December 14 , 2017

Did HR Cause The Downfall of Enron?*

I’m still not buying into HR taking responsibility!

Now before you dismiss this notion take a step back and think. Did Enron fail because of bad equipment, actions by the competitors or a collapse in the financial markets or the economy? The answer, of course, is no. Did the collapse come from:

  • A one time slip in judgment
  • A few unrelated mistakes or
  • A pattern of unethical and possibly illegal acts coupled with a series of deceptions that can only indicate that the culture and values of Enron had degenerated
  • A pattern of errors this broad could only result from management systems with serious flaws.

Ok, if you are not buying into HR’s responsibility then answer the question: “who is responsible for developing systems to build and maintain a companies value and culture”? Since there is no “values and culture” department the answer lies with the only department with company wide responsibility for developing systems to measure and reward behaviors, values and performance…HR.  And yes, of course other functions contributed (for example accounting and  finance) but such a wide spread series of errors in judgment can only result  from poorly designed or implemented reward, training and performance  management systems.

Wide spread errors like these can only be caused by badly designed people processes and systemsIf you think of HR in the more traditional backroom “overhead” role with no direct responsibility then now might be the time to re-think that attitude and approach. If a large number of people in many different departments make independent errors (and when those errors have similar characteristics) the “cause” can’t be random. A large volume of similar bad “judgments” and violations of company values can only be as a result of bad processes and systems. In this case, the only systems that can cause this wide of a range of similar errors can only be reward, performance appraisal, communications, hiring and training.

What did HR do wrong?

HR took too narrow of a view of its job. “Just talking about” the culture and values is not the same role as developing people management systems that actively reinforce those values through metrics, rewards and punishments. It developed human resource systems within Enron that:

  • Measured and incented the wrong things.
  • It’s benefits systems failed to meet its fiduciary duty to protect its employee’s retirement earnings.
  • Its performance management system did not punish (and may even have encouraged) workers, managers and executives who took unreasonable risks.

In brief, Enron failed because of the people it hired (or failed to terminate) and the HR systems it implemented that incorrectly appraised and incented risky and unethical behavior. The failure occurred because the different departments within HR failed to follow through with their jobs as stewards of the company (A more detailed list of each HR failure is found later in this article).

How HR could have saved Enron

Enron’s fall was not really a rapid one. The stock had dropped from 80 to 10 over the course of several months (prior to the ultimate crash), so there was time for managers and HR to identify problems and act to correct them. Obviously I don’t have time to go into the hundreds of possible errors that can cause a company’s downfall, but given what we currently know from public information, here are some likely failures and missteps by the HR function.

It’s important that you look at these failures not just because they happened at Enron, but also because they could help identify similar problems at your own organization. Because not all of the evidence against Enron is in yet (and I have not been a consultant to Enron) I have made about what happened. However, I believe that you will find that the following list is a reasonable estimate of what HR did wrong and what you might be able to do to prevent such catastrophe at your organization.

Benefits mis-management

  • The most obvious mis-management error is the appearance of inequity by setting retirement fund rules that restricted employees from selling holdings in Enron stock, while allowing senior management to sell large volumes of theirs.
  • It is also clear that the message sent to employees (by HR and the executives) about the need to diversify their 401(k)’s was clearly ineffective because some employees had Enron stock as a majority of their 401(k) portfolios. Because HR has a fiduciary responsibility to adequately represent and protect the interests of shareholders, many of whom were employees and retirees, benefits departments need to take a more active role in ensuring that the message gets through. This means benefits must proactively “run the numbers” to monitor the percentages of their own company’s stock that is held in 401(k)’s until average holdings fall below 20 percent, and where necessary, strengthen the message that is sent to employees outlining the negative consequences of holding too much of any company’s stock in 401(k) portfolios.

The company culture and values

  • HR often assumes the role of the “builder and maintainer” of the culture and the organization that is responsible for maintaining values and ethical behavior within the company. Clearly the Enron culture “got out of hand” and HR failed to keep it within reasonable parameters. The “new”culture that evolved (grow the business at any cost) from their original mission clearly killed the company. HR must realize that when the size of “new hire” group in a rapid growth company exceeds the size of the “long tenure”group, the company’s culture (which originally made the company strong) will invariably become “diluted” due to an over-abundance of outside influences.

Performance management and appraisal

  • The performance management system at Enron allowed executives, managers and employees (who made major errors) to go unidentified and unpunished. HR developed a performance appraisal system that filed to immediately identify potential problems and it failed to put “teeth” in its performance management systems that would severely punish (or fire)individuals that kept secrets, took excessive risks or that violated the company’s values or ethics. As a result, HR inadvertently sent a message toemployees and managers that results, regardless of how they are obtained, areall that matters.
  • “Blind faith” and a reliance on value statements and a once a year performance appraisal system must be supplemented by safeguards and precision performance monitoring systems when the company’s business model shifts from a normal risk to a high-risk one. HR leaders in companies operating SPE’s (special purpose entities) and trading derivatives can’t be naive about the risks involved. Performance management and monitoring systems must bedesigned to fit the level of risk that’s established in the company’s businessmodel.

