Enron and Theranos Case Studies PDF

CORPORATE GOVERNANCE FAILURES: ENRON AND THERANOS BIEM, Class 17 Prof. Alessandro Minichilli Department of Management & Technology CORPORATE GOVERNANCE FAILURES 2 When does a failure of corporate governance occur? CORP...

CORPORATE GOVERNANCE FAILURES: ENRON AND THERANOS BIEM, Class 17 Prof. Alessandro Minichilli Department of Management & Technology CORPORATE GOVERNANCE FAILURES 2 When does a failure of corporate governance occur? CORPORATE GOVERNANCE FAILURES 3 A failure of corporate governance: - arises when the internal rules and processes designed to ensure effective management and accountability break down. - leads to unethical actions among directors, poor decision- making, or a lack of transparency. CORPORATE GOVERNANCE FAILURES 4 AGENDA 1. ENRON 2. THERANOS 3. ENRON AND THERANOS: A COMPARISON 1.0 ENRON CORPORATE GOVERNANCE FAILURES: ENRON 6 Enron: key highlights —Founded in 1985 in Houston, Texas —From a traditional energy provider to a powerhouse in energy trading —Quickly grew into one of the largest global companies in the natural gas and energy industry —In 2001 the fraud comes out: Enron collapses CORPORATE GOVERNANCE FAILURES: ENRON 7 Enron: main questions —What went wrong? Which players are responsible for what went wrong and why? —Did the Enron board of directors fulfill its role? Why, or why not? —What lessons can be learned from the Enron case? CORPORATE GOVERNANCE FAILURES: ENRON 8 CORPORATE GOVERNANCE FAILURES: ENRON 9 A star has fallen CORPORATE GOVERNANCE FAILURES: ENRON 10 Mark-to-Market Accounting Technique — Normally, companies record revenues when they are realized (e.g., after issuing an invoice), though exceptions can sometimes be made. — However, when a company books revenues it didn’t realize the financial statement can become inaccurate, because of the uncertainty regarding future operations. — Mark-to-Market accounting is a method that measures the fair value of assets and liabilities that fluctuate over time by adjusting their recorded value to reflect current market prices. — While this technique aims to provide a more accurate picture of a company’s financial position, it can also be abused. CORPORATE GOVERNANCE FAILURES: ENRON 11 How Mark-to-Market Accounting Technique fueled Enron’s fraud — In the case of Enron, the company exploited Mark-to-Market accounting to book unrealized future revenues based on speculative and overly optimistic projections. — This led to the creation of virtual earnings, where profits existed solely on paper, not in reality, resulting in highly misleading financial statements. — As a result, there was intense pressure to close more M&A deals to maintain the illusion of continuous earnings growth, regardless of the actual financial health of the company. — Despite audit oversight meant to prevent such fraud, Enron’s auditors failed to detect or act on these manipulations, allowing the fraud to escalate. CORPORATE GOVERNANCE FAILURES: ENRON 12 The use of Special Purpose Vehicles (SPVs) Enron successfully concealed debts and losses, deceiving investors and employees, through the use of special purpose vehicles (SPVs). — SPVs are legal entities created to fulfill narrow, specific, or temporary objectives. — They can be used to relocate the risk of a venture from the parent company to a separate orphan company (the SPV) and to isolate financial risk in the event of bankruptcy or default. — The SPV obtains funds to purchase the asset through debt financing from independent equity investors. — Enron established numerous SPVs to hide over $30 billion in debt, allowing the company to present a deceptively strong financial position. CORPORATE GOVERNANCE FAILURES: ENRON 13 CORPORATE GOVERNANCE FAILURES: ENRON 14 Energy market deregulation Energy Policy Act of 1992 (US) — This act deregulated electricity transmission grids, previously monopolized by utility companies. This opened the market to outside competitors and allowed companies like Enron to buy, sell, trade, and transport natural gas. Enron’s market position in California Enron leveraged its position as a significant player in California's energy market by employing manipulative tactics that drove up energy prices for consumers and businesses: — Death Star strategy, creating artificial shortages to drive up prices, — Explote energy supply and demand, scheduling and rescheduling power deliveries to create scarcity. CORPORATE GOVERNANCE FAILURES: ENRON 15 Who are Enron key stakeholders and what was their role in the fraud? CORPORATE GOVERNANCE FAILURES: ENRON 16 Enron’s key stakeholders — Top management: Skilling (CEO), Fastow (CFO), Lay (Founder and Chiarman) — Auditors: Arthur Andersen: — Employees (no jobs and pension funds) — Board of directors — Banks — Retail and institutional investors — Media — Government — Regulatory bodies (SEC) CORPORATE GOVERNANCE FAILURES: ENRON 17 What were the main reasons for Enron’s collapse? CORPORATE GOVERNANCE FAILURES: ENRON 18 Main reasons for Enron’s collapse —High-risk, aggressive corporate culture —Excessive risk taking —Remuneration system: bonuses on short-term profits —The role of regulation and regulators —Lack of transparency in financial statements —Inadequate Board oversight —The role of auditors CORPORATE GOVERNANCE FAILURES: ENRON 19 Some improvements to reduce conflict of interest: —Independence of directors —Independence of auditors (no consulting, physical location) —Separation of banks’ activities (underwriters and investors) —Sarbanes-Oxley Act (2002), in response to a series of high- profile corporate scandals, including the Enron collapse, introduced stricter regulations aimed at improving corporate accountability and transparency.  