Wednesday, July 05, 2006
King Lear?
This will not be a defense of Lay. In my estimation, he was at least in part responsible for some very important bad things at Enron which damaged the company and all of its constituents. Still, I don't think the collapse of Enron has been well reported or chronicled. And we have taken some incorrect lessons from the company's plight.
Lay was the founder, CEO and finally just Chairman of the company. It was an energy company, replete with hard assets and commodity trading capability. In the name of growth, Lay transformed that fairly stodgy, dull business into a financially leveraged, global trading behemoth with burgeoning telecommunications assets. He sold off hard pipeline assets to help finance the growth. He and his CEO successor Jeff Skilling were lauded in the financial markets and the business press for this transformation, heralded as a "most admired Company." The stock, as most telecom bubble stocks, took off; and then collapsed.
What happened? What did Lay and Skilling do wrong? First and foremost, they made bad business decisions, investing scarce equity capital into economically disastrous projects. When that equity was destroyed because their asset value declined, the levered company was bankrupt. As confidence in the company melted away, Enron's counterparties staged a "run on the bank," and Enron could no longer function. It could only be liquidated to pay off creditors, with nothing left over for equity holders.
So their first sin was bad business judgment. It was driven by the fad of the moment -- the telecom and internet bubble -- willingly, eagerly financed by the credit markets, supported by the business media, validated by a skyrocketing stock and unanimously approved by a fawning Board of Directors.
Their second sin is more conjecture on my part. At some point, they knew the jig was up. The players may not have woken up to it together. But Fastow the CFO understood and started covering up the core balance sheet problem he had. And Skilling woke up too - that's why he resigned not long after being handed the CEO reins and started selling stock. Suddenly he understood he had been handed the booby prize. They had a joint interest in hiding the ball and playing for time, hoping they might get bailed out by a recovering market -- which never came.
What fascinates me about Lay is that he had retired and handed the top job to Skilling. If he understood the pending disaster, why retake the job as CEO to try to save the sinking ship? He took it - a terribly foolish idea - and now he is dead at 64. Did he know the extent of the corruption at Enron? Did he willingly look the other way and suspend disbelief?
I don't know. I suspect he was an inveterate entrepreneur - a true believer. An optimist. He almost certainly cut corners to support getting to tomorrow. He was probably not particularly financially or legally sophisticated. He probably assumed that if the lawyers and accountants blessed what they were doing, and the lenders lent to it and the stock went up, it was all okay. A game. A confidence game. He likely did not ask demanding questions, because he didn't want to know the answers. Did he know Fastow stole money from Enron via the formation of these partnerships? Not clear to me. But I can see the entrepreneur rationalizing paying Fastow via the partnerships "off the books" since he was a relative latecomer and thus owned less stock than if he had been there longer. Fastow was the financial and legal architect who allowed the successful execution of the Enron business plan, so Lay would have wanted to reward him.
Skilling was the brilliant McKinsey consultant-becomes-operator who would pull off the feat of transforming Enron. It seemingly worked. Lay had built a spectacular company with top shelf talent. They had a joint interest in sustaining the game, whether or not they even discussed it.
It was all a confidence game which fell apart. Lay was responsible. The entire management was responsible. And so was the Board of Directors. I bet every key decision, acquisition or financing was brought to the board. I vaguely recall they suspended certain ethics rules to allow the partnership payments to Fastow. Why? Because they thought their management was winning. And how do you tell Michael Jordan to stop shooting the basketball? How does a Board of Directors say NO to the management of a company voted most admired, their stock flying, validating them as geniuses every day? With the benefit of hindsight, it seems so easy, but I promise you clarity of foresight is a rare commodity. To exercise it in combination with the character and persona necessary to restrain management against their entrepreneurial impulses when they've apparently been right so often is incredibly difficult, and requires a willingness to act as a minority, often as a minority of one.
For those who long for the CEO job, there are high stakes, high rewards and high costs. The buck has now stopped with Ken Lay. Fit for Shakespeare, isn't it?
More from TigerHawk: A family member of mine knew Lay years ago, when Enron was just a gas pipeline. His sense was that Lay was a shmoozer and a good ole boy who could work the politics necessary to keep a regulated utility cushy and profitable, but no financial genius. If this assessment is broadly true, Lay probably stepped back into the CEO role out of pride -- he did not want to embarrass his friends on the board and himself by turning down the job, and he did not know enough to realize how dangerous it was for him to take it.