Compensation and Incentives

  • Having a percentage of your pay based on performance is an excellent practice. However making the rewarded percentages “too high” can essentially“over incent” employees to take unreasonable risks. The large incentives for rapid growth, stock price growth and short-term gain drove behavior beyond reasonable limits at Enron.
  • Employees must be able to make mistakes and then to report them rapidly. That’s how organizations learn. In reverse, having large penalties for failure can encourage secrecy and the “hiding” of mistakes, so that no one learns from them.
  • It’s also highly likely that the executive compensation packages at Enron (especially the CFO) were so large and focused on short-term results and stock price increases that they incented (or even hiding) risks that would not have occurred without such benefits.
  • HR should have known that risks could be outrageously high in the derivative trading and offshore investment business. As a result, they should have taken a conservative approach toward incenting and rewarding “risk taking” and “results” (regardless of how you got them).

Communications

  • Senior executives were continually telling employees (erroneously) about the high likelihood of large stock price growth and HR clearly failed to recognize and communicate that their message needed to be toned down.
  • HR and other communications systems failed to incent or encourage “whistleblowers” to criticize or speak out about questionable business practices. Only a single employee’s warning message (which happened to be at avice presidential level) reached the top. A culture that castigates orstifles individuals who criticize management or questionable practices needsto be monitored and changed. If HR is to have an impact on business decisionmaking practices, it must develop formal and informal feedback andcommunication mechanisms that ensure that the “alternative perspective” isalways heard. HR must make it easy for employees to anonymously complain as well as proactively “seek out” employee opinions and concerns.
  • HR must develop systems that encourage employees to identify and “out” employees and managers that take unacceptable risks and that violate our values.
  • In another communications failure, HR allowed the wrong start date of the 401(k) stock selling freeze to be announced, so that even when employees were actually free to sell stock…they didn’t know it.

Training

  • Clearly the training provided in the areas of acceptable risks, ethics, reporting and performance monitoring were either ineffective or the incentives to ignore the training were so strong, that they negated any impact it might have had. HR must ensure that training effectiveness is measuredbased on performance, results and an actual change in behavior

Hiring and retention

  • With its dramatic growth and large-scale hiring, Enron’s hiring standards could not always be met while their assessment tools were inadequate(especially in the areas of ethics, risk-taking and honesty in communications). Clearly the new breed of “traders” that were hired differedsignificantly from the old “oil drillers” that previously dominated thecompany. HR hiring and retention systems that worked with the “oil drillers”became ineffective when the company’s business model shifted into a riskier“trading” mode. The lesson to be learned by HR is that the people management systems that “worked” when the company was smaller and had a different “mix”of employees must evolve with the changing business model and employee population mix.

Conclusion

The many human resource failures that contributed to Enron’s demise should send a powerful message that an opportunity for HR to become as prominent as other recently popularized business functions. Although the final determination of which factors contributed the most to Enron’s failure might take years to resolve. But it is already clear that the human element in Enron’s failure played the largest part. Numerous individuals made bad decisions that resulted in a catastrophic failure. All companies make bad decisions. But, those companies who have effective HR departments also tend to have performance management systems and metrics that catch errors early.

HR must learn to become proactive and to develop “smoke detectors” which can help identify “bad people and people processes” long before they can have a major negative impact on their company. HR must also look more closely at the design of compensation systems to ensure that the incentive to “speak out” (about unreasonable risks and ethical concerns) is at least as high as the incentive to keep quiet.

It’s also clear now that the 64 page ethics manuals and crystal clear value statements (that include respect and integrity) are not enough to change everyone’s behavior from bad to good — especially when huge egos are involved. Unfortunately, the cost for learning that lesson will be thousands of jobs, many ruined retirements and the loss of billions of dollars.

“Business is not unlike sports. When a team loses big you can’t blame the equipment, the fans or the accounting department. It’s the people on the team and the systems that manage them that “cause” failure (and success)! Any questions?”

If you’re one of the many that initially viewed the Enron disaster as an accounting problem I hope this article has changed the way you evaluate future business events. Maybe you didn’t buy all of the arguments but I hope it did make you think. And one last thought. Does you HR department currently have systems that would “warn” you if your own firm had the same problems occurring as Enron did?

We all know that the answer in most cases is sadly…No!

* This piece is intended as an “outsiders view” and a “think piece” and it is not intended to be an indictment of how individuals in HR at Enron operated.

About Dr John Sullivan

Dr John Sullivan is an internationally known HR thought-leader from the Silicon Valley who specializes in providing bold and high business impact; strategic Talent Management solutions to large corporations.