There are various conflict of interest in the case of Enron and Arthur Andersen scandal, and they came from various fraudulent ways. Giroux (2008) listed some of them: the huge executive compensation incentive packages maintained by manipulation, self-dealing hidden partnerships and agreements, accommodating the auditor in Arthur Andersen as well as the law firm Vinson and Elkins, investment bankers who create non-existent financial deals for big fees, and many more.

Many companies compensate their top management partly with grants of stock or stock options, in which they have the right to buy the company’s stock at a set price for a certain period. This compensation approach is often used to align executives’ interests with the shareholders’ interests.

However, this approach has also been criticized, especially if it pushed the executives to mainly focus on their compensation pay even by doing unethical accounting practices to increase the stock price. This is what happened in Enron. The top management’s interest became too fixated on their compensation that they turned to fraudulent financial reports (Lawrence & Weber, 2020). They enriched themselves while harming thousands of employees and shareholders.

The auditors in Arthur Andersen are in the thick of the event, either by conspiring or lax oversight. But then they also received accommodations that put them in another conflict of interest. Their laxity, even if it was not driven by evil deeds, was due to their lack of ethical behavior. They enabled Enron to manipulate their financial report, making the company seems successful, increasing its stock price, and the top management’s performance payment; while in reality, they are in severe loss with huge debts.

Another issue is the self-dealing third-party partnership to create artificial earnings while enriching the top management. It is one of the most common forms of conflict of interest. For example, Andrew Fastow, former Chief Financial Officer (CFO), was a partial owner of two of the most important Enron partnerships: LJM Cayman LP and LJM2 Co-Investment LP. Michael Kopper, former managing director, managed Enron’s third partnership, Chewco Investments LP (Sims & Brinkmann, 2003). They enriched themselves using the company’s money, while also creating artificial earnings from the partnership that looks good on Enron’s financial report.

To Avoid Such Conflict of Interest in the Case of Enron and Arthur Andersen

It is difficult to fix an ethical issue, such as a conflict of interest, when the issue comes from the top management. They are the ones responsible to create an ethical corporate culture. Ironically, they had developed a comprehensive ethics policy and the corporate values were “respect, integrity, communication and excellence” (Mees, 2020). The formalized corporate values wouldn’t be successfully translated to an ethical corporate climate when the executives failed to show any moral leadership.

One of the most common ways to avoid this is to have strong corporate governance, especially the committees of the board. Strong and ethical committees will perform their most important roles: to review the company’s financial reports, recommends the appointment of outside auditors (accountants), and oversees the integrity of internal financial controls. This is why the law required the committee to be composed entirely of outside directors and to be literate financially (Lawrence & Weber, 2020).

The Enron case is an example of a corporate governance scandal, which had not just been because of a failure of moral leadership, but also a lack of financial prudence (Mees, 2020).

Utilizing the Laws to Mitigate the Issue

There must be laws that obligate the executives and auditor to vouch for the accuracy of the financial report. The law must be followed with severe consequences for those who violate it. It must also ensure that firms maintain high ethical standards.

A law such as the Sarbanes-Oxley Act of 2002 (SOX) is a good sign, although evaluation and refinement of the law seemed also necessary. The law addressed the ethical standards of firms in their operation. For instance, SOX requires a clawback rule, where executives have to pay back bonuses based on earnings that are later proved fraudulent in the financial reports. SOX also established strict rules for auditing firms.

Indeed, SOX law has not totally eliminated fraudulent financial report cases to appear, however, it can be a strong law that pushes companies to enhance their corporate culture. With a strong law enforcement, the scandal of Enron and Arthur Andersen may be avoided.

Other than legal pressures, companies can encourage ethical culture to be formed in the company. However, if the top management failed in showing ethical leadership, this would be difficult. The committees of the board should be strengthened in terms of financial literacy to perform their audit role and put the top management under scrutiny.

References

Giroux, G. (2008). What Went Wrong? Accounting Fraud and Lessons from the Recent Scandals. In Social Research (4th ed., Vol. 75, pp. 1205–1238). The John Hopkins University Press. https://www.jstor.org/stable/40972113

Lawrence, A., & Weber, J. (2020). Business and Society: Stakeholders, Ethics, Public Policy (16th ed.). McGraw Hill.

Mees, B. (2020). The Rise of Business Ethics. Routledge.

Sims, R. R., & Brinkmann, J. (2003). Enron Ethics (Or: Culture Matters More than Codes). Journal of Business Ethics, 45(3), 243–256. https://www.jstor.org/stable/25075069

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