Four years ago this month, Enron CorporationNo. 7 on the Fortune 500filed for bankruptcy, culminating a collapse that shocked America.
It is commonly believed that Enron fell because its leaders, eager to make money, schemed to bilk investors. The ethical lesson, it is said, is that we must teach (or force) a businessman to curb his selfish, profit-seeking impulses before he turns criminal.
But all this is wrong.
Enron was not brought down by fraud; while the company committed fraud, its fraud was primarily an attempt to cover up tens of billions of dollars already lostnot embezzledin irrational business decisions. Most of its executives believed that Enron was a basically productive company that could be righted. This is why Chairman Ken Lay did not flee to the Caymans with riches, but stayed through the end.
What, then, caused this unprecedented business failure? Consider a few telling events in Enrons rise and fall.
Enron rose to prominence first as a successful provider of natural gas, and then as a creator of markets for trading natural gas as a commodity. The company made profits by performing a genuinely productive function: linking buyers and sellers, allowing both sides to control for risk.
Unfortunately, the companys leaders were not honest with themselves about the nature of their success. They wanted to be New Economy geniuses who could successfully enter any market they wished. As a result, they entered into ventures far beyond their expertise, based on half-baked ideas thought to be profound market insights. For example, Enron poured billions into a broadband network featuring movies-on-demandwithout bothering to check whether movie studios would provide major releases (they wouldnt). They spent $3 billion on a natural-gas power plant in Indiaa country with no natural gas reserveson ludicrous assurances by a transient Indian government that they would be paid indefinitely for vastly overpriced electricity.
The mentality of Enron executives in engineering such fiascos is epitomized by an exchange, described in New York Times reporter Kurt Eichenwalds account of the Enron saga, between eventual CEO Jeff Skilling and subordinate Ray Bowen, on Skillings (eventually failed) idea for Enron to sell electricity to retail customers.
An analysis of the numbers, Bowen had realized, told a damning story … Profit margins were razor thin, massive capital investments were required. Skillings response? Youre making me really nervous … The fact that youre focused on the numbers, and not the underlying essence of the business, worries me … I dont want to hear that.
When Bowen responded that the numbers have to make sense … Weve got to be honest [about whether] … we can actually make a profit, Eichenwald recounts, Skilling bristled. Then you guys must not be smart enough to come up with the good ideas, because were going to make money in this business. … [Bowen] was flabbergasted. Sure, ideas were important, but they had to be built around numbers. A business wasnt going to succeed just because Jeff Skilling thought it should.
But to Skilling and other Enron executives, there was no clear distinction between what they felt should succeed, and what the facts indicated would succeedbetween reality as they wished it to be and reality as it is.
Time and again, Enron executives placed their wishes above the facts. And as they experienced failure after failure, they deluded themselves into believing that any losses would somehow be overcome with massive profits in the future. This mentality led them to eagerly accept CFO Andy Fastows absurd claims that their losses could be magically taken off the books using Special Purpose Entities; after all, they felt, Enron should have a high stock price.
Smaller lies led to bigger lies, until Enron became the biggest corporate failure and fraud in American history.
Observe that Enrons problem was not that it was too concerned about profit, but that it believed money does not have to be made: it can be had simply by following ones whims. The solution to prevent future Enrons, then, is not to teach (or force) CEOs to curb their profit-seeking; the desire to produce and trade valuable products is the essence of businessand of successful life.
Instead, we must teach businessmen the profound virtues money-making requires. Above all, we must teach them that one cannot profit by evading facts. The great profit-makers, such as Bill Gates and Jack Welch, accept the facts of realityincluding the market, their finances, their abilities and limitationsas an absolute. Face reality, advises Jack Welch, as it is, not as it was or as you wish … You have to see the world in the purest, clearest way possible, or you cant make decisions on a rational basis.
This is what Enrons executives did not graspand the real lesson we should all learn from their fate.
Alex Epstein is a junior fellow at the Ayn Rand Institute ( www.aynrand.org) in Irvine, Calif. The Institute promotes the ideas of Ayn Randbest-selling author of Atlas Shrugged and The Fountainhead and originator of the philosophy of Objectivism. Copyright© 2005 Ayn Rand® Institute. All rights reserved.
From the Dec. 7-13, 2005, issue