Accounting Scandal Updates on August 30, 2002
Bob Jensen at Trinity University

Bob Jensen's main document on the Enron scandal and other accounting frauds is at http://www.trinity.edu/rjensen/fraud.htm 

Possible headlines on the Enron saga following the guilty plea of Michael J. Kopper:

These are Jensen originals, although I probably shouldn’t admit it.

Duncan Williamson added "Kopper, bottomed."

Bob Jensen's threads on Enron humor can be found at http://www.trinity.edu/rjensen/fraud.htm#Humor 

Reply by Tom Omer

Anthropologists speak of the Copper Age, the Bronze Age, and the Iron Age as steps or stages through which societies and cultures pass in the course of their advancement toward becoming true civilizations. It would appear we have entered the Kopper Age in accounting

Thomas C. Omer 
Associate Professor Department of Accounting 
University of Illinois At Chicago 
The Art of Discovery: Finding the forest in spite of the trees.

An Accounting Paradox:  When will accounting for an asset destroy the asset?

If you are following the accounting saga following the implosion of Enron and Andersen, I strongly recommend the Summer 2002, Volume 21, Number 2 of the Journal of Accounting and Public Policy --- http://www.elsevier.nl/inca/publications/store/5/0/5/7/2/1/ 

Enron:  An Accounting Perspective

  • Reforming corporate governance post Enron: Shareholders' Board of Trustees and the auditor 97 -- 103 
    A.R. Abdel-khalik
  • Enron: what happened and what we can learn from it pp. 105 -- 127 
    G.J. Benston, A.L. Hartgraves
  • Enron et al.--a comment pp.129 -- 130 
    J.S. Demski
  • Where have all of Enron's intangibles gone? pp.131 -- 135 
    Baruch Lev
  • Enron: sad but inevitable pp.137 -- 145 
    L. Revsine
  • Regulatory competition for low cost-of-capital accounting rules pp.147 -- 149 
    S. Sunder

Regular Paper

  • How are loss contingency accruals affected by alternative reporting criteria and incentives? pp. 151 -- 167 
    V.B. Hoffman, J.M. Patton

Question:
Where were Enron's intangible assets?  In particular, what was its main intangible asset that has been overlooked in terms of accounting for intangibles?

Answer by Baruch Lev:

Baruch Lev Quote from Page 131 (from the reference above)

On December 31, 2000, Enron's market value was $75.2 billion, while its book value (balance sheet equity) was $11.5 billion.  The market-to-book gap of almost $64 billion, while not equal to the value of intangibles (it reflects, among other things, differences between current and historical-cost values of physical assets), appears to indicate that Enron had substantial intangibles just half a year before it started its quick slide to extinction.  This naturally raises the questions: Where are Enron's intangibles now?  And even more troubling: Why did not those intangibles--a hallmark of modern corporations--prevent the firm's implosion?  In intangibles are "so good", as many believe, why is Enron's situation "so bad"?

Baruch Lev Quite beginning on Page 133 (from the reference above)

So the answer to the question posed at the opening of this note--where have Enron's intangible gone?--is a simple one: Nowhere.  Enron did not have substantial intangibles, that is, if hype, glib, and earnings manipulation did not count as intangibles.  Which, of course, also answers the second question--why did not the intangibles prevent Enron's implosion.

Back to Greenspan's comment about the fragility of intangibles: "A physical asset, whether an office building or an automotive assembly plant, has the capability of producing goods even if the reputation of the managers of such facilities falls under a cloud.  The rapidity of Enron's decline is an effective illustration of the vulnerability of a firm whose market value largely rests on capitalized reputation."  Intangibles are indeed fragile, more on this later, but "true" intangibles are not totally dependent on managers' reputation.  IBMs management during the 1980s and early 1990s drove the company close to bankruptcy, and was completely discredited (though not ethically, as Enron's).  But IBMs intangibles--innovation capabilities and outstanding services personnel--were not seriously harmed.  Indeed, under Lou Gerster's management (commencing in 1993), IBM made an astounding comeback.  Hypothetically, would a tarnished reputation of Microsoft, Pfizer, or DuPont's management destroy the ability of these similarly innovative companies to continuously introduce new products and services and maintain dominant competitive positions?  Of course not.  Even when companies collapse, valuable patents, brands, R&D laboratories, trained employees, and unique information systems will find eager buyers.  Once more, Enron imploded, and its trading activities "acquired" for change not because its intangibles were tied to management's reputation, but partly, because it did not have any valuable intangibles--unique factors of production--that could be used by successor managers to resuscitate the company and create value.

