Three Eras

The decade prior to 1995 had been long and eventful. In 1984, the new chairman and CEO of Houston Natural Gas Corporation (HNG) transformed the Texas-centered company by purchasing two interstate pipelines: Transwestern Pipeline and Florida Gas Transmission. HNG’s previous management had rejected a lucrative takeover, and some investors were suing. Lay’s pricey acquisitions were no cure for that problem, however. Though doubled in size, the reconstituted company had less market valuation at the end of 1984 than the year before.¹

Lay ended his inherited fiduciary problem in 1985 when HNG stockholders handsomely cashed out thanks to a merger with InterNorth Inc.² Lay’s second revamping, which more than doubled the size of HNG once again, yielded a geographically diversified, integrated US natural gas company. But HNG/InterNorth had massive debt in unforgiving markets. A long slog seemed inevitable, with the company’s engineers, accountants, and a few lawyers doing what energy firms traditionally did.

Ken Lay was not an engineer, accountant, or lawyer. He was a big-picture economist with a skill set tending toward the political in an inherited mixed economy. Impatient, energized, and überconfident, Lay—with many favors to give and conflicts of interest to create—was out to do things grandly and to shoulder large risks. Exxon, where he had once worked, was the tortoise; Enron would be the hare in a newly created energy industry.

Enron’s third era was empowered by government policy. A regulatory restructuring by the Federal Energy Regulatory Commission (FERC) created a fourth industry segment—wholesale natural gas marketing—to join exploration and production, transmission, and local distribution. With its two predecessor gas-trading units already ahead, Enron became the national leader in 1985–86 and remained so until late 2001.

Enron Three also included high-risk international projects enabled by government-related financing. Another government-created opportunity was mandatory open access (MOA) for wholesale electricity, the product that joined Enron’s portfolio in 1994.

Enron’s next remake, the new frontier for Enron 2000, rested on a major public policy strategy. Wholesale MOA for gas and electricity, mastered by Enron, would be joined by retail MOA whereby both energies would be profitably sold to millions of homes and tens of thousands of businesses across the United States. Short of long-shot federal legislation opening up the retail market nationally, state legislatures and utility commissions stood between the third and fourth Enrons.

Energy, government, and smarts: Lay assembled brainy talent for the new competitive arena, quite unlike what HNG and InterNorth, and most any other energy firm, had ever seen. Enron’s chief PhD had first learned about regulated markets as an economist at the Federal Power Commission (FPC, 1971–72) and the Department of the Interior (1972–74). He learned more when he worked among the regulated at Florida Gas Transmission (1974–81) and Transcontinental Gas Pipe Line Company (1981–84). Moreover, while in Washington, Lay had taught the topic in graduate-level courses in microeconomics, macroeconomics, and business-government relations.

From the get-go, Lay jumped at new profit centers enabled by federal regulations and subsidies. He hired John Wing away from General Electric to form a leading gas-fired cogeneration business, a division enabled by a 1978 federal law requiring electric utilities to buy power from qualifying facilities at a (generously determined) avoided cost. The iconoclastic Wing would have a series of hits that expanded Enron domestically and defined Enron internationally.³

Early Enron also began buying and selling natural gas in interstate markets, an area created by new rules from FERC (the successor to FPC). Both HNG and InterNorth had skill and experience when MOA opened up dozens of major interstate transmission systems across the country beginning in 1985–86.

For the first time since 1938, (unregulated) marketers could profitably buy and sell natural gas in interstate markets, replacing the hitherto bundled sales handled by regulated interstate pipelines wherein no margin was allowed for the gas itself. (It was only a cost passthrough.) The result was Enron Gas Marketing—renamed Enron Gas Services in 1991 and then Enron Capital & Trade Resources in 1994—which commoditized natural gas in the United States, Canada, and then Europe. Next up for commoditization would be electricity, first at wholesale and then retail.

Another defining change was the 1987 relaunching of Enron Oil & Gas under newly hired Forrest Hoglund. A PURPA-enabled contract from Wing’s side and federal tight-sands tax credits propelled EOG in the late 1980s and early 1990s.⁴ By using a different business model from that of Ken Lay, Hoglund created real marketplace value in his company-within-a-company—one that would gradually divorce from Enron. A fishes-and-loaves story for its parent, EOG generated more than $2 billion from profits, lucrative tax credits to shelter Enron’s company-wide earnings, and stock sales in the period under review.

Internationally, Enron began with triumph: a megaproject in Margaret Thatcher’s UK privatization push and dash-for-gas enabled by North Sea production. John Wing’s Teesside, the world’s largest cogeneration plant at 1,875 MW, beat strict deadlines to become an important profit center for Enron.

With international credentials, Enron leveraged government funding and lobbying to target high-risk/high-return projects in underdeveloped countries. Particularly during the Clinton administration, the United States put its full weight behind Enron’s bold pursuits with loans, loan guarantees, trade missions, and government-to-government pressure in dozens of countries that were traditionally inhospitable to capitalist institutions, including the rule of law.

Electric restructuring was launched with an Enron-sponsored provision in the Energy Policy Act of 1992 (1992 EPAct), which led to MOA rules for the interstate (wholesale) market via FERC Orders No. 888 and No. 889 in 1996. The same George H. W. Bush legislation stipulated a lucrative tax break for qualifying renewable-energy generation, which would underlie Enron’s entrance into solar power in 1995 and into wind generation two years later. (Enron did not lobby for this provision, however.)

PURPA projects; FERC Orders No. 436, No. 497, and No. 636 (wholesale gas MOA rules); Section 29 of the Omnibus Reconciliation Act of 1990 (tight-sands tax credit); OPIC and Ex-Im financing (for developing-country projects); Section 721 of 1992 EPAct (wholesale power wheeling); Section 1212 of 1992 EPAct (a renewable-production tax credit); and FERC Orders No. 888 and No. 889 (MOA for wholesale power): politically opportunistic Ken Lay was moving in directions far different from those of the traditional energy major.

Enron’s unprecedented political orientation was part of something bigger. Lay’s management strategy did not have a name, only such descriptions as hyper-agressive and rule breaking. Part of the strategy was using public relations in ways that made the business seem bigger than it really was. Another part was gaming the rules legally to create a desired result or image despite the purpose and intent of those rules.

Enron’s strategy also had other defining aspects: using government as an enabler or counterparty; building widespread faith in a grand corporate narrative; persuading itself that the ends justified the means; treating the promise of future profits as a form of current income. In the most general terms, then, the strategy comprised rent-seeking, philosophic fraud, and strategic deviations from bourgeois virtue: But these terms were not used or even considered. Without thinking about it or even realizing it, Ken Lay was pioneering a new management philosophy: contra-capitalism.⁵

Circa 1996

Thrice revamped, Enron in 1996 stood in stark contrast to the Houston Natural Gas that Ken Lay found in mid-1984. Assets and revenues in 12 years had grown sixfold, to $16 billion and $13 billion respectively. Reported net income had increased almost fivefold to $584 million. And the market value of the enterprise was three to four times greater than 1984’s $3.7 billion.

Enron’s 38 percent debt-to-total-capital ratio at the close of 1996 compared to 1984’s 59 percent—and was a vast improvement from 1985’s postmerger peak of 73 percent. But there was a back story. Off the balance sheet, Enron had $5.2 billion of debt (versus $3.3 billion reported on the balance sheet). This represented a 63 percent debt ratio, which could have reduced Enron’s BBB+ (strong investment grade) rating to B (junk) according to John Bilardello, an analyst for Standard & Poor’s Corp.

In fact, as reported at the time in CFO magazine, Enron’s “ingenious structure” of off-balance-sheet entities allowed the company to report profits without the associated assets and liabilities. To the naked eye, it was as if the reported assets were generating all the profit.

And this too was during the Richard Kinder era.

At least on Enron’s balance sheet and income statement, the trend lines were positive. ENE’s appreciation increased capitalization to help bolster Enron’s all-important credit ratings. But as detailed elsewhere, Enron was borrowing from the future in every way it could without setting off alarms, a practice that began in 1989.⁶ Off-balance-sheet financing was increasing and about to skyrocket too.

Houston Natural Gas and InterNorth each had an international side, but major foreign divisions were divested or eliminated after the merger. Thus, Teesside began a new era for Enron, whose international units would involve some 30 nations by 1996.

Enron’s employee count went down—then back up. The newly merged HNG/InterNorth had 8,800 employees. Asset sales and layoffs, as well as increasing efficiencies (including pipeline automation), reduced the headcount by one-third. From this 1988 low, new businesses brought the workforce to an all-time high of 11,000 at the end of 1996.

