When companies shift focus from servicing the consumers to seeking to profit from regulation, trouble lies ahead. That’s the story of Enron’s debacle according to a former employee.
Enron used to be the seventh largest corporation in the US, but filed for bankruptcy in 2001 (see timeline of Enron scandal here)
Writes Robert L Bradley Jr. at the Library of Economics and Liberty (hat tip Professor David Henderson)
Enron was a political colossus with a unique range of rent-seeking and subsidy-receiving operations. Ken Lay's announced visions for the company—to become the world's first natural-gas major, then the world's leading energy company, and, finally, the world's leading company—relied on more than free-market entrepreneurship. They were premised on employing political means to catch up with, and outdistance, far larger and more-established corporations.
A big-picture Ph.D. economist with Washington, D.C. experience regulating oil, gas, and electricity, Lay found his niche in the private sector managing federally regulated interstate gas-transmission companies, first at Florida Gas Company and then at Transco Energy Company. When Lay became CEO of Houston Natural Gas Corporation, he transformed a largely unregulated intrastate natural-gas company to a federally regulated (interstate) one in 1984-85. Then, during the next 16 years, he steadily moved the renamed Enron into rent-seeking.
The interesting part is how Enron gamed the system (bold added)
Any analysis of Enron's business history will reveal entrepreneurial error and unhealthy government dependence that left major divisions of Enron in the red or just marginally profitable. But rather than make midcourse corrections, Enron manipulated the highly prescriptive—indeed politicized—tax and accounting systems to create the illusion of profitability. Such gaming was another crucial government front for the company.
The corporate tax division acted as a profit center at Enron by meeting earnings targets. Federal investigators identified 881 offshore subsidiaries as part of Enron's tax-sheltering strategy. Enron's general tax counsel remembers reaching his gaming limit: "When the [tax-saving] number got up to $300 million [in 2001] I said... 'We have to come up with a way to get this through [real] earnings—through regular business'."
Gamed financial reporting was a second "profit center," as Enron scoured the Generally Accepted Accounting Principles (GAAP) rulebook to book paper earnings where economic profit (positive cash flow from operations) was absent. "Financial engineering" also hid liabilities and inflated assets, allowing Enron to meet investor expectations and concoct peculiar narratives about its business performance.
A particularly contrived business in this regard was Enron Energy Services (EES), which purportedly split energy savings with customers via long-term outsourcing agreements. EES buttressed Enron's "green" image, but the green was not monetary. Mark-to-market accounting turned into mark-to-model, under which arbitrary assumptions about future energy prices turned losses into profits. The GAAP game was even explained in Enron's employee Risk Management Manual:
Reported earnings follow the rules and principles of accounting. The results do not always create measures consistent with underlying economics. However, corporate management's performance is generally measured by accounting income, not underlying economics. Risk management strategies are therefore directed at accounting rather than economic performance.
A third exercise in government gaming that gave Enron false profitability concerned electricity trading in California in 2000-2001. Through contrived schemes with code names like "Get Shorty" and "Ricochet," Enron exploited loopholes in the state's highly regulated system, which generated hundreds of millions of dollars of paper profits that utilities and their ratepayers could not and would not pay. One manipulation was described in an Enron memo: "The net effect of these transactions is that Enron gets paid for moving energy to relieve congestion without actually moving any energy or relieving any congestion."
The bottom line:
Although an Enron could not have been predicted, it is yet another example of the unintended consequences of interventionism in the field of energy, as well as from the politicized accounting and tax systems that governed all corporations
And then there is the ultimate consequence from the dynamics of intervention. Historically, the failures of the mixed economy have been an excuse to further politicize the economy. Richard Epstein warned: "The greatest tragedy of the Enron debacle is not likely to be the consequences of the bankruptcy, but from the erroneous institutional reforms that will take hold if its causes are not well understood." The Sarbanes-Oxley Act (2002) and the Bipartisan Campaign Reform Act (2002), enacted with Enron in mind, proved him right.
Read the rest here
No comments:
Post a Comment