Finally, to the fragility of intangibles.  As I elaborate elsewhere,3 along with the ability of intangible assets to create value and growth, comes vulnerability, which emanates from the unique attributes of these factors of production:

Partial excludability (spillover): The inability of owners of intangible assets to completely appropriate (prevent non-owners from enjoying) the benefits of the assets.  Patents can be "invented around", and ultimately expire; trained employees often move to competitors, and unique organizational structures (e.g., just-in-time production) are imitated by competitors.

Inherently high risk: Certain intangible investments (e.g., basic research, franchise building for new products) are riskier than most physical and financial assets.  The majority of drugs under development do not make it to the market, and most of the billions of dollars spent by the dotcoms in the late 1990s to build franchise (customer base) were essentially lost.

Nonmarketability: Market in intangibles are in infancy, and lack transparency (there are lots of patent licensing deals, for example, but no details released to the public).  Consequently, the valuation of intangible-intensive enterprises is very difficult (no "comparables"), and their management challenging.

Intangibles are indeed different than tangible assets, and in some sense more vulnerable, due to their unique attributes.  Their unusual ability to create value and growth comes at a cost, at both the corporate and macroeconomy level, as stated by Chairman Greenspan: "The difficulty of valuing firms that deal primarily with concepts and the growing size and importance of these firms may make our economy more susceptible to this type of contagion".  Indeed, intangible-intensive firms are "growing in size and importance", a fact that makes the study of the measurement, management, and reporting of intangible assets so relevant and exciting, irrespective of Enron the intangibles-challenged sorry affair.

 

Answer by Bob Jensen

I have to disagree with Professor Lev with respect his statement:  " Enron did not have substantial intangibles."  I think Enron, like many other large multinational corporations, invested in a type of intangible asset that has never been mentioned to my knowledge in the accounting literature.  Enron invested enormously in the intangible asset of political power and favors.  There are really two types of investments of this nature for U.S. based corporations:

  1. Investments in bribes and political contributions allowed under U.S. law, including the Foreign Corrupt Practices Act (FCPA)
  2. Investments in bribes and political contributions not allowed under U.S. law, including the Foreign Corrupt Practices Act (FCPA)

I contend that large corporate investment in political power is sometimes the main intangible asset of the company.  This varies by industry, but political favors are essential in agribusiness, pharmaceuticals, energy, and various other industries subject to government regulation and subsidies.  Enron took this type of investment to an extreme in both the U.S. and in many foreign nations.  Many of Enron's investments in political favors appear to violate the FCPA, but the FCPA is so poorly enforced that it seldom prevents huge bribes and other types of investments in political intangibles.

I provide you with several examples below.

Two Examples of Enron's Lost Millions in Political Intangibles
India and Mozambique:  Enron Invests in U.S. Government Threats to Cut Off  Foreign Aid

SHAMELESS:
1995'S 10 WORST
CORPORATIONS

by Russell Mokhiber and Andrew Wheat
http://www.essential.org/monitor/hyper/mm1295.04.html 

 

The module about Enron in 1995 reads as follows:

Enron's Political Profit Pipeline

In early 1995, the world's biggest natural gas company began clearing ground 100 miles south of Bombay, India for a $2.8 billion, gas-fired power plant -- the largest single foreign investment in India.

Villagers claimed that the power plant was overpriced and that its effluent would destroy their fisheries and coconut and mango trees. One villager opposing Enron put it succinctly, "Why not remove them before they remove us?"

As Pratap Chatterjee reported ["Enron Deal Blows a Fuse," Multinational Monitor, July/August 1995], hundreds of villagers stormed the site that was being prepared for Enron's 2,015-megawatt plant in May 1995, injuring numerous construction workers and three foreign advisers.

After winning Maharashtra state elections, the conservative nationalistic Bharatiya Janata Party canceled the deal, sending shock waves through Western businesses with investments in India.

Maharashtra officials said they acted to prevent the Houston, Texas-based company from making huge profits off "the backs of India's poor." New Delhi's Hindustan Times editorialized in June 1995, "It is time the West realized that India is not a banana republic which has to dance to the tune of multinationals."

Enron officials are not so sure. Hoping to convert the cancellation into a temporary setback, the company launched an all-out campaign to get the deal back on track. In late November 1995, the campaign was showing signs of success, although progress was taking a toll on the handsome rate of return that Enron landed in the first deal. In India, Enron is now being scrutinized by the public, which is demanding contracts reflecting market rates. But it's a big world.