The company’s composition had changed too. HNG at the end of 1984 was centered on natural gas transmission (mostly FERC regulated), representing 60 percent of assets and 80 percent of profits. Enron circa 1996 had gas marketing and international divisions accounting for nearly one-third of the parent’s total earnings before interest and taxes. The new-business headcount, which was less than 200 through 1991, reached 1,500 by 1995 and more than doubled that the next year.

Enron’s focus was still natural gas. In 1984, the front cover of Lay’s first annual report stated: “We’re going to stay with our knitting and do what we do best.” This was reconfirmed with the purchase of two interstate gas pipelines that year, and it remained unchanged with the 1985 merger. (Petroleum was secondary to InterNorth’s operations as well.)

In 1996, Enron was still oriented to natural gas except in those developing countries where a lack of indigenous gas supply made oil more affordable than imported LNG for power plants. Renewable energy, which competed against natural gas in electrical generation, was a new emphasis for Enron as a “green” provider for the retail marketplace. It was also a pure political profit play, as detailed in chapter 13.

Enron’s common stock was a growth story with high expectations built in. ENE’s total return to shareholders was 234 percent between 1990 and 1996, outdistancing Standard and Poor’s 135 percent as well as Enron’s peer group (mostly natural gas firms), which recorded 43 percent growth. A $0.90/share dividend, though being raised approximately 5 percent annually, represented a 2 percent return. ENE was a growth stock, not a yield stock.

ENE had a relatively high price/earnings ratio of 19 to 1, based on 1996’s closing stock price. (Peer companies were lower, with Williams Company tops at 17 to 1.) Optimism abounded. Chief of staff Ed Segner spoke of the need to increase Enron’s BBB credit rating from S&P and Baa1 credit rating from Moody’s, as “a first step towards the A rating that we want to obtain.” S&P did upgrade Enron to BBB+, but Moody’s left Enron unchanged. The new goal of A–, set in 1997, would never be reached.

A Changing Company

Each of Enron’s four major businesses could scarcely expect double-digit annual earnings growth. Enron’s fifth division, renewable energy, was a start-up in a traditionally money-losing business. A new growth story was required to effectuate Enron 2000.

Out with the old; in with the new: Enron was cashing out of EOG to reduce debt and finance its new ventures. The third selldown in 1995, to 61 percent, included an agreement to reduce ownership to 54 percent three years later. Enron would do this and more, with a complete divestment of Enron Oil & Gas Company in 1999.

The interstate pipelines, although a model of entrepreneurship within their FERC-set rate ceilings, could not expect double-digit earnings growth, except in a rare year when major expansions came on stream. Five percent growth was good. But far from expendable, the interstates gave Enron a predictable earnings base and a high cash flow. The humming interstates would go down with the ship and be the most valuable assets sold by a bankrupt Enron.

International’s touted $20 billion in potential projects was long on negotiations and short on signings, not to mention operational success. The counterparties—poor, unstable governments—were not prone to execution. The Dabhol power project in India, although back under construction in 1996, was not generating revenue to offset its snowballing costs, now in the hundreds of millions of dollars. Competition was also intensifying for the most viable projects, with host countries turning from negotiated deals to bids that narrowed returns.⁷

The coming of a new year at ECT did not bring new increments of earnings from previously executed multiyear deals. All the profit had been marked-to-market; changing circumstances might increase anticipated revenues, but change might also bring decreases, something Enron did not like to think about, as the Sithe deal showed.

Competition from Dynegy, El Paso, Coastal, and Transco—and other marketers in a field estimated at 200—were normalizing profits too. Earnings growth required new divisions and novel ways of doing business. Said Jeff Skilling in 1994: “The things we are doing are the things that our competition will be doing two or three years from now.” But maintaining first-mover status by constant innovation had risks, and other firms were hiring away Skilling’s talent, in order to emulate Enron’s best.

Traditional Enron had annual earnings growth of 5 to 10 percent at best, particularly considering some postponed and looming write-offs, two of which neutered Enron 2000 in 1997.⁸ New businesses, none greater than in electricity, had to come on as strong as natural gas had earlier in the decade, but electricity was an unknown despite Enron’s confident proclamations. In addition, leading the fourth and most ambitious reinvention would be an untested new president—the new heir apparent to Ken Lay.

New Leadership

Ken Lay was Enron’s constant from start to the finish. But a number of other executives were noteworthy in the overall progression of the company during the pre-1997 era. The most notable was Rich Kinder, who ran Enron alongside Lay for almost the entire period. Kinder was a real chief operating officer and, with good reason, was poised to become CEO in the mid-1990s.

Jeffrey Skilling built a company on the gas-marketing side. Another company builder was Forrest Hoglund, whose EOG exercised autonomy from the parent. John Wing, in fits and starts, was a third division builder for Ken Lay, first with domestic cogeneration plants and then with Teesside.

Rebecca Mark erected a major division, Enron Development, that would benefit Enron far less than the other three. In terms of opportunity cost, Mark’s developing-country investments equated to a major domestic gas pipeline acquisition, perhaps one to the (missing) Northeast, to achieve lasting asset value and cash flow for the corporation.

Enron’s honor role on the pipeline side in the 1984–96 era would include Jim Rogers in the 1980s and Stan Horton thereafter. In the midstream and wholesale gas businesses, Ron Burns was a top executive who would be missed after leaving Enron in 1995.

Michael Muckleroy, who crucially limited the damage from Enron’s oil-trading scandal in 1987, ably ran gas liquids until departing in 1993. John Esslinger led physical trading at Enron Gas Marketing, under its various names, until his departure by early 1997. And at EOG, Mark Papa was on the rise under Forrest Hoglund.

Richard Kinder Departs. There was much to like about Ken Lay’s longtime number two. President and COO Richard Dan Kinder was a keen operations manager and an able strategist. He performed the hard jobs for Lay after joining HNG in January 1985, none greater than rectifying underperformance. In the early years, he was number three in the corporate division, behind president and COO Mick Seidl, and served as Lay’s hammer.

As senior vice president and general counsel, Kinder chaired a cost-containment committee in the dark days of 1986 to learn all about the company. Promoted the next year to executive vice president and chief of staff, Kinder was breathing down the neck of Seidl before replacing him as Enron’s number two in 1989. It was during this time that Kinder shepherded Jeff Skilling through a gauntlet of doubters—and drained the swamp of alligators in the transition away from bundled sales and transportation by pipelines.

Kinder confronted Enron’s issues. His “brutal” executive staff meetings got problems solved. Accountability? Kinder got that from everyone except, perhaps, from his boss.

“I believe my expertise lies in analyzing complicated problems and situations, formulating several workable solutions, and with the aid of other talented people, reassembling them into a strategy,” Kinder stated. This was good enough for growth of 5 to 10 percent. But when Ken Lay’s zeal and permissiveness got Enron into new fields too quickly or dangerously, it ended up on Kinder’s top-10 list of problems, which he carried in his pocket for action. The “roving Mr. Fixit,” however, having signed off on such aggressiveness, even if reluctantly, had some items of his own making too.

Kinder’s was a voice of humility and caution, at least compared to the CEO. “I believe in the old saying that ‘pride goeth before the fall’,” he wrote employees after a strong year. “We must continue to pay attention to detail and hard work and stay ahead of our competition if we want to remain the industry leader.” Kinder warned against “drinking our own whiskey” or “smoking our own dope” in matters Enron, earning him a nickname, “Dr. Discipline.”

Rich Kinder was detail oriented and stayed inside Enron’s walls, two reasons why Lay increasingly relied on him. But Rich dutifully did the external tasks as well, such as chair the pipeline trade group Interstate Natural Gas Association of America (INGAA) in the mid-1990s.

With Kinder taking over, Lay gravitated to his first love: government affairs, public relations, and any outside-the-walls effort that would promote him as a Great Man—and ENE as a momentum stock. Lay and Kinder worked well as a team, although Lay thought himself far less replaceable than the COO, as did Enron’s board of directors.

Kinder doggedly worked, cajoled, and browbeat to make the fat numbers promised to the Street. But this went from being a strength (when based on reality) to a major weakness (when based on manipulation), and he got Enron into a bad habit that would infect, and eventually take over, its corporate culture and business model. The post-Kinder Enron derided in books about the company’s collapse was nurtured in the Lay-Kinder era.

Rich Kinder had been number three at Enron since 1987 and number two since 1989. In early 1994, the board debated elevating Kinder to CEO with Lay remaining as chairman. The directors were not quite ready for that, but the number two’s new five-year employment contract, effective February 1, 1994, set up the changeover.

Kinder’s new deal contained a trigger date of February 8, 1997, at which time Kinder could exit with full benefits “if mutually satisfactory terms pertaining to his future employment with Enron have not been agreed to by Mr. Kinder and Enron.” Lay’s new contract provided for an early termination on this same date.

