Enron and Information Age Disclosure

In the New Economy, more companies are being built on soft assets, and that makes trustworthy financial reporting all the more critical

The downfall of Enron Corp. has occasioned a chorus of "we-told-you-so" from the self-proclaimed fuddy-duddies of the business world. They say Enron tumbled so quickly because it lacked enough hard assets, and that its $60 billion-plus market value was built in the clouds -- on brands, intellectual capital, transactional networks, and other tricky-to-measure stuff that will be difficult for creditors to get a piece of in bankruptcy court. In their view, real assets are the Industrial Era things that remain useful and valuable even if the company that owns them goes belly-up -- airplanes, coal deposits, steel-rolling machines, and the like.

This nostalgic view is understandably popular in the aftermath of the biggest bankruptcy in U.S. history. But it misunderstands the problems of Enron as well as the ongoing transformation of Corporate America. Like it or not, the era of hard assets' supremacy is over -- for good. Instead of fighting the transition to an economy of ideas and information, we need to figure out how to build in safeguards against more New Economy flameouts like Enron's. And the key to preventing such disasters is detailed, understandable information about how a company works, instead of razzle-dazzle press releases masquerading as disclosure (see BW Cover Story, 12/17/01, "The Fall of Enron").

OLD-FASHIONED TROUBLE. Start by taking another look at what went wrong at Enron. Ironically, it wasn't its New Economy side that triggered the downward spiral. The soft assets at Enron, especially the energy-trading business, were doing just fine, even if most of us couldn't begin to understand the derivatives transactions they specialized in. The trouble at Enron started the old-fashioned way, with dumb investments in hard assets like power plants and a fiber-optic network.

Enron's financial wizards appear to have used accounting sleight-of-hand to hide their mistakes. When those errors came to light, Enron's credit rating tumbled. That proved fatal to the trading operation, which can't survive unless people doing business with it are confident they'll be able to collect their money. In short, the Old Economy part of Enron infected the New Economy part, not vice versa.

Critics of the New Economy do have one thing right, though: Soft assets are far more vulnerable to destruction than hard assets. Take the Enron name, which the company proudly plastered on its business units and Houston's baseball stadium. Whatever marquee value the Enron name once had is gone. Or take the trading operation itself. Because of a crisis of confidence, it went from being the nation's dominant energy-trading platform to virtually nothing in a matter of weeks.

CONFIDENCE IS KEY. That's what used to happen to banks on a regular basis before federal deposit insurance: Even if Depositor A was confident of a bank's soundness, she might still pull out her money if she thought Depositors B and C were about to yank their money. No bank in the world keeps enough cash on hand to pay off its depositors if they all want their money at once. Ditto for Enron's trading operation, where counterparties' fears about its creditworthiness rapidly became a self-fulfilling prophecy.

What can be done to protect employees, investors, and the economy from a repeat of the Enron disaster? It's a crucial question for the New Economy, in which more and more companies are built on perishable intellectual assets. Government insurance isn't really the answer. Companies would be tempted to take all manner of foolish risks, knowing that the government would bail them out -- and the costs would be enormous.

Actually, investors themselves can help prevent another Enron, as can regulators and Wall Street. For far too long, investors, research analysts, and credit-rating agencies took Enron at its word, pushing the stock higher and higher without much information on what was behind the company's spectacular performance, which in hindsight was not so spectacular at all. When a New Economy company is wowing everyone with its results, it can be easy to forget that no one except management knows exactly how those results are being produced.

A few harder questions early on in the Enron debacle might have provided a warning that the company was jeopardizing key assets. With more prodding, Enron might have been forced to disclose its accounting gimmickry much earlier, preventing billions of dollars in losses.

LATE CRUSADE. It's all too easy now to see now that at Enron, problems festered until it was too late. Joe Berardino, the managing partner of Arthur Andersen, wrote a long piece in The Wall Street Journal on Dec. 4 calling for accounting reforms in the wake of the Enron debacle. It so happens that Andersen got paid $52 million last year as Enron's accountant and adviser, and gave it a clean bill of health. So his crusade seems to come a bit after the fact. But Berardino's message is correct: If companies' books can't be trusted, many more will blow up.

That would be unfortunate, because Information Age companies like Enron are worth far more intact than in salvage. To keep them from blowing up, let's strengthen our disclosure rules so that these companies don't get overinflated in the first place.

---