Could HR have saved Enron?

While senior management directed the Enron ship, the firm’s collapse highlights the danger of HR-related missteps

Human resources professionals continually claim they are strategic and have business acumen. But almost universally, the response of HR professionals to the collapse of Enron has been silence. Why? What current business issue could have more strategic relevance than that one of the 10 biggest firms in the world declining into bankruptcy? Employees lost most, if not all, of their retirement funds, job security (and maybe their jobs) and possibly part of their employability due to the tainted reference of being associated with the Enron debacle.

While the actions of senior management led to Enron’s demise, HR failures, omissions and a narrow, tactical view of the HR role contributed to a catastrophic company failure.

Enron failed because of a pattern of unethical 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. Who is responsible for developing systems to build and maintain a company’s 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 behaviour, values and performance — HR.

Of course other functions contributed (accounting and finance has a lot to answer for), but such a widespread series of errors in judgment can only result from poorly designed or implemented people processes, such as reward, training and performance management systems.

If a large number of people in many different departments make independent errors (especially 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 a result of bad processes and systems. In this case, the systems that caused this wide range of similar errors were reward, performance appraisal, communications, hiring and training.

The failure occurred because HR did not fulfill its role as steward of the company. Just talking about culture and values is not the same as developing people management systems that actively reinforce those values through metrics, rewards and punishments. Enron’s HR department developed human resource systems within Enron that measured and rewarded the wrong things. The company’s benefits systems failed to meet its fiduciary duty to protect its employees’ retirement earnings. And its performance management system did not punish (and may even have encouraged) workers, managers and executives who took unreasonable risks.

Enron failed because of the people it hired, or failed to terminate, and the HR systems it implemented that incorrectly appraised and rewarded risky and unethical behaviour. Enron’s fall was not really a rapid one. The stock had dropped from $80US 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 correct them. Given what we know from public information, here are some likely failures and missteps by HR. It’s important that HR professionals look at these failures not just because they happened at Enron, but also because they could aid in the identification of similar problems within other organizations.

I was not privy to any more information than what was made public, but I have made educated guesses about what happened. However, I believe that the following list is a reasonable estimate of what HR did wrong and what you might be able to do to prevent such a catastrophe at your organization.

The company culture and values: 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”) killed the company. HR must realize that when the size of the 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.

Benefits mismanagement: The most obvious error was the setting of 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 pensions was ineffective because some employees had Enron stock as a majority element of their 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 professionals must proactively run the numbers to monitor the percentages of their own company’s stock that is held in pension plans until average holdings fall below 20 per cent, 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 their portfolios.

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 failed to identify potential problems or to put “teeth” in its performance management systems that would severely punish (or fire) individuals who kept secrets, took excessive risks or violated the company’s values or ethics. As a result, HR inadvertently sent a message to employees and managers that results, regardless of how they are obtained, are all 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 normal risk to high risk. HR leaders can’t be naive about the risks involved in corporate ventures. Performance management and monitoring systems must be designed to fit the level of risk that is established in the company’s business model.

Compensation and incentives: Having a percentage of an employee’s pay based on performance is an excellent practice. However, making the rewarded percentages too high can encourage employees to take unreasonable risks. The large incentives for rapid growth, stock price growth and short-term gain encouraged bad behaviour.

Employees must be able to make mistakes and then safely report them. 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.

Executive compensation packages at Enron were so large and focused on short-term results and stock price increases that they rewarded risk-taking that may not have occurred without such benefits.

HR at Enron should have known that risks could be outrageously high in the derivative trading and offshore investment business. As a result, they should have pushed for a more conservative approach toward rewarding risk-taking.

Communications: Senior executives were continually telling employees (erroneously) about the high likelihood of large stock price growth. HR failed to recognize and communicate that these messages needed to be toned down.

HR and other communications systems failed to encourage whistle-blowers to speak out about questionable business practices. Only a single employee’s warning message (which happened to be at a vice-presidential level) reached the top. A culture that stifles individuals who criticize management needs to be monitored and changed. If HR is to have an impact on business decision-making practices, it must develop formal and informal feedback and communication mechanisms that ensure that the alternative perspective is always heard. HR must make it easy for employees to anonymously complain, as well as proactively seek out employee opinions and concerns.

In another communications failure, HR allowed the wrong start date of the pension stock selling freeze to be announced, so that even when employees were actually free to sell stock they didn’t know it.

Training: 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 measured on performance, results and an actual change in behaviour.

Hiring and retention: With its dramatic growth and large-scale hiring, Enron’s hiring standards could not always be met, and assessment tools were inadequate, especially in the areas of ethics, risk-taking and honesty in communications. The new breed of traders who were hired differed significantly from the old “oil drillers” who had previously dominated the company. 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. People management systems that work when a company is smaller, with a different mix of employees must evolve with the changing business model and employee population mix.

The many HR-related failures that contributed to Enron’s demise should send a powerful message that HR has an opportunity to become as prominent as other business functions.

John Sullivan is a professor of management at San Francisco State University. He can be reached at [email protected] or www.drjohnsullivan.com.

Latest stories