Financial Illusion: Accounting for Profits in an Enron World

By Hake, Eric R. | Journal of Economic Issues, September 2005 | Go to article overview

Financial Illusion: Accounting for Profits in an Enron World


Hake, Eric R., Journal of Economic Issues


The rapidity of Enron's decline is an effective illustration of the vulnerability of a firm whose market value largely rests on capitalized reputation. The physical assets of such a firm comprise a small proportion of its asset base. Trust and reputation can vanish overnight. A factory cannot.

--Alan Greenspan

In December 2001, the Enron Corporation and many of its subsidiaries filed for bankruptcy protection. At the time of filing, Enron was the largest bankruptcy in U.S. history, having previously ranked as the seventh largest U.S. corporation in terms of revenue. A string of similar high-profile bankruptcies followed, amid allegations of fraudulent accounting practices and the apparent failure of American securities market regulation (U.S. Senate Committee on Governmental Affairs 2002b).

While the fortunes of these corporations changed rapidly, it was not accidental. The problems that have emerged in recent years are the result of intentional design. The past twenty years have seen the rapid adoption of innovative financial techniques, while a renewed faith in the efficiency and stability of market structures has been used to justify a reduction in funding for capital market agencies. Corporate interests have increasingly influenced the construction and passage of accounting rules and market regulations. Touted as the growth of freely competitive markets, the current drift of economic policy is more clearly caused by the growing influence of narrowly defined corporate interests (Champlin and Knoedler 1999).

For the most part, critics of these trends have been dismissed. Those who do not believe the circular logic of natural efficiency- where the existence of a practice is evidence of its efficiency--argue the recent history of deregulation has produced an increasingly fragile capital structure in industry. Loosened oversight has encouraged the exploration of the boundaries of corporate practice, creating an economy where the manipulation of financial assets has become a more important source of corporate value than the act of production and sale.

Thorstein Veblen's description of the modern corporation provides valuable insight into the tendency toward financial fragility and the role of regulation. He argued the most important asset of the modern corporation was its expected future earning capacity-an intangible and volatile asset whose price was determined by social expectations about the future ([1904] 1978; Raines and Leathers 1996). The nature of this asset benefits the consolidation of market power. Through the mechanism of equity finance and the stock market, the corporation is able to convert expectations of future profitability into contemporary purchasing power, purchasing power that can then be used to realize those expectations or simply to divert income. Consequently, the ability of the corporation to extend its influence and reorganize industry in the future is determined by the social perception of its worth in the present. To incorporate this social characteristic of corporate value, accounting conventions have necessarily evolved. Intangible assets such as goodwill, the growing sophistication of financial instruments and structured finance, and the use of the secondary stock market to define the constantly changing value of the corporation are evidence of Veblen's "credit economy."

Because corporate value is influenced by social perception, the foundations of the corporate economy are fundamentally prone to manipulation. Seeking competitive advantage or personal enrichment, managers may aspire to manipulate the value of the putative earning capacity of some block of capital (Veblen [1904] 1978, 155). While Veblen's description of the credit economy focused on particular assets generally conceptualized as goodwill, the growth of modern finance has simply extended the range and number of assets/contracts whose values are subject to a greater degree of future uncertainty and malleability. …

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
  • A full archive of books and articles related to this one
  • 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 ...
Default project is now your active project.
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

Financial Illusion: Accounting for Profits in an Enron World
Settings

Settings

Typeface
Text size Smaller Larger Reset View mode
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?

Help
Full screen

matching results for page

    Questia reader help

    How to highlight and cite specific passages

    1. Click or tap the first word you want to select.
    2. Click or tap the last word you want to select, and you’ll see everything in between get selected.
    3. You’ll then get a menu of options like creating a highlight or a citation from that passage of text.

    OK, got it!

    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

    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.