Skilling's Appeal and Enron's Legacy

Regardless of the outcome—which very well may be favorable to Skilling—the question remains: Why didn't Enron's board pay more attention?

By Malcolm S. Salter

Nearly seven years after its collapse, Enron continues to fascinate those interested in the leadership and governance of companies.

The latest chapter of the Enron story opened on Apr. 2 at the Fifth Circuit Court of Appeals in New Orleans. Lawyers for former Chief Executive Officer Jeffrey Skilling argued that his 2006 conviction on 19 counts of fraud, conspiracy, insider trading, and lying to auditors—along with his 24-year prison sentence—should be overturned. Some four months later, a ruling by the appellate court on Skilling's appeal is near.

A great deal is at stake with the court's ruling. For Skilling, the judges' ruling will either seal his fate as a convicted criminal or open up possibilities for further vindication. (In the 2006 trial, nine of the ten insider-trading counts against him were dropped.) However, for the rest of us, the ruling will do much to define the true legacy of the Enron case.

If the appellate court overturns the lower court's conspiracy conviction, which is possible in light of recent precedent in similar conspiracy cases, such a partial decriminalization of Skilling's conduct will reopen discussions of what was the real offense committed by Skilling. The answer to this question is important because many of Skilling's allegedly fraudulent activities fall into what Owen D. Young—the founding chairman of RCA and NBC, and later chairman of GE (GE)—once called the "shadowed space" or "penumbra" between the clear light of doing right and wrongdoing, where the law is unclear and the spirit of the law is open to interpretation.

A close reading of the record suggests that much of Enron's behavior fell into this penumbra. But that same record also suggests that Skilling lost his way in this shadowed space by encouraging and tolerating aggressive gaming of accounting and SEC rules throughout that portion of the company where he had direct authority and accountability. Former SEC Commissioner Arthur Levitt made this savvy observation in the immediate aftermath of Enron's collapse, and this judgment looks as correct today as it did seven years ago. Since Enron is certainly not the only company to have engaged in such gaming, the important question raised by this marker case is how to rein in the kind of aggressive, but not incontestably illegal, gaming of society's rules that led to Enron's collapse.

The answer points to three persistent tasks of corporate governance: the avoidance of perverse incentives for executives, the strengthening of board oversight, and the reinforcement of ethical discipline in the conduct of business affairs.

Enron's approach to compensation and incentives included many perverse features: It encouraged growth over profitability. It rewarded employees for closing commodity deals and power-generation projects without concrete evidence of their future profitability. It deepened a deadly addiction to pumping up the price of the stock through a variety of obfuscating maneuvers. It helped encourage a corporate culture that tolerated and sometimes encouraged deception. It created many opportunities for executives to reap enormous personal gains from gaming accounting and SEC rules.

If Enron-type breakdowns are to be avoided in the future, corporate boards need to keep in mind seven propositions—drawn directly from Enron's experience with perverse incentives—that collectively address the potentially perverse effects of turbocharged financial incentives.

• That awarding "up front" bonuses—before cash and profits flow from commercial endeavors—invites employees to maximize their short-term pecuniary interests while compromising the company's long-term interests.

• Systems of reward that ignore comparative measures of business performance vis-à-vis leading competitors often lead to overcompensation and lull executives into a false sense of security.