. The corporate ethics were
in place, but they were rarely policed and frequently ignored if they stood in
the way of the more ‘important’ business.

The lead for this came from the top. In an interview two years ago, Skilling
recalled his impatience with the mundane business of approving expenses claims.
"You’ve got to be kidding me," he said. Here was a new world of
opportunities to be tapped "and I’m going to sit here and go through an
expense statement line-item by line-item?" Henceforth, he decreed, expense
reports would be routinely approved without review.

The lesson to be gleaned from this is clear, says Goodman at Watson Wyatt:
it is no use having a corporate ethics policy "unless you have processes
in place that ensure these codes are enforced." If you want to prevent
people taking "expeditious routes" you need to "spell out the
penalties", even to those at the top.

The decline of corporate ethics at Enron was no sudden event, but rather the
"gradual erosion of standards". This made it very easy to turn a
blind eye to malpractice because, eventually, breaking the rules became the
norm. As one employee points out: "Towards the end everyone knew the
company was a house of cards. But people thought if they were getting away with
it now, they would get away with it forever."

Performance management and incentives

One of Skilling’s undoubted achievements at Enron was to put the notion of
intellectual capital firmly on the map. His belief that the main engine driving
the company’s growth was talent meant he was prepared to go to almost any ends
to nurture his growing pool of thrusting young MBAs – and discard anyone who
failed to make the grade.

Skilling claimed that Enron’s ruthless system of performance evaluation –
swiftly christened ‘rank and yank’ – was pivotal to forging a new strategy and
culture "It is the glue that holds the company together," he said. At
a senior level, he presided over a peer-review process imported from management
consultants McKinsey and Co. This was, in effect, a star chamber, consisting of
some 20 executives who regularly sat in judgement over every vice-president in
the company, ranking them numerically. The stakes were high: the top 5 per cent
of ‘superior’ managers were typically rewarded with bonuses some 66 per cent
higher than the next grade down. The process was also laborious, because the
committee’s decision had to be unanimous.

Skilling claimed the system helped eliminate a ‘yes man’ culture because
"it was impossible to kiss 20 asses". In practice, the reverse became
true. The best way to get a good rating, employees agreed, was to not
"object to anything". Further down the company chain, rank and yank
became even more cut-throat. Skilling decreed that every six months the bottom
10 per cent of the workforce was to be eliminated regardless of individual
performance. The upshot was a regular frenzy as employees jostled to make their
numbers by hook or by crook.

Although one of the criteria on which Enron staffers were supposed to be
judged was team-work, in practice this became the first casualty of a
dog-eat-dog system in which an individual’s ability to ‘add value’ to the
bottom line was paramount. Far from operating as a collective entity, says one
commentator, Enron began to resemble "a collection of mercenaries".
It became common practice, when working on a project, to bring in as few people
as possible "so you wouldn’t have to split your bonus".

This survival of the fittest system, while undoubtedly ruthless, may have
had a certain efficacy while times were good. But as the new economy soured
there was much less success to go around, and the process took on a new and
highly corrosive viciousness. As employee denounced employee in a desperate
attempt to survive selection for the chop, the system became more political and
more crony-based. It also encouraged desperate pragmatism. Some managers lied,
altering the records of colleagues they wanted removed, others made use of
Enron’s much-vaunted whistle-blowing system, to submit negative reviews against
people they were competing against for rankings.

One of the first casualties of this system was corporate transparency, and a
sinister use of euphemism crept into the corporate vocabulary: employees
scheduled for "redeployment" were told they had 45 days to find a new
job within the company. In reality there were no such jobs available: the HR
department was instructed to deter managers from other divisions from hiring
them.

In common with many of its new economy peers, Enron made a point of
rewarding successful executives with stock options. The logic was unassailable:
by linking performance with shareholder value, executives aligned their actions
with the wider interests of company stakeholders. "If you have incentives
that aren’t aligned, the risk is that executives operate in a manner that
doesn’t give the best return to shareholders," says Duncan Brown,
principal of Towers Perrin.

But at Enron, where the vast bulk of executive remuneration comprised stock
options – senior chiefs cashed in some $1bn in stock in the years immediately
preceding the company’s crash – the environment was ripe for abuse. The
personal interest that senior managers had in keeping the share-price high at
any cost encouraged corruption, greed and financial impropriety and discouraged
transparency. Far from promoting the best behaviour, the incentive system at
Enron frequently spawned the worst.

