Class Notes (1,100,000)
CA (620,000)
UTSC (30,000)
MGS (70)
Lecture

MGSC14H3 Lecture Notes - Production Planning, Distributive Justice, Hydrogen Cyanide


Department
Management (MGS)
Course Code
MGSC14H3
Professor
William Bowen

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Case Name: Enron
Main Topic: Hedging against its own losses, lying to the public, auditing scam
Summary of important facts:
Chewco:
Limited liability partnership created in Nov 1997 to buy CalPERS’ ownership in JEDI without
needing to have Enron report losses from JEDI on its financial statements. Enron wanted to
keep JEDI afloat but needed an outside partner to have at least a 3% stake in the company or it
would be consolidated. Chewco was a Special Purpose Entity (SPE) and would need to meet 3
criteria to keep JEDI in nonconsolidation.
1. Continuously invest at least 3% of the SPE’s assets
2. Exercise control and assume risk of the SPE
3. Provide real economic benefits to Enron
Fastow wanted to be appointed manager but Enron’s legal team advised against it. Michael
Kopper – who worked for Fastow but this fact was only known to Jeffrey Skilling on the BoD –
was appointed manager of Chewco. In Nov/Dec of 1997, Enron and Kopper created a new
financial structure for Chewco.
1. 240 million unsecured loan from Barclays which Enron would guarantee. (This was
funded through Enron shares owned by Enron)
2. 132 million advance from JEDI to Chewco under revolving credit agreement (Normal
credit system in which amounts repaid are added back to your limit)
3. 11.5 million in equity (3% of total capital) from Chewco
Kopper only invested about 125,000 into Chewco. The remaining 11.4 million of equity came
from a loan by Barclays through a company owned by Kopper. 6.6 million was required to be
held in reserve, meaning Chewco didn’t really meet the 3% rule. Once investigation occurred
and facts about Chewco were brought to the BoD and Andersen, they reported that JEDI and
Chewco should have been reconsolidated in Nov 1997 and announced that they would restate
prior financial statements to reflect this. Chewco’s net effect was 400 million of fake profits and
600 million of hidden debt.
LJM1:
June 28 1999, Enron board approved Fastow’s proposal that he invest 1million and become the
sole managing/general partner of LJM1 (LJM Cayman LP). The purpose of LJM1 was to raise
funds from outside investors that could be used to hedge the possible loss of market value of
Enron’s investment in Rhythms NetConnections Inc. Fastow was the sole and managing
member of LJM Partners LLc, which was the general partner of LJM Partners LP, which was the
general partner of LJM1.
LJM1 ultimately did 3 things for Enron:

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1. Hedge Enron against Rhythms NetConnections
2. Purchase a portion of Enron’s interest in a brazilian power project (Cuiaba)
3. Purchase certificates of an SPE called Osprey Trust
In March 1998, Enron invested 10 million in Rhythms at 1.85 per share. At IPO, it was opened
at 21/share and by closing was at 69/share, making Enron’s investment worth 300 million. But
Enron wasn’t allowed to sell the share before the end of 1999 as per an agreement with
Rhythms. Because Enron accounted for this investment as part of its merchant portfolio, it
reflected the changes in stock price on its financial statements. Fastow and Glisan created an
SPE that would pay Enron if the Rhythms investment decreased, reporting the payment as
revenue and offset the loss on Enron’s books. This allowed Enron to report the appreciation of
Enron stock under GAAP. LJM1 was funded by Enron stocks so it’s creditworthiness depended
on the value of Enron stocks, eventually 95 million was lost in the Rhythms stock value but was
paid out by LJM1, making Enron’s income higher. LJM1 didn’t meet the nonconsolidation criteria
of having 3% from an independent partner because Fastow wasn’t independent and the Enron
stock was paid for by a promissory note not cash. When Enron’s stock fell in 2000 and 2001,
LJM1’s ability to pay Enron declined significantly.
Despite this, Enron’s law firm Vinson & Elkins indicated that the hedge was reasonable. Later
Andersen reported that financial statement for 1999-2001 had to be restated and would reflect a
decrease in income of 95 million in 1999 and 8 million in 2000.
LJM2:
Oct 1999 Fastow proposed another LJM partnership, LJM2 Co-Investment LP, where he would
serve as general partner through intermediaries to encourage up to 200 million outside
investment that could be used to purchase assets that Enron wanted to syndicate. Fastow
proposed that all transactions between Enron and LJM2 be approved by both Enron’s Chief
Accounting Officer and Chief Risk Officer, also the Audit and Compliance Committee would
annually review all transactions. Based on this it was voted that Fastow would not have a
conflict of interest and adversely affect Enron.
Raptors:
Raptors were Rhythms-like hedging arrangements for several of Enron’s other merchant
investments. 1, 2 and 4 were modeled after LJM1.
Ethical dilemma: false financial information, abusing stakeholders’ trust
What should they have done: been truthful, be transparent
Case Name: The good business reference
Main Topic: Honesty in giving references
Summary of important facts:You supply paper for a new printing company. Has missed
deadlines/printing errors and business is struggling but one big contract could turn the business
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around. Major corporation has asked you for reference because they’re considering using the
business for all of its financial printing, ink supplier has asked for credit reference.
Ethical dilemma: What should you say about the business based on your experience/beliefs
What should they have done: Give different references for supplier and for major corporation.
Talk about risks but highlight potential in the company for corporation. Talk about
creditworthiness for ink supplier.
Case Name: Pinto Fires
Main Topic:
Cost benefit analysis
putting a value on a life
a car, Ford created, was blowing up
Summary of important facts:
first time a corporation was charged for criminal conduct, not negligence, but murder
ford was trying to compete with Japanese cars
Lacocca (president of ford), wanted the pinto ready by 1971, but that would require short
production planning
noticed that fuel tank often ruptured during rear-end impact
ford felt people cared only about money and costs
Ethical dilemma:
ford put profits ahead of safety
different stages where they could have changed
put price for people dying, “what’s your life worth”
had a chance to fix the car problem for $11 each car, but felt that the cost of 180
liveswas worth less
What should they have done:
beginning, they shouldn’t rush the process
leakage issues they should have changed
pay the $11 for each car
Case Name: Firestone
Main Topic:
Summary of important facts:
tread separation
100 years of relationships
a lot of intensity
implications reach far more than imaginable
brands are more important than the ACTUAL car
aesthetics are more important
Engineers suggested design changes, but management rejected the redesign
Ethical dilemma:
putting a value on a life
didn’t generate detail instructions about the safety of the car
more concerned with launching the product than the safety
What should they have done:
Ford should have changed the design, and incurred the costs
Firestone should be not just be complying with the recommendation of ford, rather
instructed what should have been done. Should have helped with the replacement
they should both pay the cost of recalling the product and the injuries
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