Corporate Financial Reporting Enron

1
Corporate Financial Reporting Enron

• By. Matt Ogle

2
Issue

• Enormous energy company gives false financial
  reporting. Loses Billions.
• We have an accounting technique that allows
  companies to include as current earnings the
  profits they expect to realize from
  energy-related contracts and other derivative
  instruments in future periods.

3
Who Wins? Who Loses?

• Winners
• -Top Executives
• -Government Officials
• Losers
• -Government Funding (Taxes)
• -Employee Retirement Plans
• -Shareholders
• -Employees

4
Economic Policies

• Prisoners Dilemma (Tragedy of the Commons) Is
  moral behavior your best strategy? Make as much
  money as you can by providing false information
  about your company. This will benefit you and
  some other executives, but not the majority.
• If you got to talk to everyone in the company at
  the same time everyone would agree that you
  should not report false numbers so that more
  people would invest.
• Leads to laying off and company downsizing.

5

• - Accountants (A) cooperate with Management (B).
  Each win
• - Both sides defect and neither sides gets any
  benefit.
• (Both instances assuming false financial
  reporting)

http//drs.yahoo.com/S96062883/Kprisoners
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Economic Policy

• Negative Externality Enron created a cost to
  society with its by-product of false accounting
  information.
• The top Enron executives did not account for the
  cost imposed on others (employees, stakeholders,
  and society).
• Social cost is greater than private cost.

7

• Shaded triangle is the negative externality.
• MPC less than MSC
• The policy of reducing the externality would need
  to shift the private cost towards the social
  cost.

http//drs.yahoo.com/S96062883/Kmarginalprivate
cost/v2/lIVR/-http//www.bized.ac.uk/stafsup/e
xams/new
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Reducing Externality

• Market solutions Change the costs of false
  financial reporting to account for the negative
  externality.
• Government enforcing policies to police this kind
  of behavior.
• The Sarbanes-Oxley Act of 2002. Increases the
  transparency of corporate financial statements,
  reforms oversight of accounting, and restores
  investor confidence (2).

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Ways to reduce negative externality

• Public policies Government restrictions on
  amount of authority top executives get.
• Large companies hire government official/auditor
  to shadow accounting procedures.
• Hold top executives responsible for companies
  illegal activities so they cant plead ignorance.

10
Rent Seeking

• Enron pursued profits through the political
  process (President Bush).
• Rent Seeking is Legal, what Enron did was illegal
  because it manipulated the government to receive
  a tax benefit and also received government
  funding.
• Profit seeking in the marketplace (when done
  legally) is efficient and fosters economic growth
  because profits are generated by serving
  consumers better.

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Economic Policy

• Public Good Corporate financial reporting is
  nonrival, although excludible.
• How much public good should be produced? MBMC
• Everyone must consume the same amount.

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Public goods

• The public willingness to pay is the sum of the
  individuals willingness to pay.
• Get public demand by vertical summation of the
  individual curves.

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Sarbanes-Oxley Act of 2002

• Policy will provide
• Increased penalties for those who abuse their
  power
• Additional funding for SEC
• CEO, CFO official certification
• (PCAOB) Public Company Accounting Oversight Board

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Sarbanes-Oxley Act (contd)

• Positive
• -Holds executives accountable
• -Tells shareholders what is really going on
• -Gives accurate information
• -Limits power
• - Negative
• -Cost money to police
• -Raise societies taxes

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Implementation

• MPB based on false information so we dont get
  an efficient outcome
• Economy gains by having accurate information
  because information is not inflated and doesnt
  create a missing market
• Need to increase MPC to increase MSB

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Resources

• 1)Subrahmanyam,A., Titman, S. (1999, June). The
  going-public decision and the development of
  financial markets. The Journal of Finance.
  Retrieved October 26, 2003 from
  http//jstor.org/jstor/gifcvtdir/ap000853
• 2)House Committee on Financial Services. (2002,
  January 23). Committee continues Enron review,
  Pitt, Berardino to testify. committee news
  http//financialservices.house.gov/news.asp?FormMo
  de
• 3)The Gottesdiener Law Firm. (January 18, 2002).
  Enron 401K plan Lawsuit press release.
  http//enronsuit.com/press.html
• 4)The Baltimore Chronicle. Ten habits of highly
  defective companies. http//www.baltimorechronicle
  .com/defectives_sep02.html
• 5)National Review Online. York, B., (2002,
  January 10). Enron, round one. http//nationalrevi
  ew.com/york/york011002.shtml
• 6)http//www.sec.gov/rules