Come 1996, Kinder was ready. The changeover might have happened already had the elder Bush been reelected and tapped his friend Ken Lay for a plum appointment, perhaps as Chief of Staff or Secretary of the Treasury. (Lay had reputedly turned down the lesser position of Secretary of Commerce, previously held by his own friend Robert Mosbacher.) Or, the change might have taken place had the mighty AT&T, faring poorly under CEO Robert Allen in the MOA telecommunications era, persuaded the 54-year-old Lay to come its way.⁹

During Lay’s AT&T negotiation, Enron’s board thought hard about Kinder as Mr. Enron. He was not as polished, diplomatic, or politically adept as Lay, they concluded. Neither was Kinder as visionary as Lay or, for that matter, Jeff Skilling—so the thinking went.

Lay, meanwhile, was enjoying Enron, with ever more reason to be Mr. Outside. The political and public sides of the company, Lay’s playground, were more important than ever. The national effort to market gas and electricity to homes and businesses, after all, was a crusade for lower prices and competition in place of franchised monopoly. Mr. Enron could now become Mr. Economist to make this case to millions.

The branding challenge for customers to trust and choose Enron required Ken Lay to become nearly as well known as the company. Opening markets meant a lot of work in Washington and in dozens of state capitals. There was local work as well, such as securing public financing for new professional sports stadiums in Houston, to enhance Enron in direct and indirect ways.

Being the progenitor of energy retailing would be a step up for Mr. Natural Gas and the industry’s provocateur on global warming. There was also congruency. Lay liked the applause from mainstream environmentalists, and renewable (“green”) energy was now a means to differentiate retail Enron to create a “new energy major.”

As the date for management succession neared, something else became crucial in the decision that would mark Enron for the rest of its life. Drama in the executive suite created a divide between Kinder and Lay, which sealed the fate of the man who had been positioned to become Enron’s new chief executive officer, effective January 1, 1997.

By mid-1996, it became known that Kinder was romantically involved with Nancy McNeil, Ken Lay’s top assistant, who had risen to become the vice president of corporate affairs. “The little general,” as she was known, was attractive, smart, tactful, and orderly. Along with Lay’s wife, Linda, Nancy was Ken’s confidante and liaison. McNeil had ended her marriage, and Kinder was about to end his when the rumors broke. Kinder did not admit to anything when directly asked by his boss, but the evidence was there.

Ken Lay informed his board of the facts. Personally, he felt doubly double-crossed. Had he not done more favors for Nancy and for Rich than could ever be known? The board voted not to promote Kinder, knowing the likely result. Kinder immediately tendered his resignation, and Lay entered into a new five-year contract as chairman, CEO, and president. The November 1996 announcement surprised just about everyone.

“I want to do more than be No. 2,” Kinder told the Wall Street Journal. “They offered me the chance to stay on, but it was sort of like ‘Been there, done that’,” Kinder told the Houston Chronicle.

ENE dropped less than 2 percent, hardly alarming but indicative of some pullout. Kinder had been the real Mr. Enron to the banks, the rating agencies, the whole investment community. “I view this as a loss to Enron,” stated Carol Coale, energy analyst with Prudential Securities Research. PaineWebber’s Ronald Barone was less concerned: “This is a company with great depth of management.”

Rich Kinder left with a package exceeding $6 million. In short order, he sold his ENE cache for several times more and married Nancy McNeil. Enron’s PR department presented Rich with a huge banner signed by thousands of employees. A lot of inside drama was forgotten at the instruction of smooth-things-over, friend-of-everyone Ken Lay.

What now? Though rich, Kinder had no thought of retirement. Instead, he approached William “Bill” Morgan, an old college and law school friend, as well as former colleague at Florida Gas and HNG/InterNorth. His idea was to start a midstream energy company. In fact, Kinder had laid the groundwork by acquiring the very assets that he had helped Enron spin off several years before: Enron Liquids Pipeline Company (ELPC).

Kinder Morgan Energy Partners was established in February 1997 upon the purchase of Enron’s general-partner interest in ELPC. For $40 million, Kinder Morgan assumed two liquids plants, a carbon dioxide pipeline, and a coal-transfer terminal. By using a master limited partnership to buy assets with a lower rate of return than was acceptable to corporations paying income taxes, and by cutting costs in a way he could not at Enron, Kinder launched a midstream play that would achieve a billion-dollar valuation by 1998.¹⁰

When Enron was liquidated several years later, Kinder presided over a company worth $7 billion. His company’s 200-page notebook for the 2003 analyst meeting was titled: “Same Old Boring Stuff: Real Assets, Real Earning, Real Cash.” Kinder would take no questions about Enron, despite the obvious differentiation he was making from a company that, two years before, Jeff Skilling had claimed to be worth $126 per share (at a time when ENE was at $82). Just four months after that pitch, Skilling would resign from Enron, and four months later, Enron would declare bankruptcy, and ENE soon became worthless.

Jeff Skilling: President and COO. Who would be the new number two at Enron? Ken Lay, now chairman, CEO, and president for the first time since 1990, told his top operation officers—Jeff Skilling, Stan Horton, Rebecca Mark, and Forrest Hoglund—that no replacement would be named for the time being. The press, meanwhile, mentioned Horton, Enron’s Kinder-like disciplinarian over the pipelines, and Ed Segner, Enron’s brainy, finance-savvy chief of staff.

Lay wanted a number two with commercial experience. Forrest Hoglund was approached by the board but immediately declined, and Rebecca Mark, though a Lay favorite, was not considered ripe for the position. The frontrunner was wunderkind Jeffrey K. Skilling—who told Lay that he was ready for this promotion and was prepared to leave Enron if he did not get it.

On December 12, just one month after Kinder’s resignation, the 43-year-old Jeff Skilling was named, effective January 1, 1997, Enron’s president and chief operating officer, while remaining chairman and CEO of Enron Capital & Trade Resources. Lay and the board had wasted little time in choosing the new direction of Enron, which was already embarking on a growth path right up Skilling’s alley. But to some near the top, “Jeff basically blackmailed Ken.”

There was now a visionary at number one and number two, which Lay and the board felt was fine, as long as Horton and Hoglund were still in place. But Horton and Hoglund were Old Enron; the new businesses were another story. With Skilling’s attention now divided, he had to turn the baton at ECT over to the talented but erratic Lou Pai. (John Esslinger, a mainstay on the physical side of ECT’s business, had just retired.) Internationally, Lay was confident about Rebecca Mark, although Jeff Skilling (like Kinder) was not.

Wall Street liked Rich Kinder, but Skilling had never disappointed either. The father of commoditized natural gas at the center of a restructured industry was being compared to Clark Kent himself. “Don’t ever think that Jeff doesn’t have a big red S under his dress shirt,” stated Steve Parla of Credit Suisse First Boston. “He was so far ahead that it took us a while to figure out what he was trying to do,” stated another top Wall Street analyst, Kurt Launer of Donaldson, Lufkin & Jenrette. (Both bulls, incidentally, worked for investment banking firms that benefitted from Enron equity issues and were little inclined to peek too far under the hood.)

And wasn’t Jeff Skilling the value creator who turned the 2-person Enron Finance Group and the 140-strong gas-marketing group into a 2,000-person behemoth, increasing revenues from $10 million in 1990 to $300 million? In thought and practice, there was virtually no blemish on his record.

But there were doubts. John Wing, for one, cashed out of ENE upon hearing of the change at the top. Investment analyst John Olson at Merrill Lynch had a furrowed brow. As it would turn out, Skilling-for-Kinder proved calamitous. Skilling was not skilled at setting and enforcing divisional budgets. Though Skilling engineered current-period profits, he was not managing costs. Enron’s head of administration, Jim Barnhart, remembers Skilling saying “on several occasions, ‘I don’t care what you spend as long as you make your numbers’.” Richard Kinder, by contrast, would say: “‘Jim, even when times are good, we want to be counting heads and looking at money…. You are going to have to justify everything you do’.”¹¹

The new COO was a big-concept guy, a 15-percent-growth thinker, who needed a disciplinarian. Skilling could certainly read financials and get to the essence of things, but Enron had many parts outside of the new COO’s expertise. Perhaps most important, Skilling was a proven corner cutter, a deceiver in the cause of making the numbers to reach personal and corporate goals.

Skilling’s dual titles with corporate and ECT were complicated. Citing burnout, he had almost quit Enron before hatching a plan to work half-time, although the plan was abandoned at the last minute. In 1994, Ron Burns had joined ECT with a title coequal to Skilling’s (and Esslinger’s), in order to deal with the Skilling uncertainty, but neither Burns nor Esslinger was still at the company.

