Enronomics

What Is Enronomics?

The term Enronomics refers to a fraudulent accounting technique used by executives and accountants at Enron to hide losses, toxic assets, and massive amounts of debt from shareholders and the general public. The scheme involved the use of accounting tricks.

Although the losses were real according to generally accepted accounting principles (GAAP), Enron illegally cooked its books to avoid reporting the losses to the market, which would have affected the stock price. The discovery of the scheme led to the largest corporate bankruptcy of its time, along with criminal charges for many of the personnel involved.

Understanding Enronomics

Enron operated the first nationwide natural gas pipeline network in the United States. Beginning in the 1990s, the Houston-based company began to shift from natural gas distribution to trading in the unregulated energy markets. This led to an explosion in annual revenue, from $10 billion in the early 1990s to $139 billion by 2001. However, as the company began to invest outside of its core operating area, it suffered several setbacks, losses and mounting debt.

Enron began using dubious accounting tricks to hide its losses and debts which later became known as Enronomics. The company used mark-to-market (MTM) accounting methods, which allowed assets to be noted at their fair market value on the company's balance sheets and highlight so-called profits. Accountants transferred debt off Enron's balance sheet to create an artificial distance between the debt and the company that incurred it. The company set up special purpose vehicles (SPV), also known as special purposes entities (SPE), to formalize its accounting scheme that went unnoticed for a long time.

Enron continued to use these accounting tricks to keep its debt hidden by transferring it to its subsidiaries on paper. Despite this, the company continued to recognize revenue earned by these subsidiaries. As such, the general public and, most importantly, shareholders were led to believe that Enron was doing better than it actually was, despite the severe violation of GAAP rules.

The Securities and Exchange Commission (SEC) was criticized for being asleep at the switch, and Enron's auditor, Arthur Andersen—previously held in high regard as an independent professional accounting firm—was disgraced in its handling of Enron's books and ultimately folded.

Special Considerations

Enron is one of the largest and most well-known examples of accounting fraud in financial history. Its demise also led to one of the largest corporate bankruptcies in history. As a result of the scandal, several key executives and other Enron personnel were prosecuted. For instance, the company's founder Kenneth Lay and Jeffrey Skilling, Enron's chief executive officer (CEO), were charged and convicted of securities and wire fraud.

Certain protective measures were put in place as a result of the Enron scandal. It was an impetus for the Sarbanes-Oxley Act of 2002, which serves to enhance transparency and criminalize financial manipulation.

Further, as a result of Enron's wrongdoings, the Financial Accounting Standards Board (FASB) strengthened its rules surrounding ambiguous accounting practices, and more accountability was imposed upon corporate boards in their role as management watchdogs.