Summary: The Fall Of Enron | Healy
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2 Enron's Business
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2.1 From Regulated Industry to Energy Trading
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What is a 'swap'?
A swap is a transaction that exchanges one security for another with different characteristics.
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What is a forward contract?
A forward contract is for the purchase or sale of a specific quantity of a good at the current (spot) price, but with payment and delivery at a specified future date.
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2.2 Extending the Natural Gas Trading Model
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What characteristics did Enron want for her markets in the mid-1990s?
Markets needed to be fragmented, with complex distribution systems, commodity was fungible and pricing was opaque.
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3 From Regulated Industry to Energy Trading
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3.1 Trading Business and Mark-to-Market Accounting
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What is 'mark-to-market accounting'?
When a contract is signed, the present value of the stream of future inflows under the contract was recognized as revenues and the present value of the expected costs of fulfilling the contract were expensed.
Unrealized gains and losses were then required to be reported as part of annual earnings when they occurred.
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3.2 Reporting Issues for Special Purpose Entities
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What are Special Purpose Entities?
Special Purpose Entities are shell firms created by a sponsor, but funded by independent equity investors and debt financing.
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4 Governance and Intermediation Failures at Enron
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4.1 Role of Top Management Compensation
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What was the problem with the top management compensation?
Top management were compensated with stock options, but there were no rules about holding the stock for a long-term. So managers were motivated to pump-up the short-term stock performance, but they did not need to look for the long- and medium-term, because that was not interesting for them.
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4.2 Role of Audit Committees
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What was the problem with the Audit Committee of Enron?
The AC had only a few short meetings, in which they covered a lot of ground. Also, the AC did not challenge or were skeptical about specific transactions. And last, they did not require full disclosure.
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4.3 Role of External Auditors
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What was the problem with Arthur Andersen?
They had conflicted incentives. Enron paid a high fee that allowed them to pressure Arthur Andersen.
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4.4 Role of Fund Managers
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What was the problem with the fund managers?
They were mislead by accounting statements/sell-side analysts. Also, the incentive to seek out high-quality information was poor
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4.5 Roll of Sell-Side Analystst
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Why were analysts so slow to recognize the problems at Enron?
Many analysts had financial incentives to recommend Enron to their clients to support their firms' investment banking deals with Enron.
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