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Did we learn the lesson from Enron: Who will be next?

By Prof. Geoffrey Baring

07 December, 2006

We have a plethora of laws, standards and regulations in relation to financial reporting. Why? So that investors/stakeholders are supposedly provided with a superior quality of information that will enable them to make better informed judgments about the financial viability of potential investments. So if this is the objective of all of the rules and regulations, what happened to Enron? Why did the share price collapse from more than $80.00 per share to less than $9.00 per share in a matter of several weeks and then, ultimately, we saw the company collapse into bankruptcy leaving debts of some US$80 billion.

The book, and film, “The Smartest Guys in the Room” provides an expose of the way that Enron was managed or, more correctly, mismanaged. It succinctly demonstrates that the motives of the key management personnel in the organisation far outweighed the primary objectives of organisations as espoused by Milton Friedman, that is, that organisations exist to maximize their shareholder’s wealth. The maximisation of wealth, in this instance, was to maximize the wealth of the management team led by Ken Lay and Jeffrey Skilling at Enron. How did the Enron disaster occur with all of the supposed safeguards in place?

Firstly, it would have been more difficult for Enron to have occurred had there not been complicity of a number of individuals and organisations. The most obvious of these, and the one that received the most attention, was the role played by Enron’s auditors, Arthur Andersen. Andersen’s sanctioned practices such as “mark to market” pricing which were unacceptable. Enron’s lawyers and many reputable bankers were prepared to accept the “creative” approach to accounting that the Enron key executives created. The motive of all of these organisations, like that of Enron management, appeared to be greed. Andersen was being paid $50 plus millions each year as were several of the other advisers. It is very difficult for any professional adviser to turn their back on fees of some $1 million a week and the bonuses associated with that level of fees. While Andersen paid the ultimate price, how many would still turn a blind eye to such professional fees?

The introduction of the Sarbanes Oxley Act and various other international corporate governance initiatives are designed to ensure that this situation does not occur again. However, they can at best be described as a knee jerk reaction that will act as a “band aid” treatment for a relatively short time. Then, as previously, we will slip back into our bad old ways.

Key Lay and Jeffrey Skilling were regarded as the “smartest guys in the room” What company will be the next Enron and when will the “smarter guys in the room” appear? Because the rewards of circumventing the system are so great it seems it will be only a matter of time before the “smarter guys” learn to manipulate the new system so that they can reap the “extraordinary rewards” associated with manipulation of the accounting system. Assisting them in their task in one way or another will be the accounting profession. What is missing, is not regulations, governance, or laws – it’s a basic corporate ethic that commits organisations to the objective of maximization of shareholder wealth.

As Emeritus Professor Ray Chambers, one of the doyens of Australian accounting remarked in a paper about accounting ethics published in 1991. “Corporate accounting does violence to the truth not only occasionally, but daily, weekly, monthly and perennially”. It seems that little has changed since then. Let’s see if changes after the next Enron…

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