Friday, March 30, 2012

Enron: The Smartest Guys in the Room

Only a few years ago, Enron was the nation's seventh largest corporation, valued at almost seven billion dollars. Pundits praised the company as a new business model. This trading floor was manned by America's best and brightest, charting the futures of energy and power. But high above, each with a private staircase, Ken Lay and Jeff Skilling had built their own plush state rooms; they were known as the smartest guys in the room, captains of a ship too powerful to ever go down.

"In the titanic, the captain went down with the ship. In Enron, it looks to me like the captain first gave himself and some friends some bonus, then lowered himself and the top folks down in the life boat then hollered up and said 'By the way, everything's gonna be just fine."
- Sen. Byron Dorgan (D-ND), Chairman of the Senate Commerce Committee Hearings on the Enron scandal

When I was still teaching, I always used Enron to illustrate the limitations of accounting procedures and the pitfalls of relying too much on accounting information. But even then, I was not familiar with all the details of the case. This documentary, based on the book of the same name written by Bethany McLean and Peter Elkind, is a good way to learn about, and from, the downfall of one of the most admired and respected American companies at the turn of the new millennium.

The Enron case foreshadowed many of the mistakes that were made a mere six years later during the subprime crisis; unfortunately, either people were too ignorant to heed the warnings or were just greedy enough to use the scandal as an inspiration.

For those who can't afford to spend 110 minutes of their time to watch the film, here are the three things than enabled Enron's leaders to pull-off what is perhaps the biggest case of corporate fraud in history.

1) Mark-to-market accounting, which allowed Enron to book incomes as soon as project contracts were signed. The problem was that these projects often didn't go as planned, and reported project earnings were at times actually losses.

2) Special purpose entities, or shell companies, which Enron used to hide its debt.

3) "Synergistic corruption", where entities that were supposed to provide check and balances to the system--accounting firms, legal firms, investment banks--were actually also in collusion with Enron.

If you do have the time, then I suggest you watch the video--I'm pretty confident that it will be well worth your time. Enjoy.

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