In November 1995, the company announced that it has signed a $700 million deal to build a gas pipeline from Mozambique to South Africa. The pipeline will service Mozambique's Pande gas field, which will produce an estimated two trillion cubic feet of gas.

The deal, in which Enron beat out South Africa's state petroleum company Sasol, sparked controversy in Africa following reports that the Clinton administration, including the U.S. Agency for International Development, the U.S. Embassy and even National Security adviser Anthony Lake, lobbied Mozambique on behalf of Enron.

"There were outright threats to withhold development funds if we didn't sign, and sign soon," John Kachamila, Mozambique's natural resources minister, told the Houston Chronicle. Enron spokesperson Diane Bazelides declined to comment on the these allegations, but said that the U.S. government had been "helpful as it always is with American companies." Spokesperson Carol Hensley declined to respond to a hypothetical question about whether or not Enron would approve of U.S. government threats to cut off aid to a developing nation if the country did not sign an Enron deal.

Enron has been repeatedly criticized for relying on political clout rather than low bids to win contracts. Political heavyweights that Enron has engaged on its behalf include former U.S. Secretary of State James Baker, former U.S. Commerce Secretary Robert Mosbacher and retired General Thomas Kelly, U.S. chief of operations in the 1990 Gulf War. Enron's Board includes former Commodities Futures Trading Commission Chair Wendy Gramm (wife of presidential hopeful Senator Phil Gramm, R-Texas), former U.S. Deputy Treasury Secretary Charles Walker and John Wakeham, leader of the House of Lords and former U.K. Energy Secretary.

 
United States Deregulation of Energy That Needed a Change in the Law:  Enron's Investment in Wendy Gramm

Forwarded by Dick Haar on February 11, 2002

Senator Joseph Leiberman 
706 Hart Senate Office Building 
Washington, D.C. 20510

RE: Enron Investigation

Dear Senator Leiberman,

I watched your Sunday morning appearance on Face the Nation with intense interest. Inasmuch as I own a fair amount of Enron stock in my SEP/IRA, I'm sure you can understand my curiosity relative to your investigation.

Knowing you to be an honorable man, I feel secure that you will diligently pursue the below listed matters in an effort to determine what part, if any, these matters contributed to the collapse of Enron.

1. Government records reveal the awarding of seats to Enron executives and Ken Lay on four Energy Department trade missions and seven Commerce Department trade trips during the Clinton administration's eight years.

a. From January 13, 1995 through June 1996, Clinton Commerce Secretary Ron Brown and White House Counsel Mack McLarty assisted Ken Lay in closing a $3 billion dollar power plant deal with India. Four days before India gave final approval to the deal, Enron gave $100,000 to the DNC. Any quid pro quo?

b. Clinton National Security Advisor, Anthony Lake, threatened to withhold aid to Mozambique if it didn't approve an Enron pipeline project. Subsequent to Mr. Lake's threats, Mozambique approved the project, which resulted in a further $770 million dollar electric power contract with Enron. Perhaps, if NSA Advisor Lake had not been so busy strong-arming for Enron, he might have been focused on something obliquely related to national security like, say, Mr. Bin Laden? Could it be that a different, somewhat related, investigation is warranted?

c. In 1999, Clinton Energy Secretary Bill Richardson traveled to Nigeria and helped arrange a joint, varied, energy development program which resulted in $882 million in power contracts for Enron from Nigeria. Perhaps if Energy Scretary Richardson had been more focused on domestic energy, we might have avoided:

i. The severe loss of nuclear secrets to China and concurrently ii. developed more domestic sources of energy.

d. Subsequent to leaving Clinton White House employ, Enron hired Mack McLarty (White House Counsel), Betsy Moler (Deputy Energy Secretary) and Linda Robertson (Treasury Official). Even a person without a high school diploma (no disrespect to airline security screeners) can see that this looks like Enron paying off political favors with fat-cat corporate jobs, at the expense of stockholders and Enron pension employees.

e. Democratic Mayor Lee P. Brown of Houston (Enron headquarter city), received $250,000 just before Enron filed Chapter 11 bankruptcy. Isn't that an awful lot of money to throw away right before bankruptcy?

The Democratic National Committee was the recipient of hundreds of thousands of dollars from 1990 through 2000. The above matters appear to be very troubling and look like, smack of, reek of, political favors for campaign payoffs. I know you will find out.

2. Recently, former Clinton Treasury Secretary Robert Rubin called a top U. S. Treasury official, asking on Enron's behalf, for government help with credit agencies. As you well know, Rubin is the chairman of executive committee at Citigroup,