Enron Scandal ; Agency Problem Case Study.docx

Introduction To Business Finance

Corporate collapse; Case Study Of Agency Problem CASE STUDY OF ENRON SCANDAL

Ahsan Iqbal BS Economics ( 3rd) 31/03/2019

ENRON SCANDAL INTODUCTION In 1985, Kenneth Lay merged the natural gas pipeline companies of Houston Natural Gas and InterNorth to form Enron. In the early 1990s, he helped to initiate the selling of electricity at market prices, and soon after, Congress approved legislation deregulating the sale of natural gas. The resulting markets made it possible for traders such as Enron to sell energy at higher prices, thereby significantly increasing its revenue. This deregulation allowed energy providers to expand their approach and become more competitive. Enron diversified with these changes, it became a market maker in electric power, coal, steel, paper and pulp, water, and broadband fiber optic cable capacity. Its domestic trading and international business grew dramatically through the 1990’s.

FALL OF ENRON In May 2000, the stock price of enron was $40 per share which went to $90 per share in August 2000.The market capitalization value of Enron went to $60 billions . In 2001, analysts said that there is something wrong with the Corporation because the shares of enron are going so high that like none of its other competitors in energy sector. In the same period in October 2001, company reveeals the loss of $618 millions and said that they were overstating their earnings since 1997. In December 2001, company filed the petition of Bankruptcy because of its sudden fall of shares which were <$1 per share.

WHAT WENT WRONG? Three main point where the managers kept the BOD in dark.

1) Revenue Recognition According to the principle, revenues are recognized when they are realized or realizable, and are earned (usually when goods are transferred or services rendered), no matter when cash is received. But in ENRONs case we see that revenues are recognized without any probability that the revenues will be realized or not.

2) Hiding Debt SPVs are formed to hide the debt of Principal Corporation so that in accounting books and statements they can manipulate the investors and shareholders. Many cases debts were shown as the equity of the firm.

Management They used to manage bankers auditors and accountants. There was a famous world class audit company named as Arthur Anderson & Co. which audits ENRON, they get weekly $1 Million to hide the accounting and corporal mismanagement.