Enron, Herding, and the Deterrent Effect of Disclosure of Improprieties

By Renas, Stephen M.; Cebula, Richard J. | The American Journal of Economics and Sociology, July 2005 | Go to article overview
Save to active project

Enron, Herding, and the Deterrent Effect of Disclosure of Improprieties


Renas, Stephen M., Cebula, Richard J., The American Journal of Economics and Sociology


The [visitors'] book [at a tourist destination] had a column for remarks. Reading down the list I saw, "Nice," "Real nice," "Very nice," "Nice." Such eloquence. I turned back to an earlier page. One visitor had misunderstood the intention of the remarks column and had written, "Visit." Every other visitor on that page and the facing page had written, "Visit," "Visit," "Revisit," "Visit" until someone had turned the page and they got back on the right track.

--Bill Bryson, The Lost Continent

I

Background

THE FALL OF ENRON has understandably generated significant interest in the professional literature as well as in the popular press. The activities and events underlying Enron's collapse are manifold, but several stand out as particularly noteworthy. One is the use of special purpose entities (SPEs). Although SPEs often serve legitimate economic purposes and are still in use today, Enron used several of them to hide debt and to overstate equity and earnings. Accounting standards required that third parties own at least 3 percent of the assets in SPEs. This rule was violated. Enron also represented that the SPEs helped it to hedge downside risk. This turned out not to be the case, because the SPEs used Enron's stock and financial guarantees to carry out the hedges. While Arthur Andersen, Enron's outside auditor, initially raised objections, the accounting firm ultimately softened its position. Andrew Fastow, Enron's former CFO, became a partner in several SPEs and profited personally, which poses serious questions as to whether he breached his fiduciary duty to Enron stockholders. In late 2001, Enron was forced to restate its financials for 1997 through 2000 after consolidating the SPEs, resulting in a decline in earnings of approximately $600 million and an increase in debt of approximately the same amount. Equity fell by $1.2 billion (see Healy and Palepu 2003 for a fuller description).

A second procedure Enron used was mark-to-market accounting, in which a firm that signs a long-term contract can, under certain circumstances, recognize as current revenue the present value of the expected stream of future inflows and expense the present value of expected future

costs. While such a process is appropriate in some situations, Enron used mark-to-market accounting to book future revenues as current revenue even when serious questions existed as to whether the long-term revenues would in fact materialize.

As the price of Enron stock declined, some Enron executives exercised their stock options and sold their shares, in some cases out of public view through loan repayment plans, while at the same time encouraging employees to hold and even to buy the stock. Many employees who tried to sell the stock in their 401(k) plans were barred from doing so and lost not only their jobs but most or all of the asset value of their retirement plans.

What caused Enron to engage in the activities that ultimately resulted in its downfall, and what can be done to reduce the likelihood of future collapses? Opinions as to the causes of the downfall and possible remedies abound (see, for example, Healy and Palepu 2003).

Top executives at some firms, including Kenneth Lay and Jeffrey Skilling at Enron, receive a substantial portion of their compensation in the form of stock options. It has been argued that the activities Enron used were largely attempts to manipulate stock prices so as to enhance the value of these options. A wide range of proposals has been offered to reduce the incentive for top executives to engage in manipulation. Among these are proposals to substitute stock for stock options in executive compensation packages, proposals requiring those who receive and exercise stock options to hold the stock for an extended period of time, perhaps until after they leave the firm, and proposals to increase dividend payments on stocks, which is expected to reduce investor (and hence executive) interest in shortrun stock price swings and make investors who may rely more heavily on dividends as income become more interested in and vocal about corporate management.

The rest of this article is only available to active members of Questia

Sign up now for a free, 1-day trial and receive full access to:

  • Questia's entire collection
  • Automatic bibliography creation
  • More helpful research tools like notes, citations, and highlights
  • Ad-free environment

Already a member? Log in now.

Notes for this article

Add a new note
If you are trying to select text to create highlights or citations, remember that you must now click or tap on the first word, and then click or tap on the last word.
One moment ...
Project items

Items saved from this article

This article has been saved
Highlights (0)
Some of your highlights are legacy items.

Highlights saved before July 30, 2012 will not be displayed on their respective source pages.

You can easily re-create the highlights by opening the book page or article, selecting the text, and clicking “Highlight.”

Citations (0)
Some of your citations are legacy items.

Any citation created before July 30, 2012 will labeled as a “Cited page.” New citations will be saved as cited passages, pages or articles.

We also added the ability to view new citations from your projects or the book or article where you created them.

Notes (0)
Bookmarks (0)

You have no saved items from this article

Project items include:
  • Saved book/article
  • Highlights
  • Quotes/citations
  • Notes
  • Bookmarks
Notes
Cite this article

Cited article

Style
Citations are available only to our active members.
Sign up now to cite pages or passages in MLA, APA and Chicago citation styles.

(Einhorn, 1992, p. 25)

(Einhorn 25)

1

1. Lois J. Einhorn, Abraham Lincoln, the Orator: Penetrating the Lincoln Legend (Westport, CT: Greenwood Press, 1992), 25, http://www.questia.com/read/27419298.

Cited article

Enron, Herding, and the Deterrent Effect of Disclosure of Improprieties
Settings

Settings

Typeface
Text size Smaller Larger
Search within

Search within this article

Look up

Look up a word

  • Dictionary
  • Thesaurus
Please submit a word or phrase above.
Print this page

Print this page

Why can't I print more than one page at a time?

While we understand printed pages are helpful to our users, this limitation is necessary to help protect our publishers' copyrighted material and prevent its unlawful distribution. We are sorry for any inconvenience.
Full screen

matching results for page

Cited passage

Style
Citations are available only to our active members.
Sign up now to cite pages or passages in MLA, APA and Chicago citation styles.

"Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences." (Einhorn, 1992, p. 25).

"Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences." (Einhorn 25)

"Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences."1

1. Lois J. Einhorn, Abraham Lincoln, the Orator: Penetrating the Lincoln Legend (Westport, CT: Greenwood Press, 1992), 25, http://www.questia.com/read/27419298.

Cited passage

Welcome to the new Questia Reader

The Questia Reader has been updated to provide you with an even better online reading experience.  It is now 100% Responsive, which means you can read our books and articles on any sized device you wish.  All of your favorite tools like notes, highlights, and citations are still here, but the way you select text has been updated to be easier to use, especially on touchscreen devices.  Here's how:

1. Click or tap the first word you want to select.
2. Click or tap the last word you want to select.

OK, got it!

Thanks for trying Questia!

Please continue trying out our research tools, but please note, full functionality is available only to our active members.

Your work will be lost once you leave this Web page.

For full access in an ad-free environment, sign up now for a FREE, 1-day trial.

Already a member? Log in now.