Enron and The Asymmetric Information
Prior to its bankruptcy, Enron was the seventh largest, and was awarded as the most innovative company in the United States. It was a public limited company whose business was firstly stated in energy trading industry. The company itself was established in 1985 by Kenneth Lay, who later in 1989 hired a Harvard MBA (Master of Business Administration) graduates, Jeffrey Skilling, to be its chief of finance.
Years before, the U.S. government deregulated the energy business, by lifting many of the regulation that had kept the prices fixed. As a result, gas prices began to fluctuate widely, so it was risky for both buyer and seller. But instead, this event brought an opportunity and outcome to Enron Company.
The idea came from Skilling, which Enron served the buyers, by signing contracts with sellers to buy their gas with fixed price, which within the year, removing the risks for both parties. An innovative idea from such a genius top five Universities graduates in United States. Soon it recruited members consisting of mostly MBA graduates, to expand their trading ideas to more markets, selling long contracts for electricity, coal, paper pulp, and other different kinds of its many products.
But many articles mentioned “The Fraud of Enron”, “Enron Collapsed”, etc. So, what makes Enron failed? And the most important thing is what make this company becomes the lesson everyone should learn about business ethic?
This disaster was started when Enron needed more money to survive its business. However with it huge amount of liabilities already, the possibility to borrow money was quite impossible, because no company would like to deal with another company which has big amount of liabilities. Logically, companies with high liabilities would be more likely to go bankrupt.
Skilling and his newly appointed vice president, Fastow, tried to think of strategies that enable them to have more money without endangering their relationship with buyers and sellers. That was when the idea to abuse the weaknesses in United States Accounting Procedure popped up in their mind. According to this procedure, companies may develop special entities within companies, which may make their own financial statements separately from its parent company.
Skilling and Fastow then, created a Special Purpose Entities within Enron. They gave this entity 3% of their stocks. With these stocks, the entities will be able to “buy” Enron’s liabilities. Since the Special Purpose Entities’ financial statements were reported separately, Enron would be able to only report the profitable contracts. This action made the stock became interesting so that the price went higher, so much than its actual price.
What was their mistake at that time? They ignored the rule stating that when the stock price is going down into a certain price, both the parent company and its special entities’ financial statement must be combined. In March 5th 2001, somehow the stock price was getting down due to some investors’ suspicion after an article in Fortune Magazine. The article wrote that Enron’s stock price might be overvalued. People started to believe the article and later the stock price began to get lower and lower, until the rule that forced Enron to record its combined financial statements must be applied. People got surprised when they knew that Enron actually experienced a big loss.With this big loss, many people became more suspicious that Enron was involved in unaccepted conduct. For at last, people know that Enron, fraud its financial statements.
When more and more people knew these financial statements, they began to panic and sold their stock immediately. This made the stock price, jumped nearly to zero. By November 2001, the company collapsed into bankruptcy.
Where is the information asymmetry here? Remember when this website stated clearly, that Enron actually had a huge amount of liabilities, he and Fastow were the only people who knew the information about this, instead, they reported bigger amount of asset. Knowing this situation, Skilling and Fastow was far from feeling guilty when they paid themselves million of dollars for their salaries in their made belief company, Special Purpose Entities.
Thanks to an integrated insider of the company named Sharon Watkins, public knew about this fraud. Their stock fell down, and dropped nearly to zero. At the very last, the company has gone bankrupt. It later found out that Kenneth Lay, Skilling and Fastow, all of them owned a quite big amount of Enron’s stock, sold theirs a few weeks before things got worst. They also tried to fire Sharon Watkins fearing that she would reveal this wrongdoing.
In this case, Sharon Watkins and the Fortune Magazine was a newer version of Stetson Kennedy, whom exploited the information asymmetry in Ku Klux Klan, making it asymmetry. With this all happening, Enron definitely become the worst company fraud ever made and at the same time become the best lesson learned on the importance to hold business ethic at its highest position.
Years before, the U.S. government deregulated the energy business, by lifting many of the regulation that had kept the prices fixed. As a result, gas prices began to fluctuate widely, so it was risky for both buyer and seller. But instead, this event brought an opportunity and outcome to Enron Company.
The idea came from Skilling, which Enron served the buyers, by signing contracts with sellers to buy their gas with fixed price, which within the year, removing the risks for both parties. An innovative idea from such a genius top five Universities graduates in United States. Soon it recruited members consisting of mostly MBA graduates, to expand their trading ideas to more markets, selling long contracts for electricity, coal, paper pulp, and other different kinds of its many products.
But many articles mentioned “The Fraud of Enron”, “Enron Collapsed”, etc. So, what makes Enron failed? And the most important thing is what make this company becomes the lesson everyone should learn about business ethic?
This disaster was started when Enron needed more money to survive its business. However with it huge amount of liabilities already, the possibility to borrow money was quite impossible, because no company would like to deal with another company which has big amount of liabilities. Logically, companies with high liabilities would be more likely to go bankrupt.
Skilling and his newly appointed vice president, Fastow, tried to think of strategies that enable them to have more money without endangering their relationship with buyers and sellers. That was when the idea to abuse the weaknesses in United States Accounting Procedure popped up in their mind. According to this procedure, companies may develop special entities within companies, which may make their own financial statements separately from its parent company.
Skilling and Fastow then, created a Special Purpose Entities within Enron. They gave this entity 3% of their stocks. With these stocks, the entities will be able to “buy” Enron’s liabilities. Since the Special Purpose Entities’ financial statements were reported separately, Enron would be able to only report the profitable contracts. This action made the stock became interesting so that the price went higher, so much than its actual price.
What was their mistake at that time? They ignored the rule stating that when the stock price is going down into a certain price, both the parent company and its special entities’ financial statement must be combined. In March 5th 2001, somehow the stock price was getting down due to some investors’ suspicion after an article in Fortune Magazine. The article wrote that Enron’s stock price might be overvalued. People started to believe the article and later the stock price began to get lower and lower, until the rule that forced Enron to record its combined financial statements must be applied. People got surprised when they knew that Enron actually experienced a big loss.With this big loss, many people became more suspicious that Enron was involved in unaccepted conduct. For at last, people know that Enron, fraud its financial statements.
When more and more people knew these financial statements, they began to panic and sold their stock immediately. This made the stock price, jumped nearly to zero. By November 2001, the company collapsed into bankruptcy.
Where is the information asymmetry here? Remember when this website stated clearly, that Enron actually had a huge amount of liabilities, he and Fastow were the only people who knew the information about this, instead, they reported bigger amount of asset. Knowing this situation, Skilling and Fastow was far from feeling guilty when they paid themselves million of dollars for their salaries in their made belief company, Special Purpose Entities.
Thanks to an integrated insider of the company named Sharon Watkins, public knew about this fraud. Their stock fell down, and dropped nearly to zero. At the very last, the company has gone bankrupt. It later found out that Kenneth Lay, Skilling and Fastow, all of them owned a quite big amount of Enron’s stock, sold theirs a few weeks before things got worst. They also tried to fire Sharon Watkins fearing that she would reveal this wrongdoing.
In this case, Sharon Watkins and the Fortune Magazine was a newer version of Stetson Kennedy, whom exploited the information asymmetry in Ku Klux Klan, making it asymmetry. With this all happening, Enron definitely become the worst company fraud ever made and at the same time become the best lesson learned on the importance to hold business ethic at its highest position.
Copyright © 2011 Ionwyn Sean
