At Enron, "The Environment Was Ripe for Abuse"

The energy company's unrelenting stress on growth and its absence of controls helped push execs into unethical behavior

At Enron Corp., they called her "the Weather Babe." Lynda R. Clemmons, a French and history major from Southern Methodist University, was supposed to be emblematic of the rebels in Enron's freewheeling culture. In 1997, as a 27-year-old gas-and-power trader, she launched an esoteric enterprise in weather derivatives. Within two years, her startup had written $1 billion in weather hedges to protect companies against short-term spikes in the price of power during heat waves and cold snaps.

Clemmons' story made the rounds, from a favorable Harvard Business School case study to The New York Times business section, where she was pictured in black leather on a Harley-Davidson. She was, after all, a product of what Enron's culture was supposed to be all about: smart, sassy, creative, and risk-taking. And Enron made the most of her business, trumpeting weather derivatives as yet another high-potential deregulated market.

Like other Enron initiatives, this one never lived up to the hype. "It was such a flaky business," says John Olson, an analyst at Sanders Harris Morris in Houston. "They got more mileage out of the public relations than they actually made in earnings." Not exactly the way Enron's "cultural revolution" was supposed to play out. But as everyone knows, with Enron, nothing was quite as it appeared.

For most of the 1990s, CEOs at Old Economy companies struggled to turn slow-moving organizations into nimbler, more flexible outfits. Failure cost chieftains their jobs at General Motors (GM ), Eastman Kodak (EK ), Westinghouse, and a host of other behemoths. Truth is, real transformations are the exception rather than the rule. Changing the core values, the attitudes, the fundamental relationships of a vast organization is overwhelmingly difficult. General Electric Co.'s (GE ) John F. Welch and IBM's (IBM ) Louis V. Gerstner Jr. have been lionized for having led two of the very few successful makeovers.

That's why an army of academics and consultants descended on Enron in the late 1990s and held it up as a paragon of management virtue. Enron seemed to have transformed itself from a stodgy regulated utility to a fast-moving enterprise where performance was paramount. The Harvard case study put it simply enough: "Enron's transformation: From gas pipelines to New Economy powerhouse."

If only that were true. Many of the same academics are now scurrying to distill the cultural and leadership lessons from the debacle. Their conclusion so far: Enron didn't fail just because of improper accounting or alleged corruption at the top. It also failed because of its entrepreneurial culture--the very reason Enron attracted so much attention and acclaim. The unrelenting emphasis on earnings growth and individual initiative, coupled with a shocking absence of the usual corporate checks and balances, tipped the culture from one that rewarded aggressive strategy to one that increasingly relied on unethical corner-cutting. In the end, too much leeway was given to young, inexperienced managers without the necessary controls to minimize failures. This was a company that simply placed a lot of bad bets on businesses that weren't so promising to begin with.

Before 1990, Enron was a sleepy, regulated natural-gas company dominated by engineers and hard assets. But that year, Enron Chairman Kenneth L. Lay hired McKinsey & Co. partner Jeffrey K. Skilling, who had been advising Lay as a consultant. Skilling's mandate was to build Enron Finance Corp. into an asset-light laboratory for financially linked products and services. Skilling expanded the unit into a model of what all of Enron would become. Its success led to his promotion to president in 1997 and to CEO in early 2001.

Skilling's recipe for changing the company was right out of the New Economy playbook. Layers of management were wiped out. Hundreds of outsiders were recruited and encouraged to bring new thinking to a tradition-bound business. The company abolished seniority-based salaries in favor of more highly leveraged compensation that offered huge cash bonuses and stock option grants to top performers. Young people, many just out of undergraduate or MBA programs, were handed extraordinary authority, able to make $5 million decisions without higher approval.

In the new culture, success or failure came remarkably fast. "One potential flaw in the model was that Enron managers tended to move relatively quickly, not within businesses but between businesses," says Jay Conger, a management professor at London Business School who studied Enron. "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."

It was not unusual for execs to change jobs two or three times in as many years. Indeed, turnover from promotions alone was almost 20%. Clemmons, for example, went from analyst, to associate, to manager, then director, and finally to vice-president running her own business, all in seven years.

"In larger companies like IBM and GE, even though there is a movement toward youth, there are still enough older people around to mentor them," says James O'Toole, professor at the Center for Effective Organizations at the University of Southern California. "At Enron, you had a bunch of kids running loose without adult supervision."

In theory, of course, the kids were closely supervised. Skilling often described the new culture as "loose and tight," one of the eight attributes of the successful companies profiled by McKinsey consultants Thomas J. Peters and Robert H. Waterman Jr. in their best-selling book, In Search of Excellence. The idea is to combine tight controls with maximum individual authority to allow entrepreneurship to flourish without the culture edging into chaos.