Enron would now increasingly become Jeff’s company with an (MOA-enabled) asset-light strategy. But could he run the entire enterprise? Ken Lay was not Richard Kinder, and there was really no one else, certainly not the vice chairmen, who had narrow roles.¹² Ron Burns, chairman of Enron Pipeline and Liquids Group before cochairing ECT, had left the year before to become president of Union Pacific Railroad.

But prior to Skilling’s appointment, Burns was suddenly available to rejoin Enron after a rocky 15 months at Union Pacific Corporation. Lay invited him to do so, but Ron wanted to be number two (COO and president) with authority over both Skilling and Mark, who were sideways with each other. This was more than what Lay had in mind. The idea was to add Burns, not risk losing Skilling and upsetting Mark.

Ken Lay: Going Outside. Ken Lay had been Mr. Inside after joining HNG in mid-1984. With a bulging lawyer’s briefcase, the workaholic tackled all things HNG, HNG/InterNorth, and Enron. This began to change in the late 1980s when it increasingly became Lay as “Enron’s Mr. Outside and Kinder as Mr. Inside.”

It was not that Lay was incapable of handling intricate detail, and a lot of it. His Pentagon research, turned into a doctoral dissertation, showed his technical proficiency in mathematics and statistics. And Lay always did what needed to be done at his previous corporate stops.

With Kinder et al. inside the walls back home, Lay’s mission went international: first to put Teesside into play with the UK authorities and thereafter to court foreign dignitaries for Enron’s developing-country projects. There was increasing work in Washington. And also beyond 1400 Smith Street in Houston, Lay’s busy itinerary included state capitals, including Austin, Texas.

By the time Kinder left, Mr. Outside had become “the imperial chairman” who was not inclined to revert to his former hands-on life. This board director of Texas Commerce Bank (joined 1985), Compaq Computers (joined 1987), Trust Company of the West (joined 1992), and Eli Lilly Company (joined 1993) had responsibilities with dozens of other organizations, such as the President’s Council on Sustainable Development, the Business Council, the National Petroleum Council, the American Enterprise Institute, and the H. John Heinz III Center (an environmental think tank). Past chairmanships included the Greater Houston Partnership, the University of Houston Board of Regents, and the Houston Host Committee for the Republican National Convention, as well as his cochairmanship of the 1990 Houston Economic Summit.

Hosting events for important people and for philanthropic causes made for busy evenings. There was active grant making by the Linda and Ken Lay Family Foundation. Being everyone’s friend—all in the service of branding Enron and widening the market for ENE—would increase Lay’s association count to 76 by 2000. The question became: “When did Ken Lay even have the time to run Enron?”

Into 1997, Lay was the face of Enron to external constituencies and to employees, now a major investor group in the company. “Ken will spend much of his time on international projects, business development, government, customer, and employee relations,” Enron Business explained in early 1997. “Both Ken and Jeff will continue to focus a lot of their time on strategy, including new energy-related business areas which will further accelerate Enron’s growth.”

But who would veto expediency that endangered financial sustainability? And who would dig deep into budgets to question and cajole the unit heads—and follow up weekly on the difference between what was promised and delivered? That would not be Skilling, and Kinder was doing it at his own company two blocks away—and with just-purchased Enron assets.

The New Enron

Old Enron was in the background by 1996. Interstate gas transmission remained at the core, and talent infusions would try to “Enronize” the pipelines in the face of regulatory constraints. But Enron was monetizing its traditional assets almost everywhere with selldowns and public offerings.¹³ International was slowing: although Dabhol’s construction was restarted in December 1996, most other projects were only inching ahead.

New Enron was centered on Jeff Skilling and Enron Capital & Trade Resources. Enron had mass customized (commodified) natural gas at wholesale in terms of price, term, location, and reliability. ECT, which between 1990 and 1996 increased its gas-product slate to more than 200, was moving more quickly on the power side. Enron’s North American electricity unit (wholesale only) listed some 250 different products in 1996, whereas none had existed several years before. Europe, too, was offering an energy-product slate in excess of 250 by 1996, versus zero in 1994.

This was prologue to Enron’s new big bet. The basis of Enron 2000’s aggressive, even audacious, goal was natural gas and electricity retailing.

“We have started a new stand-alone retail business that five years from now will, we believe, generate revenues equal to or greater than our total 1996 net income of $584 million,” Enron’s 1996 Annual Report informed investors. This would make Enron an energy major, on a par with the integrated oil majors. Assuming a 10 percent share of the $207 billion US retail electricity market (a figure considered conservative, given Enron’s one-third share of the wholesale market), Ken Lay hypothesized that Enron’s retail revenues would exceed those of the oil giants. Part of this was size: electricity’s $207 billion market compared to gasoline and diesel’s $107 billion market at the service station. Mobil, Shell, Exxon, Texaco—Enron would outsize them all.

The goal was to secure as many as 20 million households. The national effort would lead with pilot programs and a campaign to brand Enron. In addition to New Hampshire, where the major pilot program was under way, the first statewide push would be in California, which had set dates for a retail phase-in program for electricity.

As detailed in chapter 15, Enron was working on five fronts to become a mass retailer of gas and electricity to homes and businesses:

• A business plan and product development to offer end users an alternative to utility service;
• Advocacy and lobbying for federal and state initiatives to open markets via mandatory open access on the retail level;
• Advertising and outreach (“branding”) so customers would be comfortable in switching from their utility to Enron;¹⁴
• Pilot programs to prove the concept of signing up retail customers;
• Purchasing Portland General Electric (PGE) to learn the distribution business and set up a pilot program in the Northwest.

No other company was doing this. It was no small experiment. In relation to the rest of Enron, mass retailing was a bet the company strategy for keeping ENE’s momentum. But electric utilities with decades of incumbency and political power stood between Enron and Enron 2000. It would not turn out as expected by the upstart.

1996 Annual Report. Enron’s first branded annual report—dated March 4, 1997—described the company’s storied past and transformative future. Lay’s 14th annual report was different from Enron’s previous 11, HNG/InterNorth’s 1, and Houston Natural Gas’s 2. The change was not only in the office of chairman, where a new number two executive was pictured. It was also the exuberant story of a Horatio Alger–like business poised to monetize a reinvented future.

The who we are section of the “Letter to Shareholders and Customers” (Letter) had several self-descriptions, such as:

• “one of the largest integrated natural gas and electricity companies in the world”
• “the top natural gas and electricity wholesale marketer in North America”
• “the most successful developer of energy infrastructure in the world”

Looking ahead: “We’re also becoming one of the largest international suppliers of wind and solar renewable energy.”

“We are proud to be a leader in a great industry,” Lay and Skilling wrote. “But we believe our achievements so far are just a prologue to a new and enormously exciting story that is unfolding on the energy landscape.”

Specifically, the deregulation of gas and electricity (translation: retail MOA for gas and electricity in North America) was creating “a huge new $300 billion a year market.” And in other Western industrialized countries: “State owned and private monopolies are giving way to private competition.” In the developing world, “new markets are emerging as governments turn toward privatization, especially in the areas of telecommunications, transportation—and energy.”

Enron was in the middle of all three new energy plays, the Letter emphasized. The plan was to “become the largest provider of electricity and gas in the U.S.”—and in Europe, in 5 to 10 years. LNG projects, not only electricity marketing, were “off to a tremendous start.” Add renewables, and three new businesses were “on track” to deliver “a net present value of at least $1 billion or more by early in the next decade.” Spin-offs were envisioned, such as EOG (but not ECT).

Buzz terms in the annual report included “extraordinary change” … “extraordinary promise and potential” … “accelerating convergence of the natural gas and electricity markets” … “the new world of energy” … “reinventing the energy business.”

Live-for-the-moment Enron—which used and abused mark-to-market accounting and sold assets (future profit streams) in order to record extraordinary profit—publicly declared itself living for the future. “Enron is convinced the correct view is the long view,” the 1996 Letter stated. “Invest time and resources now, plant seeds that will bear fruit, bolster market development efforts, cultivate change, grow the company.”

This exuberance left many important underlying issues unmentioned, ones that the (conflicted) investment analysts were slow to uncover, much less highlight. They were:

• The challenge of earnings growth in rate-of-return regulated businesses, not only for the interstate pipelines but also for the pending acquisition, Portland General Electric.
• Normalizing margins in ECT, as well as the each-new-year burden from mark-to-market accounting.
• The trade-off (double counting) between prospective retail market share and already held wholesale market share.
• The lack of international deal closings and, in particular, the remaining counterparty problem of the Dabhol power plant that was back under construction.
• The prospect of imminent write-offs. (Teesside II’s J-Block liability was discussed in the back of the annual report; the soured MTBE investment not at all.)¹⁵
• The November 21, 1996, propane explosion in San Juan, Puerto Rico, that left 33 dead, 80 injured. (Immediate suspicions would be confirmed, and Enron’s San Juan Gas Company would conclude settlements in 2000.)

