Which Segment of Its Operations Got Enron Into Difficulties? 8
Which segment of its operations got Enron into difficulties?
The fall of Eron 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. 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
The fall of Eron 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. 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