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Enron opens the economy's books

Some good is finally coming of Enron's collapse: Other companies with questionable accounting practices are losing value. (There was a New York Times article on this yesterday.)

Not that it's good for anyone that other companies had inflated stock prices. But if any lasting change in accounting practices is to be made, it will have to be market-driven — companies will have to want to make their financial statements transparent.

After all, Enron had the simplest of reasons for exploiting accounting loopholes to make its numbers look better: It wanted to improve its stock price. It simply took to the logical limit what practically every major corporation already does to some extent already. And it worked. Analysts and investors loved the stock so much they ignored questions raised about the company's finances as early as a year ago.

And the accountants that were supposed to oversee these practices were silenced by the same force that fostered them in the first place: greed. Much has been made of the renewed call for increased regulation of accounting practices, but the fact remains that tremendous amounts of money were involved, and it's hardly likely that the people who looked the other way did so for any other reason than that they wanted a piece for themselves.

Forbidding accountancies from also offering consulting services to their clients would eliminate one way that Andersen profited from Enron's revenue-cooking machine. But accounting is still a business, and an accountancy's success will ultimately be judged on its profits, not its (known) ethical standards. Ideally, these would always correlate, but there is no guarantee. Andersen, moreover, appears to have broken the law in any case; and additional legislation is hardly a solution for lawbreaking. It's not even likely to eliminate accounting loopholes that will enable many questionable practices to continue.

The stock market, however, rewards low-risk investments (all other things being equal). And it has become painfully obvious how risky it is to invest in a company whose financial statements are indecipherable (even when it is hyped as the hottest of the decade). Executives, investors, analysts and accountants alike will always be greedy — and if it becomes clear that the market will reward solid accounting practices with higher valuations, then they will at last have a proper incentive not to abuse the system.

Addendum: I realized I omitted another argument I had intended to make: Never before has the demand for integrity and honesty in an accountancy been higher. No doubt we'll see more than a few ad campaigns in the next year centering on the trustworthiness of one or another of the big accounting firms. Not only is there now market demand for companies that can account for their finances, there's demand for accountants that can lend that accounting credibility. This, too, is a very good thing.

[As for me, I think I need to rethink how quickly I write some of these pieces....]

January 31, 2002 5:10 PM

Comments (and TrackBacks)

apparently, an Enron Ethics Manual (unused) was on sale on ebay...

Posted by j on February 4, 2002 12:59 PM

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Copyright ©2001-2003 Matt Pfeffer


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