Half-truths were resorted to. The highlight of Enron’s new growth story was the “very successful” retail pilot projects, led by electricity in New Hampshire. True, Enron was retailing as no independent company ever had with gas and electricity. But the economics were not working, just as rival Chuck Watson at NGC (later Dynegy) had predicted. By Enron’s own math, the loss per customer at retail could not be made up on volume; the more the customers, the greater the overall deficit.

After changing out management several times, in fact, ECT was bailing out of the residential market in 1996. (The new model, total energy outsourcing for large commercial and industrial customers, led to the reorganization of Enron Energy Services in first-quarter 1997.) Talk in the annual report about serving “up to 1 million [retail] customers by year-end 1997” would not be repeated.¹⁶

The Letter contained another half-truth, even mistruth. Although not mentioned by name, Enron 2000’s pledge was reiterated: “We expect to achieve compound annual growth in earnings per share of at least 15 percent from 1996 through the year the year 2000. We expect minimum double-digit earnings per share growth every year during that time.” Yet several months later, write-offs were announced that would make 1997’s earnings growth rate a negative 18 percent. The half-truth? Year-to-year net income growth excluding the special charges was 18 percent.

By all appearances, Enron was entering its new phase strongly. Financial engineering, as well as postponed write-offs, kept 1996’s profit growth at double digits, a promise of Enron 2000. ENE was a momentum stock, not a yield stock as it had been a decade before. The optimism, the shared narrative, had to go on in order to preserve, if not upgrade, the credit ratings so crucial to Enron’s large trading operation.

Enron’s 1996 Annual Report had special help. In search of a memorable Letter, not unlike that of Jack Welch at GE, Ken Lay and Jeff Skilling turned to Peggy Noonan, the White House speechwriter who had churned out memorable phrases for Ronald Reagan and then George H. W. Bush.

Noonan spent two days touring Enron to learn about the company and its ambitions. She noted the “cavernous rooms,” “omnipresent computer screens,” and “future Masters of the Universe.” She met individually with Ken Lay, Jeff Skilling, and Rebecca Mark. Was this the New Age corporate world, she wondered, or an outlier?

Everything went according to plan, but Noonan had trouble finding special prose for what “seemed to depend on things that were provisional.” “They were building this and tearing down that, they were, they told me, talking to legislators in various state houses, lobbying to get deregulation bills passed,” all of which “seemed expensive, labor-intensive, time-intensive.”

“My contributions were not helpful,” she admitted, even after spending between 100 and 200 hours of billable time, at $250 per. “I didn’t fully understand what their mission was.” It was something different from selling a ware in a store, she later explained. There was something else: “a sort of corporate monomania at the top—if you can’t understand what we are doing then maybe you’re not too bright.”

In particular, Noonan found Skilling’s retail pitch less than convincing. It was “too complicated,” she told Jeff. In a busy world, choosing an electricity provider “just might be one item too many on the average consumer’s Daily Decision List.”

Noonan sensed what economists called high transaction costs. Sure enough, without a consumer uprising for change, Enron was spending a lot of money in multiple directions to attract what turned out to be few customers. Business from retail MOA was a breed apart from wholesale MOA, as Enron would painfully discover.

“An Empire Built on Ifs,” certainly benefitting from hindsight, was published in the Wall Street Journal the month after Enron’s bankruptcy. Noonan described greed in the abstract, recounted her Enron story, and then turned to public policy. Conservatives and Republicans, such as herself, had a “special responsibility … to come down hard on people who cheat their shareholders and their employees,” especially since Enron’s debacle was “damaging to faith in free markets.”

But like other conservatives, she did not grasp Enron as a uniquely contra-capitalist company, practicing rent-seeking and dealing in omission, half-truths, and misdirection, not to mentioned imprudent behaviors.

Roaring Ahead. Into 1997, Kinder forgotten, the outside world was buying the story of a company in the sweet spot of four energy megatrends: deregulation, as defined by Enron (MOA); privatization; demand growth, mostly in natural gas and renewables; and environmentalism, the movement away from coal in particular. Enron was playing both Bootlegger and Baptist. “We’re on the side of angels,” Jeff Skilling stated. “We’re making the environment cleaner, reducing costs for consumers, and disciplining the monopolies of 100 years.”

The media found Enron compelling. News organizations certainly received a lot more press releases from Ken Lay’s enterprise than from any other energy company. And Enron’s public and government affairs departments, outsized by industry standards, would only get bigger as Enron took on the energy establishment in the political arena.

Enron was a world-class natural gas firm entering into new and existing fields. A business feature in early 1996 in the Washington Post was titled: “You’ve Heard of Big Oil. This is the Story of Big Gas … And It Begins with Enron Corp., Which Wants to be No. 1 In World.” Catch phrases, such as “integrated energy solutions” and “energy merchant,” described a new kind of energy enterprise.

More differentiations were coming from the media and particularly from Enron. The “border-to-border, coast-to-coast” pipeline company of the 1980s was now a “new energy major” offering “energy management” and “green BTUs.”

Enron was capitalizing on “major industry discontinuities,” including a “convergence” of gas and electricity.¹⁷ “First-mover advantage” and “strategic regulatory approaches” had produced, by 1997, an “incomparable North American competitive advantage,” what two years later would be self-described as an “unassailable competitive advantage.” The same model for Europe and South America was creating a “global energy franchise,” Enron would tell investors in the 1998 annual report.

Enron was turning creative destruction into a profitable cornucopia, the message became, despite misses in the trial-and-error process. “Creativity is a fragile commodity,” Enron’s 1999 Annual Report would state. “We support employees with the most innovative culture possible, where people are measured not by how many mistakes they make but how often they try.”

In 1996, Enron had been recognized by Fortune magazine as America’s most innovative company, the first of six consecutive adulations. “Most grateful,” Enron responded in a full-page ad, thanking customers for envisioning change and employees for effectuating it. (See p. 662.)

Business Week named Lay as one of the nation’s top 25 executives; World Cogeneration magazine named him its Executive of the Year. “Keen familiarity with the political landscape has been at the heart of Ken Lay’s and Enron’s success in the restructured energy business,” the latter profile read.

Awards were also collected from outside the business community. For the company’s green-energy initiatives, the left-of-center Council on Economic Priorities awarded Enron its Corporate Conscience Award for Environmental Leadership for 1996. Much more recognition and several awards came the next year in conjunction with the international climate conference in Kyoto, Japan.

How did Ken Lay see himself and business? The answer was provided in his life history, prepared in nomination for the Horatio Alger Award (which he would receive in 1998). The Enron-prepared 12-page biography contained these highlights:

• “Much of Ken’s career has evolved around opening up regulated markets for competition and preparing whatever companies he has been involved with to win in the new competitive environment.”
• “Ken also has led Enron to become a global powerhouse in energy.”
• “He flattened the organization, reduced costs, established totally new incentive systems and, in the process, created centers of entrepreneurship throughout the company.”
• “Extending his strong belief in markets and competition, Ken and his organization have been at the forefront of a number of the economic liberalization efforts in the developing world.”

In the 10 years ending 1996, the profile detailed, Enron’s market value increased from $2 billion to $11 billion, with a total return to shareholders of 408 percent, a multiple of that of Enron’s peers and more than one-third above the average appreciation of the S&P 500.

“Ken Lay has been a strong proponent throughout his life of giving back to his community and nation,” the primer added. “He is fond of a quote that he believes is from Bruce H. Wilkinson that says, ‘You make a living from what you get, you make a life from what you give’.”

The personal-philosophy section of Lay’s application reproduced Ken’s story as published in Michael Novak’s Business as a Calling. “I grew up the son of a Baptist minister,” it began.

From this background, I was fully exposed to not only legal behavior but moral and ethical behavior and what that means from the standpoint of leading organizations and people. I was, and am, a strong believer that one of the most satisfying things in life is to create a highly moral and ethical environment in which every individual is allowed and encouraged to realize their God-given potential.

Novak resided at the American Enterprise Institute, and his book was published by AEI, a conservative, centrist public-policy foundation (think tank) where Lay was a board director. Enron’s CEO was here, there, and everywhere.

Ken Lay was an inveterate optimist. He had never failed, only exceeded expectations. “Lay displays an unshakable confidence tempered by more than a decade of taking big risks and winning,” read a mid-1997 BusinessWeek article, “The Quiet Man Who’s Jolting Utilities.” Enron versus the Edison Electric Institute was Lay’s biggest political battle yet, the article noted, and the prize was MOA as a precondition to retailing gas and electricity profitably.