At Enron, however, the pressure to make the numbers often overwhelmed the pretext of "tight" controls. "The environment was ripe for abuse," says a former manager in Enron's energy services unit. "Nobody at corporate was asking the right questions. It was completely hands-off management. A situation like that requires tight controls. Instead, it was a runaway train."

The train was supposed to be kept on the tracks partly by an internal risk-management group with a staff of 180 employees to screen proposals and review deals. Many of the unit's employees were MBAs with little perspective and every reason to sign off on deals: Their own performance reviews were partially done by the people whose deals they were approving. The process made honest evaluations virtually impossible. "If your boss was [fudging], and you have never worked anywhere else, you just assume that everybody fudges earnings," says one young Enron control person. "Once you get there and you realized how it was, do you stand up and lose your job? It was scary. It was easy to get into `Well, everybody else is doing it, so maybe it isn't so bad."'

It didn't help that Enron's Risk Assessment & Control group was answerable not to the board of directors but to Skilling, who was encouraging all the risk-taking. Another essential "check and balance" in the culture--Enron's in-house legal staff--was also compromised because of its reporting relationships. Instead of being centralized at headquarters, it was spread throughout the business units, where it could more easily be co-opted by hard-driving executives. "The business people didn't want to slow down for much," says one former in-house lawyer.

Central to forging a new Enron culture was an unusual performance review system that Skilling adapted from his days at McKinsey. Under this peer-review process, a select group of 20 people were named to a performance review committee (PRC) to rank more than 400 vice-presidents, then all the directors, and finally all of Enron's managers. The stakes were high because all the rewards were linked to ranking decisions by the PRC which had to unanimously agree on each person. Managers judged "superior"--the top 5%--got bonuses 66% higher than those who got an "excellent" rating, the next 30%. They also got much larger stock option grants.

Although Skilling told Harvard researchers that the system "stopped most of the game playing since it was impossible to kiss 20 asses," other Enron managers say it had the opposite effect. In practice, the system bred a culture in which people were afraid to get crossways with someone who could screw up their reviews. How did managers ensure they passed muster? "You don't object to anything," says one former Enron executive. "The whole culture at the vice-president level and above just became a yes-man culture."

Several former and current Enron execs say that Andrew S. Fastow, the ex-chief financial officer who is at the center of Enron's partnership controversy, had a reputation for exploiting the review system to get back at people who expressed disagreement or criticism. "Andy was such a cutthroat bastard that he would use it against you in the PRC," says one manager. He could filibuster and hold up the group for days, the exec adds, because every decision had to be unanimous. A spokesman for Fastow declined comment.

Although managers were supposed to be graded on teamwork, Enron was actually far more reflective of a survival-of-the-fittest mind-set. The culture was heavily built around star players, such as Clemmons, with little value attached to team-building. The upshot: The organization rewarded highly competitive people who were less likely to share power, authority, or information.

Indeed, some believe the extreme focus on individual ambition undermined any teamwork or institutional commitment. At other companies, by contrast, an emphasis on individual achievement is balanced by a strong focus on process and metrics or a set of guiding values. "In the Enron culture, there was no significant counterbalance," says Jon R. Katzenbach, a consultant and former McKinsey colleague of Skilling who has studied the company. "The lesson is you cannot rely solely on individual achievement to drive your performance over time. Companies with only that one path overemphasize it and run into trouble, switching over to vanity and greed."

That emphasis on the individual instead of the enterprise may have pushed many to cross the line into unethical behavior. The flaw only grew more pronounced as Enron struggled to meet the wildly optimistic expectations for growth it had set for itself. "You've got someone at the top saying the stock price is the most important thing, which is driven by earnings," says one insider. "Whoever could provide earnings quickly would be promoted."

The employee adds that anyone who questioned suspect deals quickly learned to accept assurances of outside lawyers and accountants. She says there was little scrutiny of whether the earnings were real or how they were booked. The more people pushed the envelope with aggressive accounting, she says, the harder they would have to push the next year. "It's like being a heroin junkie," she says. "How do you go cold turkey?"

The problem is, you can't. "For almost every model or system, there are certain limits," says USC's O'Toole. "It's harder to keep the growth growing and to keep coming up with new ideas. That kind of culture has a subtle encouragement to cut corners and to cheat. You can see everyone else moving forward, and you have to keep up."

Clemmons, who left Enron in March of 2000, isn't so sure. "It's quite clear that there were some accounting issues and bad decisions that had nothing to do with the trading side of the business," she says. "To distill it all down to the culture is utter bulls---."

As academics do their revisionist thing, they're not likely to agree.

By John A. Byrne, with Mike France, in New York and with Wendy Zellner in Dallas

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