Some major lessons can be learnt from Enron’s collapse. Here they are, in an easy to remember list
Readers of this column will know that good lists contain seven items. Here are seven lessons from Enron:
* Market value isn’t a measure of the size of a company
It has been said that an unprecedented proportion of the world’s largest companies are newcomers. It’s true, if you measure size by market capitalisation. On this basis, Enron became number seven in the world, and Cisco, briefly, number one.
But market value reveals what shareholders think a company might be in future, not what it is today. Using value added, the standard economic measure of productive activity, the world’s largest companies are still stalwarts such as General Electric, Exxon, even General Motors.
When the value of many new economy companies came to exceed that of old economy businesses, it was because investors believed that the growth of new economy businesses was such that their value added would exceed that of old economy businesses. At Enron, it didn’t.
* The principal job of an adviser is to get a job as an adviser
Enron generated a lot of business for lenders, investment banks, consultants, accountants and high-profile individuals. Don’t expect any of these to give impartial advice to the company about its strategy or to outsiders about the company. Their incentive was to tell the company and people outside it what the company wanted to hear. At Enron, they did.
* Everyone in a business has a common interest when things go well but divergent interests when they go wrong
Workers, managers and investors benefit from rising share prices. Not just through options and bonuses but through salary prospects and the confidence they feel in their organisation and their jobs.
Everyone also shares the hard times, but in different ways. Managers’ primary interest is in keeping things under wraps until they have left. Job security is the primary interest of workers – on average, they stay longer with the company than chief executives or shareholders. And the primary interest of shareholders is in retaining some value in the business. Don’t expect them to hang together in the downturn. At Enron, they didn’t.
* Sustainable corporate profits can’t be derived from own account trading
Markets are still basically efficient. There are few profits to be made from arbitrage gains. Some individuals may have skills that enable them to identify these but it is not very likely that organisations do.
Despite this, a surprisingly large number of businesses claim to derive regular profits from trading. Often they don’t account fully for the costs of capital employed or for the risks associated with the use of that capital – or they bundle together trading profits with profits from acting as intermediary. Or small, routine short-term profits are offset, overall, by occasional large losses from serious misjudgments. At Enron, they were.
* Be suspicious of the heroic CEO
American journalists have taken the personalisation of corporate activities to extraordinary lengths. It is as though every product of Microsoft were the creation of Bill Gates, every act of GE a reflection of the will of Jeff Immelt. The reality of successful business is quite otherwise: good management involves finding good subordinates who can make good decisions, and allowing them to do it. It is not surprising, however, that there are managers who are anxious to foster the idea that the growth of the organisation is directly associated with their own genius. It is also true that the more inclined they are to think this, the less they understand about the nature of successful business. As at Enron.
* Most mergers don’t add value
Academic evidence on the failure of most merger activity is extensive. You can look at comparisons of pre- and post-merger profitability, you can see how many acquisitions are followed by write-offs or disposals. Or you can just ask people whether they thought the merger was a success.
Acquisition activity does not come out well from any of these tests. Only stock market reactions to planned mergers put them in an acceptable light, and, to repeat, market reactions are a measure of what people think will happen rather than what actually does. Despite this, I’ve never encountered an executive team without an explanation of why its acquisition strategy will confound the rule. As at Enron.
* Understanding politics can be a large but fickle source of profit
Government is usually a company’s most effective ally in keeping competitors out. The only thing that matches it is being leader in an industry with huge sunk costs – and even then politics usually enables you to reach that pole position.
Unfortunately, what politics can grant it can also take away. Airlines and telecommunications companies built businesses around franchises that ultimately disappeared. And the business built behind the franchise was rarely set to perform well in a new competitive world. As at Enron.
What makes Enron so endlessly fascinating is that it confronts so many faultlines of modern capitalism. And yet there is a real sense in which Enron’s failure is a triumph for the market economy.
There is an eighth lesson: Bad businesses don’t usually grow and prosper in the long run. As at Enron.
That process of feedback and response is the essence of the market system. And that is why, despite the difficulties, market economies have so dramatically outperformed planned ones.