Golden Enron had a few critics. In a 1993 Forbes piece by Toni Mack, Enron’s mark-to-market accounting was criticized as a short-run expedient. In a 1995 Fortune feature on Enron, Harry Hurt III identified an unhealthy short-term bias. From time to time, John Olson in the investment community expressed doubts.

But four years after her 1993 criticism, Mack wrote glowingly about Enron as a mass energy retailer in an opening market. “The numbers are awesome,” she began her Forbes piece, pegging the contestable market for retail electricity at $215 billion and for retail gas at $90 billion. Representing a bigger market than long-distance telephony ($170 billion) and airlines ($100 billion), innumerable gas and electricity customers were in play.

“California, New York, Pennsylvania, Illinois, and some New England states are moving quickly toward deregulation,” she wrote. Federal legislation was introduced to open the whole market nationally, and states would have to move fast to forestall federalization. Enron’s branding was bold and prescient. She closed: “Enron Corp. President Jeffrey Skilling sums up the future of the electricity business when he says: ‘It’s going to be an absolute competitive battlefield.’”

Still, questions were raised about Enron’s near-term profitability from mass retailing. Branding was a $100 million job, Mack estimated. And regarding Enron’s touted $20 billion in international projects, another (otherwise laudatory) article noted: “Critics say that some of these projects are relatively small and that it’s too soon to tell whether others will be completed.” In addition: “The fate of the company’s largest international project, the planned $2.5 billion naphtha and natural gas–fueled Dabhol plant in India, they say, remains uncertain.”

In 1996, Prudential Securities and Dean Witter Reynolds downgraded ENE from a buy to a hold on profit concerns. ENE would slump after first-quarter 1997 as write-offs and retail’s start-up costs kicked in. (Enron’s negative return to shareholders in 1997 was “unacceptable,” Lay would tell investors.) In fact, ENE was in a two-year slump, and, by late 1997, Enron a rumored takeover target. “Year-Long Slide in Stock Price May Put Giant Enron on Hit List,” a Natural Gas Week headline read.

Skilling’s Company. In mid-1996, when Kinder was presiding, Enron had four units: Enron Operations (housing the interstate pipelines, gas liquids, and construction services); Enron Capital & Trade Resources; Enron International; and Enron Oil & Gas Company.

A year later, when Skilling was presiding, there were seven units: Enron Oil & Gas; Gas Pipeline Group; Enron Ventures (Engineering & Construction; Clean Fuels; EOTT); Enron Capital & Trade Resources; Enron International; Enron Global Power & Pipelines; and Enron Renewable Energy.

By the end of 1997, the count was nine, with the addition of Enron Energy Services, Enron Europe, and Enron Communications (split from PGE), and the subtraction of Enron Global Power & Pipelines.

It was Jeff Skilling’s company, with Ken Lay increasingly occupied with speeches, lobbying, and foreign projects. Skilling, with full support from Lay and Enron’s board, put all of Enron’s money on the table (and some under it). In 1997 alone, capital expenditure doubled to $1.4 billion, debt nearly doubled to $6.25 billion, and interest expense increased by almost half.

Skilling-side talent would rise too. “By the end of Skilling’s first year, Skillingites filled 11 of the 26 slots on Enron’s management committee, including such disparate positions as finance and government affairs.”

A key early initiative to speed the company was Enron Capital Management (ECM), a corporate-level group that assumed the finance and risk functions for both the corporate division and within ECT. Headed by Andy Fastow, ECM’s 100 staffers were responsible for pending projects cumulatively exceeding $15 billion with a potential for $40 billion more.

In addition to the traditional function of managing Enron’s funds flow and cash balance, ECM pledged to give all business units a lower cost of capital, so that they could increase their flow of projects. “We want the commercial teams to have capital as a weapon in their arsenal that will allow them to do deals that other companies can’t,” explained Enron’s new senior vice president. There would be no argument from Ken Lay about what his new number two was doing for Enron’s quest to get to the top—ASAP.

ECM quantified all of Enron’s financing risks in one pool, not unlike what ECT did with its deal book. Fastow had already executed on-the-edge deals to help Enron make its 1995 numbers and then its 1996 numbers. But there would be some dramatic aggressiveness, even illegality, in 1997—and much more ahead, resulting in Andy Fastow’s becoming the most infamous figure in Enron’s eventual collapse.

Righting Misinterpretations

The rise and fall of Enron Corp. stands as one of the most astounding and confounding episodes in business history and in the annals of American capitalism. Its interpretation involves the morality and efficacy of markets—and the legitimacy of commercial capitalism itself. Among political-economic narratives, that of Enron rivals the stories of John D. Rockefeller’s Standard Oil and of America’s Great Depression in terms of molding opinion and testing worldviews. Samuel Insull’s rise and fall, the subject of Edison to Enron (Book 2 in this series), was in its own day an opinion-forming event of comparable magnitude, and one with many parallels to Ken Lay’s rise and fall.

Yet through its many tellings, the Enron story has remained fundamentally misinterpreted. As presented in the company’s aftermath (2001–3)—and repeated on the 5th, 10th, and 15th anniversaries of Enron’s bankruptcy—the mainstream view has been that flawed character traits were enabled by deregulation and that underregulation caused the artificial boom and decisive bust called Enron. Capitalism’s “infectious greed” and “irrational exuberance” were the essence of Enron, it was said. Ayn Rand and free-market economists were held intellectually culpable.

These takeaways must be thoroughly and wholly reconsidered, as this book series has tried to do.¹⁸ Enron manifested contra-capitalistic tendencies, virtually from its beginning. These deviations from best-practices capitalism grew from molehills to mounds to mountains, eventually bringing down the company in complete and startling fashion.

Enron is the story of corporate decision making in action. “Ultimately,” as one Enron book concluded, “this is a story about people.” Those people were motivated decision makers, responding to inducements and opportunities that had much more to do with political capitalism and a postmodernist mentality than with classical liberalism.¹⁹

This book’s review and reinterpretation of Enron’s formative era reaches two major conclusions. First, Enron was not a free-market company; nor was Ken Lay a true free-market advocate. Just the opposite: Enron was a contra-capitalist company, and though Lay was procapitalist in his mind, he was contra-capitalist in action.

Second, Enron came to practice the incoherent philosophy of postmodernism, whereby thinking and wanting and expecting a state of affairs substituted for taking the hard, patient steps to create it—or the studied decision not to create it. Overambition, overconfidence, misplaced hope, and outright hubris were evident in the scary triumphs, major setbacks, and public relations highlighted in this book.

Enron as a Process

Enron was not a thing or a place. Enron was a process of business decisions with action leading to result, and result inspiring new action. This book’s chronology of cause and effect by division, and for the corporate whole, has attempted to present Enron in you-were-there fashion, with the reader asking: What would I have done? What would I have warned Enron’s leadership about? Such realism humanizes a story that in a simplified, storytelling, nonprocess form can appear peculiar, even inexplicable.²⁰

Subtle and evolutionary, process analysis is key to understanding how Ken Lay’s company morphed into something quite different from what even he and Enron’s board of directors could have imagined. This is why the Enron story contains multiple tipping points, even a tipping point within tipping points.

“It seemed like a small leap to make from bending the rules to breaking them,” one Enron chronology concluded. Author Loren Fox continued: “There was no single moment when Enron transgressed from rule bender to rule breaker: Rather, the transformation resulted from the gradual accretion of offenses, encouraged by a corporate culture that valued aggression.”

Similarly, Harvard’s Malcolm Salter described a “pattern of deceptive behavior that unfolded in incremental steps over time, as a result of pride and hubris, a host of unprofitable new ventures, a culture of deceit, and breakdowns in performance measurement and control systems at a time when Enron had trouble meeting its aggressive targets.”

Best-practice business consultants, drawing upon field research, have also emphasized process. In Good to Great: Why Some Companies Make the Leap and Others Don’t, Jim Collins showed how improvement “never happened in one fell swoop” but “by a cumulative process—step by step, action by action, decision by decision, turn by turn … that adds up to sustained and spectacular results.”

The “organic evolutionary” process identified by Collins can also work in reverse, with a great company deteriorating to merely good or a good company falling to bad—and worse. Enron, more than any other, demonstrated the good-to-bad sequence as the company’s defective divisions overwhelmed the good, while the corporate center fell prey to behaviors opposite from those identified in a science of success.

In sum, Enron was a for-profit commercial enterprise in the mixed economy, where pecuniary incentives emanated from a jumble of consumer-led free markets and government-driven political markets. Taking into account personalities and incentives, the elusive why behind the why of Enron’s classic saga emerges. This did not begin in the Lay-Skilling era, although it accelerated and became entrenched in 1997. Rather, this why was characteristic of the Kinder-Lay era, which closed in 1996.