4 Comments:
By 
honestpartisan, at
Thu Jul 06, 12:07:00 AM:
How does a Board of Directors say NO to the management of a company voted most admired, their stock flying, validating them as geniuses every day? With the benefit of hindsight, it seems so easy, but I promise you clarity of foresight is a rare commodity.
I don't think it took such great foresight. I would refer you to two excellent histories on the rise and fall of Enron: The Smartest Guys In the Room by Bethany McLean and David Elkind and Conspiracy of Fools by Kurt Eichenwald. They report that there were plenty of people at Enron who thought that doing business with Fastow's private partnerships was a flagrant breach of Enron's fiduciary duties to its shareholders as well as nuts. They were brushed aside by people wrapped up in the enthusiasm of the rising quarterly stock price and its effect on their options.
By Lanky_Bastard, at
Thu Jul 06, 01:01:00 AM:
That's an enjoyable read and a very different take on things. Though I have to say, I think it's too kind to a criminal who screwed thousands of families.
I'd have gone with Faust instead of Lear.
By Gordon Smith, at
Thu Jul 06, 07:43:00 AM:
"I suspect he was an inveterate entrepreneur - a true believer. An optimist. He almost certainly cut corners to support getting to tomorrow. He was probably not particularly financially or legally sophisticated. He probably assumed that if the lawyers and accountants blessed what they were doing, and the lenders lent to it and the stock went up, it was all okay. A game. A confidence game. He likely did not ask demanding questions, because he didn't want to know the answers."
Are you talking about Ken Lay or George W. Bush. The whole post is reflective of your feelings towards executive power. Interesting read.
By Cardinalpark, at
Thu Jul 06, 11:00:00 AM:
I've read the McLean book. She's quite good actually. She was an analyst at Goldman Sachs many years ago, so she has a good understanding of finance.
A couple of responses:
HP - the waiver of the company's ethics rules by the BOD to allow for the payments to Fastow was an absolute red flag. The BOD should not have allowed it. BUT - they did. They knew about the payments to Fastow. They agreed with them. So was it theft? The shareholder's representatives authorized payment of shareholder money. Complex question. Today, the answer seems clear. Then, in the midst of the internet and telecom frenzy, it was less clear. And you had some notables on the board, including the Dean of the Stanford Business School. In my judgment, these issues are not easy or obvious when the circumstances are first presented. Especially when supporting actors legitimize and validate the decision as proper and legal - so said Vinson and Elkins, a prominent Texas law firm, and Arthur Anderson, a Big 6 accounting firm. The board wasn't just "wrapped up" in a rising stock price. It was wrapped up in 10 years of rising earnings -- success.
That's my point. It's not easy for a board to counter a management team with a long record of success. That doesn't mean they shouldn't. But the management has an inherent advantage - they have much more information and are there every day. They can threaten to quit.
It's not as simple as the McLean book, or any book, or newspaper, will make it seem.
And Lanky - I hear you, but...From 1985 to 2000, Enron was a paragon of success. It grew its employment dramatically and paid alot of people well. The "thousands of families" who suffered at the end, benefitted for a long time. And so did the shareholders. Many had a tremendous ride and made their money.
Did people get stuck holding the bag at the end? Yes. But why? It's fundamentally because the management made bad business decisions and bought bad assets with leverage, not because they stole. When they sought to cover up their bad investments so they could bail out on the stock and preserve their wealth, they committed a wrong. But the Company went bust due to bad investments combined with financial leverage, not theft.
That is the part of the story that is too often forgotten. These guys are vilified for being crooks, and maybe they deseve that. But it started out with mismaagement and bad decisions, which then begat criminal behavior. When they realized how deep their hole was, they got desperate like the guy working a series of bad hands in Vegas. and the lies got bigger.
This is not simply the province of evil people. Good people, touched by hubris, can wind up there too. If anything, this is a warning...ask not for the whom the bell tolls and all that...that's I think what makes the Enron story -- or the Ebbers/Worldcom story -- Shakespearean tragedy.