2.0 THERANOS CORPORATE GOVERNANCE FAILURES: THERANOS 21 Theranos: key highlights —Biotech start-up founded in 2003 at Palo Alto (California) by Elizabeth Holmes: the new Steve Jobs? —Mission: revolutionize healthcare with its technology, performing hundreds of tests with a single drop of blood —Valued in the billions —Attracted high-profile investors —In 2015, a journalistic investigation exposed the scandal: Theranos turned out to be a false claim campaign CORPORATE GOVERNANCE FAILURES: THERANOS 22 Theranos: main questions —What were the reasons for Theranos’ collapse, and what are the major lessons from this case? —Why investors continued to support Theranos even without evidence of the innovative blood technology? —Did the Theranos board of directors fulfill its role? Why, or why not? If not, what was the motivation behind stacking the board the way Holmes did? CORPORATE GOVERNANCE FAILURES: THERANOS 23 The Edison Device: Promises and Pitfalls Theranos developed the "Edison” device to conduct over 200 different tests, including cholesterol levels, glucose levels, and various disease markers in a matter of hours rather than days. Despite Theranos' bold claims, the technology lacked independent validation, and results from the Edison device were often unreliable leading to misdiagnoses and inappropriate treatments. CORPORATE GOVERNANCE FAILURES: THERANOS 24 The rise and fall of Theranos: a fallen unicorn CORPORATE GOVERNANCE FAILURES: THERANOS 25 Manipulating the Board of Directors /1 An all-star board with no knowledge of the healthcare or medical technology industries: George Shultz, former US Secretary of State and key figure in U.S. foreign policy Henry Kissinger, former US Secretary of State and National Security Advisor William Perry, former US Secretary of Defense James Mattis, a retired US Marine Corps General David Boies, A renowned lawyer Richard Kovacevich, the former CEO of Wells Fargo Gary Roughead, a retired US Navy Admiral William Frist, Former U.S. Senator and heart surgeon Sam Nunn, a former US Senator Riley P. Bechtel, Chairman and CEO of the Bechtel Group Inc. Channing Robertson, Emeritus Professor of Chemical Engineering at Stanford University CORPORATE GOVERNANCE FAILURES: THERANOS 26 Manipulating the Board of Directors /2 Lack of biotech or medical expertise Poor governance and unchecked CEO control CEO power concentration Lack of transparency No external experts Overreliance on prestige Conflicts of interest Weak financial scrutiny CORPORATE GOVERNANCE FAILURES: THERANOS 27 Who are Theranos key stakeholders and what was their role in the fraud? CORPORATE GOVERNANCE FAILURES: THERANOS 28 Theranos’ key stakeholders Founder (Elizabeth Holmes, CEO) and the executives (i.e. Ramesh "Sunny" Balwani, Chairman and COO) Board of directors Investors (High-net-worth individuals and Institutional investors) Employees Patients and consumers Doctors and medical providers Partners and retailers (i.e. Walgreens, Safeway) Regulatory bodies (i.e. FDA, SEC, CMS) Media and journalists CORPORATE GOVERNANCE FAILURES: THERANOS 29 Why investors continued to support Theranos even without evidence of the innovative blood testing? CORPORATE GOVERNANCE FAILURES: THERANOS 30 Why investors supported Theranos Charismatic leadership: Elizabeth Holmes' visionary pitch and comparisons to Steve Jobs High-profile backers: support from prominent figures like Henry Kissinger, George Shultz, and James Mattis boosted credibility Fear of missing out: potential for disruptive innovation led investors to prioritize early involvement Limited expertise: many investors lacked deep knowledge in medical diagnostics, relying on external validation Secrecy and hype culture: Theranos operated in "stealth mode”, fostering intrigue and anticipation Partnerships and endorsements: deals with Walgreens and Safeway validated investor confidence  3.0 ENRON AND THERANOS: A COMPARISON CORPORATE GOVERNANCE FAILURES: ENRON AND THERANOS 32 Enron and Theranos: a comparison Similarities: Differences: Culture for secrecy Accounting Fraud VS Managerial hubris Technology fraud Charismatic leaders and Public VS private centrality of the founder organization Complicit in unethical behaviour Energy VS technology industry Top board of directors Enron was highly Most admired organizations diversified (role of media) Both declared bankruptcy  THANKS. 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