A remuneration system that encourages C-suite
executives to inflate a company’s share price was the root cause of
Enron and the subsequent focus on accounting and auditing has done
little to combat fraud, according to Enron whistleblower Sherron
Watkins.
Watkins, who is currently a speaker on
leadership and ethics, said that Enron, Worldcom and many other
major cases of US fraud are essentially corporate governance
failures. Accounting tricks are only tools used by corrupt
executives to carry out white collar crime.
Watkins was Enron’s former vice president of
corporate development when she first raised concerns about false
accounting to chief executive Ken Lay in 2001. She was speaking to
International Accounting Bulletin 10 years after the
former energy giant Enron filed for bankruptcy.
Enron was one of the largest frauds in history
and considered a huge audit failure that struck a nail into the
operations of audit firm Arthur Andersen, the fifth largest
firm at the time. Andersen was subsequently banned from auditing
and later dissolved.
A spate of large corporate frauds following
Enron led to the introduction of the Sarbanes-Oxley Act, which
overhauled the audit oversight system and introduced rigorous
internal control requirements for listed companies.
But Watkins believes the focus on the
accounting profession does not address the underlying problems that
led to Enron.
“If we keep looking at it as an accounting
problem we will never fix it,” Watkins, a former accountant at
Arthur Andersen, warned. “I think [accounting] is just a tool that
is making then prop up their earnings.”
Watkins said accounting rules are so complex
that “they can be twisted by anyone that wants to twist them” and
the Sarbanes-Oxley that was introduced as a response to Enron “only
codified best practices that Enron and other companies were already
following”.
At the heart of the problem is a remuneration
system that rewards company executives for taking risks to inflate
their company’s stock value.
In 1993, a law was passed in the US to cap
executive cash pay at $1m. Watkins said this had an “unintended
consequence of really blowing up the use of stock options”.
“Many chief executives’ of the top companies
were making $3m or $5m a year so that meant their companies lowered
their pay to $1m and then they had to make up the difference and
they typically made up the difference with stock options,” she
explained.
“All the sudden companies and their executives
were really incentivised to gamble the company and take on greater
risk, to really grow that stock as it benefited them directly,”
Watkins said.
In the wake of Enron, US Congress looked at
how C-suite executives exercised stock options but reforms were
taken off the agenda after backlash from the businesses
community.
Instead, Enron was considered an ‘accounting’
problem rather than one that also tackled remuneration and
corporate governance structures.
“There is not a corporate board in America
that truly governs,” she said. “I think it’s a misnomer that we
have corporate governance because the chairman of the board who
really runs the board is usually also the chief executive or the
retired chief executive, which means it doesn’t matter how many
independent people you have on the board it’s not an independent
board and it’s not doing its job.”
