Why Enron Collapsed?

Only available on StudyMode
  • Download(s): 177
  • Published: July 28, 2012
Read full document
Text Preview
What are the reasons why Enron collapsed?

* Investments
Enron dealt in energy. According to Infinite Energy, the first and main cause of Enron's collapse was failed investments. Enron invested money in fiber-optic networks, a power plant in India and water distribution in the United Kingdom, to name a few. While a company the size of Enron could afford occasional losses, the mounting, failed investments added up and created a plethora of debt. * Hidden Losses

Infinite Energy states that the second and most shady reason for Enron's collapse was the hidden losses within the company. The company allegedly enriched itself and formed partnerships specifically designed to hide $500 million in company losses. Because these losses were hidden, many continued buying Enron stock. According to the Journal of Accountancy, the bottom fell out underneath this plan in early 2001 when stock prices plummeted. Enron used false and deceptive methods to creatively hide its dealings, which led to losses of investors and creditor trust. * Competition

In the late 1990s, Enron started receiving stiff competition from other energy companies such as Duke Energy, Dynergy and El Paso, according to the Journal of Accountancy. With each new competitor, Enron profited less and less. Enron had previously thrived on large, rapid trading, which became less frequent with more competition and reduced energy costs. Instead of examining whether or not they should adjust their trading habits, the company continued on the same track they had previously operated on without regard to the changing environment around them. * Energy Price Collapse

The collapse in energy prices and the end of the California energy crisis was the death nail for Enron, according to Infinite Energy. In early 2001, California consumed less energy than it did in two previous years and the government introduced price caps for power companies like Enron. These caps meant that Enron could no longer collect as much money per kilowatt of energy, according to Infinite Energy. The Journal of Accountancy states that on October 16, Enron announced its first losses in more than four years. After this announcement, it was a rapid fall to bankruptcy. A merger was in the works with Dynergy in mid-November, but Dynergy pulled it on November 28 because of Enron's lack of disclosure. November 30 saw Enron's stock closing at 26 cents per share. The Journal of Accountancy states that once Enron was known as a junk stock, bankruptcy followed on December 2, 2001.

* Accounting Problems
The conventional wisdom is that it was "innovative" accounting practices and their consequences that started the tide of losses that brought the energy giant down. Enron collapsed not so much because it had gotten too big, but because it was perceived to be much bigger than it really was in the first place. By decentralizing its operations into numerous subsidiaries and shell corporations, Enron was able to hide huge derivative losses that would have halted its growth much sooner if widely understood. Publicly traded corporations are required to make their financial statements public, but Enron's finances were an impenetrable maze of carefully crafted imaginary transactions between itself and its subsidiaries that masked its true financial state. In other words, losses were held off the book by subsidiary companies, while assets were stated. Taken at its word, this rosy scenario made the company the darling of Wall Street, and it was able to borrow almost endlessly and expand into e-commerce and other questionable ventures. Its stock literally soared, which made employee compensation and pensions in the form of stock options seem very attractive. But what were already considered accounting practices on the edge of acceptable standards were eventually revealed to be outright fraudulent. The disgrace drove so much business away from and created such liability for accounting firm Arthur Anderson that it...
tracking img