Power and Corruption 1
Power and Corruption: Flaws in Government Policy and Accounting Strategies Lead to the Fall
of Enron.
Rachel M. Turner
0280
California Polytechnic University, Pomona
Power and Corruption 2
Introduction: What is Enron and Why Should We Care?
Since the inception of American capitalistic society the government has seen a constant
struggle to find a balance between too much and not enough government regulation. From the
Sherman Anti Trust act of 1890 to drastic deregulation in the 1980’s by the Regan administration
the government has yet to find a medium. Despite evidentiary support from past case studies
many Americas still advocate a hands off “laissez-faire” approach of completely free markets
and no government regulation. Others have come to realize that in order to ensure fair
competition and limited corruption the government must regulate the market. Perhaps before
endorsing government deregulation one should look at the adverse effects it may have. One case
in particular does a good job of demonstrating what relaxed regulations may do; that is the case
of Enron. Many scholars have cited the Enron debacle when advocating for stronger government
regulation. It is important for Americans to look at cases such as Enron’s and make sure our
government policies are setting America up for history to repeat.
Enron was formed in 1985 when a man named Kenneth Lay merged Huston Natural Gas
and InterNorth. Soon after the merger of the natural gas pipeline companies, Enron entered the
business of selling natural gas and electricity. Soon after Enron was formed the United States
Congress passed legislation deregulating the energy market, Enron took off. Enron was able to
sell their natural gas and energy at much higher prices, causing their revenue increase drastically.
By 1992 Enron was the largest seller of natural gas in North America (Healy & Palepu 2003).
Enron then began to look for new investments to make even more money. They invested in
water, power, and paper plants; they also owned gas pipelines and broadband services.
America’s eyes were on Enron as it continued to grow and appeared to be having enormous
success. According to The Journal of Economic Perspectives between 1990 and 1998 Enron’s
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stock rose by 311%, Enron stock then increased even more quickly in 1999 stock prices more
than doubled and in 2000 stock increased by 87%. In December 2001 Enron’s stocks were
valued at $83.13 a share and people were eager to invest (Lev 2003). Enron was even deemed
the Americans most innovative company by Fortune magazine.
Enron seemed unstoppable, yet less than a year later questions were emerging, documents
were being shredded, Enron’s CEO (Jeff Skilling) was resigning, stock prices plunging and the
United States Securities and Exchange Commission had opened an investigation into Enron,
concerned about “conflicts of interest”. By December of 2001 Enron was filing for bankruptcy
and key leaders of Enron were being arrested and sent to jail (Healy & Palepu 2003). So what
happened?
The Debate
The cause of the fall of Enron has been a hot topic in the debate among scholars. Many
believe poor policy making by the United States government and incentive problems led to the
downfall. They believe that the government could have prevented or dramatically decreased the
corruption by having better regulation policies. Others believe it was a faulty accounting
strategy. They believe reform is needed to prevent similar corruption from occurring in other
businesses.
Argument 1: Flaws in Government Policy and Incentive Problems Led to the Corruption in
Enron
Power and Corruption 4
In the early 1980s before Enron was formed gas pipeline companies were used to
transport natural gas from producers to local utilities. Pipeline companies such as Huston Natural
Gas would enter into long term contracts with producers. These long term contracts set fixed
prices and ensured stability of the natural gas market. However changes in regulation passed by
United States Congress in the mid 1980, around the time Enron was formed, allowed for much
more flexibility (Fooks 2003). The legislation of deregulation that was passed by Congress was
supposed to promote competition in the natural gas market and in turn provide cheaper, better
quality natural gas all across America. However, the result of the deregulation could not have
been further from the goal of Congress. After deregulation of the natural gas market pipeline
companies such as Enron began to engage in spot transaction and moved away from long term
contracts with fixed prices. This led to dramatic fluctuation and an unstable natural gas market,
which it allowed Enron to increase in revenues (Fooks 2003). In search of further success Enron
than moved from strictly a pipeline company to a trader of natural gas and also began to try its
hand in the electricity market. Similar to the deregulation of the natural gas market deregulation
of the electricity market was to promote competition and benefits consumers. However this was
based upon faulty assumptions. One such assumption was that there would be many companies
supplying electricity to the consumers, therefore the consumers would have lots of opinions and
be able to choose the lowest price. However entering into the electricity market proved much
harder than one might have thought. In order to buy or construct a power plant a company must
have a lot of significant capital. As a result of the high barriers of entry to the electricity market
there ended up being only a few large corporations that held all the electric power in their hand.
