Cggggggggg Essay Example

Cggggggggg Paper When Enron filed for bankruptcy protection on December 2, 2001, the financial world was shocked. How could this high profile leader in the world of energy trading have failed? Based in Houston, Texas, Enron was the seventh largest company by revenues in the United States, employing 25,000 people worldwide. Its performance had been lauded in the media, and business school cases had held it up as a glowing example of the transformation of a conservative energy company into a global player. It had frequently been cited in the McKinsey Quarterly as an example of how innovative companies can outperform their more traditional rivals. The drive to maintain reported earnings growth, however, had led Enron to aggressive accounting policies to accelerate earnings. In particular, the ‘special purpose entities’ (SPEs) Enron used to move assets and liabilities off the balance sheet attracted most attention. The financial involvement of Enron officers and employees in the SPEs led to further questions. Enron executives regarded themselves as an elite. The company had largely left behind the Texan ‘good ol’ boy’ culture – and certainly the culture of the regulated utility and had embraced the free market vision of Chairman Kenneth Lay. Encouraged by Jeffrey Skilling, who later became CEO, a highly paid army of financially literate MBAs sought innovative ways to ‘translate any deal into a mathematical formula’ that could then be traded or sold on – often to SPEs set up for that purpose. By the end, Enron had in excess of 3,000 subsidiaries and unconsolidated associates, including more than 400 registered in the Cayman Islands. We will write a custom essay sample on Cggggggggg specifically for you for only $16.38 $13.9/page Order now We will write a custom essay sample on Cggggggggg specifically for you FOR ONLY $16.38 $13.9/page Hire Writer We will write a custom essay sample on Cggggggggg specifically for you FOR ONLY $16.38 $13.9/page Hire Writer The SPEs set up by Enron, often with auditor Arthur Andersen’s advice and approval, have attracted much criticism – but there is nothing inherently wrong with such vehicles. In fact, almost all major companies use various forms of SPEs to manage, for example, joint ventures in foreign countries, or investments in hostile environments. What was unusual in this case was the sheer number of SPEs involved. Enron’s accounting policies led to deals being struck that would be cash negative in the early years. In one example, Enron entered into a 12-year, ixed-price gas supply deal in the Far East at a price below the current ‘spot’, and as Enron did not have its own supply it had to go into the market to purchase at the higher price. Nevertheless, the forecast price curve was such that it showed a positive net present value and a profit was booked to reflect that. The manager who had done the deal was subsequently approached by his boss towards the end of t he quarter, and told that, as they were not going to meet budget, he should revisit the deal and ‘tweak the numbers’ to squeeze out a bit more. This process was so common that it was known as ‘marking up the curve’. Enron’s shares in the late 1990s had significantly outperformed the market (see Figure 1 in PDF or print magazine) and at their highest price the market capitalisation of the company reached $60bn. At this level, the share price implied a price-earnings multiple of around 60, or nearly three times the sector average. Although the ‘irrational exuberance’ of investors of the time may have contributed, Enron was not a simple ‘dot-com’ story. Indeed, when the Nasdaq index was falling through the floor, Enron shares continued to outperform the market. Performing well on the stock market brings its own problems by raising market expectations. Consequently, there was tremendous pressure on Enron to maintain earnings-per-share (EPS) growth, which in turn led to the need for new sources of revenue and capital. Large investments in major power projects needed cash. Such investments were not expected to generate earnings or positive cash flow in the short term, placing immediate pressure on the balance sheet. The much expanded trading book added to this pressure, especially after the creation of EnronOnline. is was resisted as it would dilute EPS and in turn affect the share price. The chosen solution was to get some of the assets and related debt off the balance sheet. This required finding outside investors willing to take some of the risk through equity participation in separate entities, which, in turn, could borrow from third parties (outside lenders). This would only work if these special purpose entities (SPEs) did not have to be consolidated in Enron’s results, otherwise it would defeat the objective of such financial engineering. Furthermore, the broadband venture was losing money, with no short-term likelihood of generating profits, while continuing to suck up capital expenditure. To make matters worse, the fall in the value of Enron’s share price was likely to trigger its guarantee obligations. To compound these problems, some hedge funds had become short sellers of Enron stock. On March 5, 2001, Fortune published an article by Bethany McLean in which she questioned the current stock market value of Enron. Her main arguments were that it was very difficult to ascertain how the company was making its profits, that these profits did not seem to be generating a commensurate amount of cash, and that there was a lack of transparency in Enron’s reporting and its handling of media questions. In the meantime, Enron’s share price continued to slide. A real blow came, when Skilling resigned after only six months as CEO, citing ‘personal reasons’. Lay resumed the role of CEO. Subsequently, in an interview with Business Week, Lay said, â€Å"There’s no other shoe to fall,† going on to add, â€Å"There are absolutely no problems [ ]. There are no accounting issues, no trading issues, no reserve issues, no previously unknown problem issues. The company is probably in the strongest and best shape that it has ever been in. † Enron watchers, fearing there was more to the story, were not convinced and the share slide continued. At the same time as seeking to reassure investors, Lay was cashing in his share options, netting himself more than $100m in the process. Watkins also called an acquaintance at Andersen and voiced her concerns. Andersen had been uncomfortable for some time with Enron accounting practices that it had previously accepted. Revisiting some of the SPEs, particularly in relation to the 3 per cent rule, it decided that, at least in the case of Chewco, there had been a breach and that Chewco would have to be consolidated. It also looked again at the Raptor transactions and came to the same conclusion. Accordingly, it advised Enron that the accounts would need to be restated.