Enron’s Kenneth Lay: The Last Road Not TakenPublished: April 10, 2002 in Knowledge@Wharton
On August 22, 2001, Enron vice president Sherron Watkins visited chief executive Kenneth Lay in his Houston headquarters and warned him that the company could "implode in a wave of accounting scandals." At that moment, says Michael Useem, director of Wharton’s Center for Leadership and Change Management, Lay could have taken specific action that would have prevented bankruptcy and saved the jobs of thousands of Enron employees. Below, Useem compares Lay’s choices with those facing Salomon chief executive John Gutfreund a decade earlier.
On that day in August, it’s easy to see now, immediate intervention was essential. But this would have required a CEO and a committed management team that recognized the gravity of the moment. Yet Lay barely had a top team at all. Chief executive officer Jeffrey Skilling had quit the company a week before. Chief financial officer Andrew S. Fastow had devised the improper accounting schemes. And other senior officers had been resigning in droves.
Without a team of his own, the CEO still might have averted the bankruptcy that occurred just three months later if he had instantly cleaned house, beginning with his own resignation. The company required an outside executive with the resolve, credibility, and character to get the job done. A decade earlier, that was precisely what Salomon chief executive John Gutfreund had done to save his company. And it had worked.
Salomon trader Paul Mozer had made an illegal $3.2 billion bid for U.S. treasury securities on February 21, 1991. His boss, John Meriwether, reported the transaction to top management on April 28, but like Kenneth Lay, CEO John Gutfreund did not take the warning seriously and failed to report it for more than three months.
Gutfreund was so discredited by the delay – the day after its public disclosure the Wall Street Journal headlined an article, "Top Salomon Officials Knew About Illegal Bid" – that he instantly knew his 38-year career with Salomon was finished. He called one of his outside directors, Warren Buffett, and asked him to step in to resurrect the company and its shattered credibility.
Two days later Buffett flew to New York to take the reigns of Salomon. The new CEO instantly forced out the old management team and installed his own. Instead of shredding evidence, as Enron did, he turned it all over to investigators. Rather than delegating enforcement to others, Buffett named himself the chief compliance officer.
At Enron Lay apparently tolerated ethical lapses by subordinates, even overriding the company’s own code of ethics to permit the CFO to form debt-disguising partnerships. Buffett did the opposite, insisting that any violation of ethical standards, federal regulation, or public law be brought to his immediate attention.
Just three days after taking office, Buffett told all Salomon officers, "You are each expected to report, instantaneously and directly to me, any legal violation or moral failure on behalf of any employee." He provided his home telephone number and added that parking tickets were among the few exceptions to his reporting requirements.
Warren Buffett asked employees to apply the "newspaper test" to their every decision: Would they be prepared to read whatever they were about to do in a local paper, "there to be read" by "spouse, children, and friends"? Buffett warned they would only succeed by "playing aggressively in the center of the court, without resorting to close-to-the line acrobatics."
Though Salomon paid dearly – customers fled, shares dropped, fines topped $290 million – the firm survived, prospered, and was later sold for $9 billion. Had CEO Gutfreund not replaced himself with Buffett, and had Buffett and his own team not cleaned house, 9,000 Salomon employees almost certainly would have lost their jobs and thousands of investors their equity.
Comparable intervention restored Scandinavian Airlines (SAS) to health in 2001 when scandal shattered its reputation. Its chief operating officer had conspired with his counterpart at rival airline Maersk Air to fix rates and routes. The COO initially had denied doing so, but when an incriminating document surfaced, the board forced top management out.
But even that cleansing had not gone far enough. Though SAS directors were eminent figures in Scandinavia and had served on the board for years, they also accepted responsibility for having failed to detect the malfeasance within. Concluding that only a wholesale makeover of the company would restore its credibility, they resigned en masse. The directors’ bitter pill cured the patient.
Once Lay was warned of Enron’s prospective implosion, time began running out. With a strong management team in place, he might have rooted out the abuses. But the team was gone, leaving him only one remaining course, and that was to make way for a new leader and a new board to oversee the reconstruction.
If Lay had recruited a replacement with impeccable credentials at the end of August and a new board soon thereafter, and had the new executives and directors swept out the old, thousands of Enron employees might not be on the street, and thousands of stockholders might still be in the money.
Late August was a time to make right what was going terribly wrong, but Lay chose to avoid the difficult choice, turning the nation’s seventh largest corporation into the nation’s largest corporate disaster.