The Smartest Guys in the Room: The Amazing Rise and Scandalous Fall of Enron

by Bethany McLean

But the most poisonous explanation for the mad rush to do deals was money, not the money Enron would make but the money the developers would make. What one former international executive calls the “fatal flaw” in the business was the compensation structure. Developers got bonuses on a project-by-project basis. The developers would calculate the present value of all the expected future cash flow from a project. This was also the model the banks used to lend money. When the project reached financial close—that is, when the banks lent money but before a single pipe was laid or foundation was poured—they were paid.

The problem is that whenever a growth company disappoints Wall Street—when it announces earnings that don’t meet the aggressive target it has set for itself—the punishment is usually severe. As rapidly as growth stocks can run up when the news is good, they can spiral downward just as quickly when the news is bad.

One former Enron executive says: “It was basically prima donnas accusing other prima donnas of being a bigger prima donna.”

She also became an Enron vice chairman, a title known internally as “the ejector seat” because it was viewed as the first step out the door.

It is business wisdom that many of a company’s best deals are the ones it doesn’t do.

“If you’re told to make $25 million and you do it, you’re in great shape. It doesn’t matter how much it costs you to make that $25 million.”

‘Don’t do business with Enron: they’ll steal your wallet when you aren’t looking.’

The Enron scandal grew out of a steady accumulation of habits and values and actions that began years before and finally spiraled out of control.

“Enron borrowed from the future until there was nothing left to borrow,”

Enron would agree to deliver natural gas or oil over a period of time to an ostensibly independent offshore entity that was, in fact, set up by one of its lenders. The offshore entity would pay Enron up front for these future deliveries with money it had obtained from the lender. The lender, in turn, agreed to deliver the same commodity to Enron; Enron would pay a fixed price for those deliveries over a period of time.

On the surface, these looked like separate transactions. But in reality, the commodity part of the deal canceled out, leaving Enron with a promise to pay a lender a fixed return on money it had received. In other words, it looked suspiciously like a loan with interest. Nevertheless, Enron listed prepays not as debt but as trading liabilities that were supposedly offset by trading assets.

“I want all the money outside the building inside the building.”

By the end of the decade, Enron was trying to create markets for steel, pulp and paper, lumber, freight, metals, weather derivatives, you name it. Often, the decision to dive into such a market was driven by that classic Enron calculus: if the market is x, Enron will invariably grab y percent of it and make lots of money.

Indeed, by the end of the decade, Enron seemed to have forgotten the core rule of trading: information is even more important than brains.