DEFINITION of Enronomics
Enronomics was a favorite fraudulent accounting technique used by criminal executives at long-dead Enron Inc. that involved hiding losses in subsidiary books. In the scheme, the parent company made artificial paper-only transactions with its subsidiaries to conceal losses that it incurred. The losses were real according to GAAP, but the company illegally cooked its books to avoid reporting the losses to the market, which would have punished the stock price. Eventually, though, the game ended, with bankruptcy, painful losses to shareholders, and jail time for the leading perpetrators.
BREAKING DOWN Enronomics
Enronomics was a "profit" model that consisted of transferring debt off its 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. Parent Enron continued to hide debt by transferring it (on paper) to wholly-owned subsidiaries, but still recognized revenue from the subsidiaries, giving the impression that Enron was performing much better than it really 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.
As a result of the Enron catastrophe, certain protective measures have been put in place. The Enron scandal 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 (i.e., those that could be abused) accounting practices, and more accountability was imposed upon corporate boards in their role as management watchdogs.