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.