The Richard Kinder Question

“Tempt not a desperate man.” Enron was at a crossroads when it entered the Jeff Skilling era, and a year of hard reckoning lay ahead. Either the company needed to restructure and get back to the basics—as it had done a decade before—or accelerate with chancy bets. Already, some tipping points had been reached; now Enron was at a new crossroad, a big one.

The contra-capitalist course was chosen, in keeping with the still-fresh promises of Enron 2000 and the charge to become the world’s leading energy company. Ken Lay knew only one speed—and Skilling liked that pace too. With two rock-solid physical-asset divisions (interstate pipelines and EOG), and a world-class energy trading division, Enron had a base from which to dive into the new.

As it turned out, monumental hype in wholly new areas (renewables, energy outsourcing, broadband, water, online trading); new heights of financial engineering (mark-to-model accounting, RADR, Chewco, LJM I, LJM II); Ken Lay’s mighty persona; and political correctness would keep Enron’s narrative going until 2001, when a harsh and irreversible reality set in. In retrospect, the end had been postponed by scurrilously deft work done by an empowered, conflicted, criminal CFO.

Most historians placed the beginning of the end, the “tipping point,” in 1997, when Jeff Skilling took over as Ken Lay’s second in command. Big losses were taken in that year to clear the decks for a robust future. That was the message, anyway. Appearances winning out, ENE fell only 4 percent that year, and the all-important credit ratings were maintained. Crisis averted. But behind the scenes, a very different Enron was being put into hiding.

Next to Valhalla, which nearly reached the point of bringing down Enron, the company’s greatest what-if story is: What would have happened if Richard Kinder had become chief executive officer as originally planned, with Lay as chairman of the board?

The new CEO would have certainly been in a tight spot. Enron 2000 was Kinder’s promise too, and he had signed off on a number of undertakings that became company problems. “To view Kinder simply as the white knight who got away is to ignore a more complicated reality,” noted Bethany McLean and Peter Elkind. “In truth, some of the seeds of Enron’s downfall were sown on Kinder’s watch.”

True—but more so.

A Kinder era at Enron would have been more painful and the pitfalls greater than could have been realized (even by Kinder at the time). Given the fate of top Enron executives who stayed until the end, Kinder’s clean break in 1997 to build Kinder-Morgan made him very fortunate.

A counterfactual history of a post-1996 Kinder-Lay era can be surmised, however. First, Enron would have taken the same two write-offs that were taken in 1997. (Dabhol as a third write-down would probably not have been taken by Kinder—no change there.) But the year’s net loss would have been greater under a Kinder-approved CFO than under Skilling’s Andy Fastow, who got busy cooking the books.

A major cost-cutting campaign would have been necessary, not unlike the downsizing in 1988—when consolidation and layoffs were taken to reposition Enron “as one of the least-cost providers of natural gas in the country.” Corporate expense, an overhead charge to the various business units, would have been slashed. Rich Kinder certainly would not have been Mr. Houston or a political dynamo or serial speech giver and image maker like the prior CEO—just an inside-the-walls chief executive getting back to basics, before enlarging the company.

Kinder’s Enron would have been much closer to Forrest Hoglund’s EOG and Stan Horton’s interstate pipelines—and less like that which was taking shape by 1997–98: “a new type of company representing the next stage of U.S. capitalism.” The new ventures that redefined Enron would have not been undertaken by Kinder. Or they would have been started as smaller experiments, perhaps to be abandoned or maybe even sold rather than developed at scale as they were.

ENE’s stature as a momentum stock would have suffered with a full true-up. ENE likely would have dropped by double digits, with Kinder’s tough reform being appreciated by some investors as necessary to dodge even further decline.

What about the narrative and the excessive hyperbole related to mass retailing? Bringing Enron’s Star of Hope down to Earth would have been Kinder’s real test as CEO. Would he have (painfully) demoted what he had spoken about so optimistically before? Second, would he have done it in such a way as not to deflate Enron’s bubble, lower its credit rating, and put ECT in a downward spiral?

As in 1996, Kinder would have worked from a very sober—and not encouraging—assessment of retail. The pilots were losing big money, and the market was not opening in a way that would allow profitability. Skilling and Lay tiptoed out of this quandary by repositioning retail as total energy outsourcing (TEO) to commercial and industrial users within Enron Energy Services (established March 1997). The narrative to investors was that Enron, learning and correcting, had identified a new niche, even a mother lode.

As it was, this (artificial) energy-efficiency play nicely complemented Enron’s renewable-energy push in the global-warming era. The media and environmentalists praised Enron, which became a reason for taking the easy way out.

TEO was not a proven concept, quite the opposite. The business depended on a host of engineering issues with which Enron had little experience and on long-term projections far beyond Enron’s ability to know. Lou Pai’s lawyers struggled to cover all the contingencies in the 5-, 10-, and 20-year contracts, and revenue reporting used mark-to-market (really mark-to-model) accounting to mitigate losses and eventually eke out (paper) profits.

Kinder, it can be surmised (but never known), would not have acquiesced to a full-bore TEO effort as was undertaken by Pai, Skilling, and Lay. Kinder, it can be only hoped, would have relied on better accounting methods and insisted on more accurate model assumptions to get better feedback from profit and loss—and reposition accordingly.

With retail off the table and true-ups elsewhere, Enron would have been humbled, ENE deflated. Slippery slopes would have given way to a long march up the hill. Enron 2000? Gone. World’s leading energy company—forgotten. Revolutionary change? Replaced by incremental improvement. Extraordinary earnings? Not in every year, much less every quarter.

Ken Lay? Off to another business challenge—perhaps as a rainmaker for a major investment firm or perhaps to front the to-be-launched New Power Company. Perhaps even to Washington politics. Skilling, Pai, and Fastow might have not survived ECT’s exit from retail, leaving wholesale at Rich Kinder’s Enron.

Such a scenario is a best case. But even then, Kinder’s Enron would not have been as valuable as Kinder Morgan, given the former’s sunk investments and cost structures, and given the MLP business model of Kinder Morgan. But Kinder would surely have tapped the rich midstream asset market for Enron’s growth, perhaps even restructuring much of Enron as a giant MLP. In any case, Lay’s largesse and vision would have been relinquished and an annual earnings growth rate of 5 to 10 percent found quite acceptable.²¹

“Had he stayed, Enron’s highs would never have been as high,” McLean and Elkind surmised. “But the lows would never have been as low.” This would have been a best case, however, not a worst case for a Kinder-led Enron given the need to reverse some mighty engines started in 1995–96.

Contra-Capitalist Enron

“The Enron case is arguably the most important meltdown in the modern history of American capitalism,” noted Douglas Rae, the Richard Ely Professor of Political Science and Management at Yale University. Interpreting Enron may begin with Ken Lay’s being an “incompetent CEO, whether or not he was guilty of criminal behavior,” and continue by tying the company’s ultimate fate to “a combination of bad business decisions,” worsened by secret dealings and false accounting. But the reasons for death require a coherent motivational explanation.

Business diagnostics aside, what was the why behind the why? Why Ken Lay? Why Enron? Why in energy?

And why in America’s mixed economy where investor protection had a half-century-plus regulatory tradition?

As posited in the Introduction and documented in the rest of the book, the answer was contra-capitalist management, growing out of a competitive business world in which prevailing philosophies, business fads, and the socioeconomic system itself worked against best practices, as classically defined.

Ken Lay the chameleon; Enron the unfocused. The hitherto Great Man of Natural Gas, of Houston, and of the New Energy Economy was enabled by the philosophies and opportunities of political capitalism, not of market capitalism as understood in law, philosophy, and political economy by classical liberals.

Political capitalism was defined in Capitalism at Work (Book 1 of this series) as “a variant of the mixed economy in which business interests routinely seek, obtain, and use government intervention for their own advantage, at the expense of consumers, taxpayers, and/or competitors.” By 1996, Ken Lay’s Enron certainly fit the bill—and it would become more political in the years ahead. Infamous Enron did not refute the free market in either practice or theory. Invisible-hand economics, after all, does not apply to the heavy hand of business-government cronyism.

Enron brings into question the socioeconomic system whereby special government favor drives profit centers and can even define a whole company—and a regulatory approach to business governance under which gaming and moral hazard occur. “Rather than viewing Enron as a market failure,” Fred Smith cautioned, “we should consider whether political controls might have blocked competitive forces, which would have identified and addressed the problem earlier.”

Erstwhile market critics who praised (politically correct) Enron on the way up, feeling betrayed, lowered the boom upon Enron’s fall. Their wrath included doubling down with “grandiose hierarchic political regulatory schemes”—or laying more bricks on “the road to serfdom” (as Fred Smith put it, invoking F. A. Hayek). Progressivist post-Enron reforms would constrain good entrepreneurship in the quest to prevent bad. Laws such as the Sarbanes-Oxley Corporate Reform Act of 2002, the Bipartisan Campaign Reform Act of 2002, and the Energy Policy Act of 2005 created their own problems, some unintended and some predictable (a subject of Book 4).

