Question

“Enron: The Smartest Guys in the Room”. Discussion questions are:

a. Describe activities, which provoke a financial scandal?

b. Why financial reporting abuses did take place even though there are safeguards such as GAAP and auditors?

c. Describe the transactions Enron used to increase its reported earnings?

d. How the financial manipulations were eventually revealed?

Answer 1

A)This perspectives article surveys publications in business history and constructs a conceptual framework for researching fraud and other dubious financial practices, their determinants and their consequences. The prevalence and nature of the practices studied are mainly determined by individual traits, firm governance and control, the economic environment, and regulation. Contemporaries make sense of dubious practices by constructing narratives, possibly framing them as scandals, which are likely to lead to attempts at regulatory change. It is primarily the socio-economic impact of dubious practices that determines whether regulation becomes fundamentally stricter. Existing agendas for reform strongly influence the substance of regulatory responses.

Since the emergence of the Enron affair in 2001 and the WorldCom debacle in the following year, scholarly interest in business scandals has grown substantially. Gray, Frieder, and Clark (2005, p. 3) start their book on business scandals with the Oxford English Dictionary’s definition of a scandal: ‘an action or event regarded as morally or legally wrong and causing general public outrage’. Business scandals are likely to call into doubt existing business practices and may be turning points in the way these practices are regulated. Business scandals often – but not always – imply some kind of fraud. In its turn, fraud, which the same dictionary briefly defines as ‘criminal deception’, is not necessarily subject to public outcry. In practice, fraud and scandals will often coincide, and this perspectives article therefore covers both scandals and fraud, acknowledging that public outcry may also be caused by dubious practices which are not unmistakably fraudulent. To keep the number of aspects to be discussed within manageable boundaries, this article focuses exclusively on financial fraud involving asset misappropriation or provision of false or misleading financial information (see Section 3 for details), and allied scandals.

B)Just as troubling is the fact that many countries have created their own versions of the IFRS system by imposing “carve outs” (removal of offending passages) and “carve ins” (additions) to the official standard promulgated by the International Accounting Standards Board (IASB). India and China are notable examples. So while several countries, among them Australia and Canada, have adopted the complete, unadulterated version of IFRS, it’s always worth checking to see if a company of interest has adopted a truncated or bastardized version.

C)Enron sold assets at inflated prices to other firms, together with the promise to buy back those assets at even higher future prices. Thus, Enron received cash today in exchange for a promise to pay more cash in the future.

D) The main cause for Enron’s downfall were its deceptive financial statements that were deliberately designed to show it profitable even when it had millions of dollars in debt and losses. They were presented in such a way that they deceive and bewilder their readers and hide the actual cash flow, profit and financial position of the company. The masterminds behind this were Jeffrey Skilling and Andrew Fastow, who used such accounting vehicles which would misinform and mislead anyone who tries to read Enron’s financial statements.