1. Enron was valued at $2.3 billion when it was formed in July 1985. On August 23, 2000, its stock was at $90 per share and it had a market capitalization of $65.9 billion. Explain the major business practices that created such dynamic growth in the price of the stock.
Enron used many different tactics to inflate their stock prices. The one that sticks out to me is when they signed a 20-year contract with Blockbuster. Early in the contract Blockbuster and Enron parted ways with a null and void contract. However, Enron still kept the contract on the books as future earnings when they knew that money was never going to come in. They did this so their stocks prices would stay inflated.
Another practice is that they switched from an agent model to a merchant model when recognizing revenue. Doing this gave them a 65% increase when typical industry standards only gain between 2-3%. Once they switched to this accounting method other companies started to follow their lead in order to stay competitive with Enron.
In addition, Enron understated its liability and overstated its equity. They would do this by creating special purpose entities. These entities were created to show investors the downside of risk.
I believe the main reason the stock increased so much is due to corruption of Arthur Andersen, an independent audit firm. On Wikipedia’s website there was a statement from Enron’s Power Committee and it appears they were placing blame on the Andersen firm. They were quoted as saying, "… evidence available to us suggests that Andersen did not fulfill its professional responsibilities in connection with its audits of Enron's financial statements, or its obligation to bring to the attention of Enron's Board (or the Audit and Compliance Committee) concerns about Enron's internal contracts over the related-party transactions" (“Enron Scandal”). After reading about the scandal it seems as if Arthur Andersen was being pressured by Enron’s executive management to...
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