“Heroic Capitalism” (Part I of Capitalism at Work) developed the theory of commercial success—and failure—from classical-liberal teachings. Centuries apart, Adam Smith, Samuel Smiles, Ayn Rand, and Charles Koch not only advocated economic freedom but also explicated the preconditions of marketplace success. Looking beyond the rule of law and market freedom, these intellectuals championed prudence, authenticity, wealth creation, and course correction—in place of negligence, mistruth, cronyism, and evasion.

Capitalism at Work chronicled how capitalist philosophers long warned against the sort of practices that consumed and ultimately conquered Enron. Adam Smith’s 18th-century insights about “a sacred regard for general rules,” “self-command,” and “prudence,” as well as his warnings about “self-deceit” and “over-weening conceit,” presciently apply to Ken Lay’s organization. “Smith would have been disappointed—but hardly surprised—by the systemic failure that characterized Enron,” Capitalism at Work concluded.

A century after Adam Smith, Victorian moralist and self-help maestro Samuel Smiles tied commercial success to attention to detail, common sense, and integrity. He warned: “How many tricks are resorted to—in which honesty forms no part—for making money faster than others!” To Smiles, CFO Andy Fastow et al. would have been old vinegar in a new bottle.

A century later, and two centuries after Smith, Ayn Rand’s philosophy of Objectivism explained how Enron’s subjectivism and layers of deceits were a recipe for failure. Decades before Ken Lay’s implosion, Rand warned against the corner-cutting business leader: “An attempt to gain a value by deceiving the mind of others is an act of raising your victim to a position higher than reality, where you become a pawn of their blindness, a slave to their non-thinking and their evasions, while their intelligence, their rationality, their perceptiveness become the enemies you have to dread.”

Enron was a politically correct, postmodern company. Ken Lay “came to believe that wanting, believing, and saying something to be true could make it so.” But external reality is not shaped by personal consciousness. Enron repeatedly and increasingly committed philosophic fraud by substituting fakery and fogginess for actuality and sobriety. (Prosecutable fraud was not an issue for the company circa 1996, but it would be later.) The company survived close calls in the 1980s, oversold itself in the early-to-mid 1990s, and charged into a highly speculative revamping in 1996–97. Its corporate culture never really changed until the company went insolvent.

How ironic, then, that free-market capitalism took the fall for Enron. Ken Lay was a well-schooled, indefatigable rent-seeker, scarcely differentiating strategies to remove unfavorable regulation to level the playing field from strategies imposing government intervention to benefit Enron at the expense of consumers, taxpayers, and/or competitors. Lay did posit public policy rationales at every turn, and his nonmarket activism was not beyond what his rival CEOs could, would, or did do, at least on a smaller scale. But Lay’s political business model, and Enron itself, exemplified a paragon of political capitalism (or cronyism).

Smith, Smiles, and Rand, in their different centuries, criticized rent-seeking and pointed the way to heroic capitalism, defined in our day as “maximizing long-term profitability for the business by creating real value in society while always acting lawfully and with integrity.”²²

Charles Koch defended consumer-driven profit making against politically imbued profits: “Good profit comes from making a contribution in society—not from corporate welfare or other ways of taking advantage of people.”²³ The virus of cronyism grows and corrupts. “Far too many businesses have been all too eager to lobby for maintaining and increasing subsidies and mandates paid by taxpayers and consumers,” he noted. “This growing partnership between business and government is a destructive force, undermining not just our economy and our political system, but the very foundations of our culture.”

From Adam Smith in the 18th century to Charles Koch in the 21st century, time-honored capitalist philosophers were anti-Enron intellectuals who (as concluded in Capitalism at Work) “elucidated the character traits, mental models, and interpersonal conditions behind success and failure, while differentiating sharply between free-market entrepreneurship and political rent-seeking. Their concern was less the material outputs of capitalism, however substantial, than the moral inputs of capitalism.”

The fundamental lesson from Enron is this: Capitalism did not fail. The mixed economy failed. The capitalist worldview is stronger, not weaker, post-Enron. But there is another, deeper lesson that explains Enron and the mistakes of the intellectual mainstream before, during, and after Enron’s active life. It is that arrogant behaviors, or what in the Enron vernacular is called the smartest-guys-in-the-room problem, can strike anytime and anywhere. Whether in business or academia—or any profession or association—conceit, deceit, and dogmatism are the bane of personal, intellectual, and organizational success.

A reinterpretation of Enron, in short, has public policy implications quite different from what actually occurred in the wake of Enron’s bankruptcy, a subject for this series’ finale.

Final Thoughts

Former Enron executive Mike McConnell attempted to reconcile the company he thought he knew with the harsh reality that befell him and thousands of other Enron employees. “I watched a company that won ‘Most Innovative’ in the country five straight years move into bankruptcy, scandal and total chaos, literally overnight,” he wrote in his autobiography.

Why? I believe the truth is that it was coming to an end for a long time. We just didn’t see it…. I recognized, in retrospect, the warning signs all around us. They were important items like culture, values, the way many leaders or groups treated customers and employees; situations that should have been noted and corrected.

McConnell’s autopsy of Enron concluded: “If we paused to contemplate ‘could’ versus ‘should,’ I am convinced Enron would be a solid and growing company today.”

The process of Enron harked all the way back to 1984–85. The common denominator was one unique, empowered, brilliant, soulful chief executive officer. Anointed a titan of industry, Ken Lay had never failed, only progressed, and he was determined that Enron would be his crowning glory. It was this hyperambition that led him down a contra-capitalist road in a politicized industry within America’s mixed economy. If Lay did not recognize the treacherous path he was travelling, perhaps it was simply that no term existed to offer recognition of and thus caution against the Pragmatist-Progressivist management strategy producing his company’s artificial boom and complete bust.

Ken Lay’s enterprise would come to conflict and overtake the checks and balances of the world’s largest and most sophisticated economy. Externally, Enron was able to conflict and fool bankers, investors, security analysts, regulators, intellectuals, and the press. Internally, Enron finagled its own lawyers, accountants, auditors, board of directors, and employees.

“One wonders,” concluded one study, “whether Enron’s senior management may have misled themselves by the combined effects of all the financial manipulation that they invited and approved.” Jeff Skilling, not fooled, jumped ship. But Ken Lay, fooled, went down with his ship. More tragically, Lay stuck to a false narrative post-Enron to lose devastatingly at trial and died a broken man, awaiting what would have been a life sentence. Charlatan and criminal to the world, a greater fall of a once titan, Insull-like, could almost not be imagined. He deserved better, far better, if he could only have seen at Enron, even post-Enron, what he did not see.

“Something called ‘capitalism’ has long been held responsible for all sorts of supposed evils,” noted the business philosopher Elaine Sternberg. Much more than a “supposed evil,” Enron was a “systemic failure of American capitalism.” But it was not capitalism as classically understood and defined.

Enron defined contra-capitalism: political capitalism, political correctness, regulatory gaming, and other crony sports of the mixed economy. In broad terms, Enron was about postmodernist philosophy and the unintended consequences of government interventionism that allowed the worst to get on top.

Enron’s lessons are many, subtle, and profound. Regarding business management: Reality, not illusionism. Incrementalism, not only revolution. Win-win, not win-lose. And just doing the right thing.

Regarding political economy: Wealth creation, not rent-seeking. Simple rules for a complex world. Good profit, not bad.

Best-practices management in a free society, codified as Market-Based Management by classical-liberal entrepreneur Charles Koch, rests on the social philosophy that gave rise to capitalism just several centuries ago. This tradition lauds the epistemological virtues of reality-based thinking, trial-and-error testing from small beginnings, midcourse correction, simplicity, and, above all, humility in the face of creative destruction in the marketplace.

At the interpersonal level, classical-liberal business theorists and practitioners have embraced honesty, frankness, respect, openness, plain dealing, politeness, and promise keeping. Morally, they stand for prudence, caution, probity, character, and balance.

Enron, contrarily, absorbed a belief in image over reality, pretense over proof, feelings over facts, groupthink over independent analysis, and fads over fundamentals. Ethically, Ken Lay made room for new behaviors that came to be practiced by the smartest guys in the room. Politically, Enron embraced cronyism, whereby special public-sector favor propelled new profit centers.

True lessons must reflect what Enron did right and what it did wrong. But as G. K. Chesterton wrote, though there are an infinity of angles at which a man falls, there is only one at which he remains upright. So, too, the many negative lessons of Enron can be reduced to one positive: Truth matters—discovering it, remembering it, reporting it, practicing it. Thus, this revisionist history of Enron.