Enron was one of these large corporations who owned power plants and controlled the flow of
electricity. If for one reason or another one of their plants went out, it caused electricity prices to
Power and Corruption 5
soar and their revenue to increase. Conditions for market manipulation were prime. Enron began
to fake shortages in order to artificially increase the price of electricity (Healy & Palepu 2003).
Scholars have attributed the manipulation of the market and the fall of Enron to the above
mentioned deregulation by the government. According to Paul Krugman, a Nobel Prize winning
economist, “In fact to believe that they [Enron] were not engaging in market manipulation, you
would have to believe that they are either saints or very bad business men because they would
have been passing up an obvious opportunity to increase their profits.”
Argument 2: Faulty Accounting Strategies Led to the Corruption and Fall of Enron.
Other scholars have attributed the implosion of Enron less to government deregulation
and more to faulty accounting practices adopted by Enron and the unethical business standards
that are in place in today’s business world.
Many have stated that it was Enron’s practice of “mark to market” accounting that was
the biggest flaw in the company. The accounting practices done by companies such as Enron,
prior to adopting mark to market accounting, was pretty simple and easy to follow. At any given
time natural gas companies would record what it cost them to supply gas and what money they
receive when they sold it. However this all changed when Jeffery Skilling came on the scene and
became the CEO of Enron. Skilling said that the company needed to adopt mark to market
accounting because it would help show the “true economic value” of transactions (Kulik 2005).
Mark to marketing was a very complex form of accounting that allowed Enron to estimate the
future value of a good at the time a long term contract was signed. Because Enron was able to
estimate the future value of a contract its profits appeared to increase dramatically. Investors
were fooled into thinking that Enron was bringing in more money than it actually was. Partly due
Power and Corruption 6
to the complexity of mark to market accounting and partly because misestimated future values.
The United States Securities and Exchange Commission approved the use of mark to market
accounting for Enron in 1992 (Kulik 2005).
One example of how mark to market accounting let Enron misstated its earning is its
contract with Blockbuster. According to The Journal of Business Ethics in 2000 Enron entered
into a long term contact with Blockbuster video, the goal of the contract was to provide
broadband services. When Enron entered into the contract they estimated the future value to be
around one hundred and ten million dollars. However the contract fell through when their
technology did not work properly but Enron constituted to count future earning of the contract
(Lev 2003).
Conclusion:
Although some believe that the corruption of Enron was due to deregulation by the
government and call for the government to step in and regulate the market when needed and
others believe that the scandal could have been prevented with a simple change of accounting
particles, one thing is clear. Scholars realize the severity of the problem of business corruption. It
is important for Americans to study the case of Enron before they come to conclusions about free
markets and business ethics in order to make a more informed opinion. For me personally I had
always believed that a completely free market was the best. However after closely examining the
Enron debacle I have come to the conclusion that sometimes government regulation is needed in
order to avert corruption and ensure fair competition.
Power and Corruption 7
References
Fooks, G. (2003). Regulation, Risk and Corporate Crime in a 'Globalised' Era. Palgrave
Macmillan Journals, 5 (2), pp. 17-26.
Healy, P. M, and K. Palepu. (Spring, 2003). The Fall of Enron. The Journal of Economic
Perspectives, 17. (2) pp. 3-26.
Kulik, B. W. (Jul. 2005). Agency Theory, Reasoning and Culture at Enron: In Search of
a Solution. Journal of Business Ethics, 59, (4) pp. 347-360.
Lev, B. (Spring, 2003). Corporate Earnings: Facts and Fiction. The Journal of Economic
Perspectives, 17, (2) pp. 27-50