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), the company 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.

Key Takeaways

  • The term Enronomics refers to a fraudulent accounting technique.
  • It used by executives and accountants at Enron to hide losses, toxic assets, and debt from shareholders and the general public.
  • The company used mark-to-market accounting methods to value assets at their fair market value on the company's balance sheets and to highlight so-called profits.
  • Accountants transferred Enron's debt off its balance sheet through special purpose vehicles that went unnoticed for a long time. 

Understanding Enronomics

Enron was founded in 1985. It was an energy and commodities company based in Houston and was among the largest companies in the United States—thanks largely to the conditions of the market during the 1990s. This environment allowed Enron to take advantage of the bull rush and make deals and acquisitions to expand its horizons. But as things began to change, the company's profits began to shrink and its debts began to climb.

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.

The Enron scandal was a leading factor that led to the creation of the Sarbanes-Oxley Act of 2002, which serves to enhance transparency and criminalize financial manipulation.

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.