What lessons can be drawn from all this? It all depends, says Brown, on
whether the investigation into Enron shows that an abuse of the system was to
blame, rather than the system itself. But what happened at Enron should spell a
clear warning to HR of the dangers of monitoring and rewarding performance by
numbers alone – there is now widespread recognition that a more qualitative,
well-rounded approach is needed. The benefits of using a balanced scorecard
approach are plain.

Finally, although executive bonuses in the UK have yet to reach the
exorbitant level of those routinely doled out in the US, HR needs to start
asking tough questions now about whether executive pay rises can actually be
justified objectively.

Pensions

Progressive HR management thinkers have long been vocal advocates of
employee company ownership because of the huge benefits it offers in terms of
employee buy-in, commitment and loyalty. But the miserable fate of the many
thousands of Enron employees who lost everything when their company stock
collapsed exposes the inherent danger of putting too many eggs in one basket.

Like many US companies, Enron had begun the process of shifting
responsibility for its employees’ retirement back on to the individual via the
introduction of pension plans known as 401(k), which offered a diverse array of
investments. But thousands of employees, still mired in their ‘I’ll be taken
care of’ mentality, ignored every alternative investment to plough 100 per cent
of their pension plans into Enron stock, with disastrous results.

In the UK, of course, the system is very different. But the already
pronounced shift from defined purchase plans to Money Purchase Plans and Share
Incentive Plans means employees are now more exposed to risk. The main lesson
we must all learn from Enron is the importance of diversification. If your
company matches your retirement savings with company shares, it makes sense not
to invest in any additional stock, however tempting.

It is commonly agreed, however, that the real scandal revealed by the
collapse of Enron was how the company’s pension scheme was managed. Far from
acting in the interests of plan participants, the fund’s trustees – including
HR vice-president Cindy Olson – consistently put the interests of the company
first. This was most apparent in the decision to ban employees from selling
their stock in the weeks before the company filed for bankruptcy.

In the US, there is an active campaign to eliminate such abuse by insisting
that companies which have traditionally selected their own trustees must now be
required to appoint truly independent individuals. While the regulatory
environment in the UK post the Robert Maxwell affair is undoubtedly much
tighter than its US equivalent, it is clear that we can still draw some useful
guidance from what happened at Enron, in particular, the suggestion that
employees should have a greater input in selecting trustees.

Whistleblowing

Enron encouraged whistleblowers: its policy was to allow employees to
complain anonymously about their co-workers. So why wasn’t the whistle blown
earlier about what we now know to be widespread malpractice in its accounting
and financial departments?

In fact, financial executive Sherron Watkins was not the first voice to
raise concerns within the company. Two years ago Enron’s treasurer, Jeffery
McMahon questioned the propriety of some of CFO Andrew Fastow’s ‘partnerships’
– and found himself swiftly ‘promoted’ out of the action to a post in London.
It now emerges that Enron’s corporate lawyer, Jordan Mintz, also questioned the
partnerships and sought outside legal advice.

The answer, it is clear, lies in the autocratic system of hierarchy that
(for all its boasts to the contrary) continued to prevail at Enron. Since
whistleblowers appealing to the highest level of the company were discouraged,
ignored and ultimately punished, what hope was there of being listened to
further down the ranks? In many respects the climate prevailing at Enron was no
different from that of most other companies: while catered for on paper,
whistleblowers run a real risk of becoming corporate pariahs and damaging their
careers for good. Frequently tarred as ‘disgruntled’, they continue to be seen
as a risky hire even if they leave a company.

But it is not just fear of reprisal that prevents people speaking out. At
Enron, as we have seen, the culture itself discouraged it. People became so
identified with the organisation and its practices that they stopped seeing
that something was wrong.

As Goodman points out, it is the responsibility of HR to put in place a
formal system – independent of senior managers – in which complaints and doubts
can be freely expressed without fear. The failure of Enron’s HR department to
achieve this was the main reason why malpractice was allowed to flourish for so
long. Employees knew the system was crooked, but felt powerless to change it.
They were right. All Enron’s whistleblowers behaved in an exemplarily fashion:
they did not steal documents or go to the newspapers, they took their concerns
to the top guy. And nothing happened.

Could the Enron scandal signal a new movement in corporate challengers? One
US hot-line operator notes that calls to its centres have risen exponentially
since the scandal broke. Cynics may argue that this is transitory – deep down
most employees know the consequences for whistleblowers are usually grim. But
what Enron has shown us above all is that ignoring misconduct can have truly
terrible consequences for everyone. The most optimistic outcome of its fall
from grace is that it may issue in a new era of employee empowerment.

The players

Kenneth Lay
Founder and CEO

Lay founded Enron in 1985 following the merger of two natural
gas pipeline companies. One of the first to grasp the opportunities on offer
from the deregulation of the US energy industry, he presided over the company’s
transformation from a parochial utility to the self-styled ‘world’s leading
company’. Famously chummy with George W Bush, who habitually referred to him as
‘Kenny boy’, by the mid-90s Lay was essentially a hands-off CEO – often absent,
smoothing Enron’s path with politicians and investors. Described by one
commentator as a chief who seemed "to benignly float on the surface of
Enron’s shark-tank", he was recently painted in congressional hearings as
a well-meaning boss who did not fully grasp his company’s condition.
Whistle-blower, Sherron Watkins, who was Enron’s financial executive, claimed
Lay had been ‘duped’ by his top lieutenants. On the advice of lawyers, Lay has
taken the Fifth Amendment and maintains his silence.

Jeffery Skilling
Former CEO

Formerly a management consultant with Mckinsey & Co,
Skilling joined Enron in 1990 and quickly made it a laboratory for progressive
management thinking. Skilling, who became chief operating officer in 1995,
bought wholesale into the idea of establishing an ‘asset-light’ company whose
prime expertise was market-making. He was the chief architect of Enron’s
emergence as a new economy giant. One of the few corporate leaders to have
engineered the successful transition from ‘bricks to clicks’, he was lauded as
a management visionary: under his tenure Enron was consistently voted America’s
most innovative company. Renowned for his obsession with intellectual capital,
Skilling – whose abrasive style made him widely feared within Enron – was also
the main shaper of Enron’s ruthless performance management strategy. More than
any other individual, he stamped his own personality on the firm. His shock
resignation ‘for personal reasons’ in August last year, six months after taking
over from Lay as CEO, was seen by many as the first sign that the edifice was
crumbling.

Andrew Fastow
Chief financial officer

Fastow, a former banker, was hired by Skilling as a youthful
financial money wizard, primarily for his ability to think out of the box.
"We didn’t want someone stuck in the past," said Skilling. Fastow,
who was praised by CFO Magazine for his ‘unique financing techniques’
masterminded hundreds of off-the-books operations that paved the way for
Enron’s explosive growth and enabled it to report huge profits, while quietly
retaining control of its loss-making hard assets. He is estimated to have made
a personal fortune of $30m from these ‘partnerships’. Having resigned in
October, Fastow is at the forefront of the federal investigation into Enron. If
convicted, he is considered likely to testify against his former colleagues.

Sherron Watkins
Financial executive

A financial executive who worked with Andrew Fastow last summer, Watkins is now
famous as Enron’s chief whistle-blower. Two days after Skilling’s resignation
in August last year, she sent a memo to Kenneth Lay stating she was ‘incredibly
nervous’ the company would soon ‘implode’ in a wave of accounting scandals.
When this warning was ignored, she alerted him again in person the following
month. A key witness in the federal investigation, Watkins is still employed at
Enron.

Cindy Olson
Vice-president, HR

Olson, who became head of Enron’s HR department last year, was a newcomer to
the profession. Having spent 15 years as an accountant, she worked for three
years in community relations before assuming the top HR job. Although privy to
Sherron Watkins’ August 2001 memo, she took no action, in her capacity as an
‘independent’ fiduciary and trustee of Enron’s 401(k) pension plan, to alert
fellow employees. She later told a congressional hearing she believed Watkins’
assessment to be untrue. Even more controversially, she agreed to a moratorium
last October, which banned employees from selling the Enron stock in their
plans while it still retained some value. "We didn’t have a crystal
ball," she said. "We didn’t know where the stock was going to
go." Nonetheless, on the advice of her own financial advisor, she admitted
to cashing in some $6.5m in Enron stock, most of it in the year before the
company’s collapse.

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