Following the money trail
Researching the intricacies of the Enron debacle has become nothing short of “an industry” for George J. Benston, John H. Harland professor of finance, accounting, and economics at Goizueta and professor of economics in the College of Arts and Sciences. His books and monographs on the subject are in high demand. In fact, his latest effort, Following the Money: The Enron Failure and the State of Corporate Disclosure (Brookings Institution, 2003), was on the AEI-Brookings Joint Center’s top 10 list of most downloaded items, with nearly 2,200 downloads since the initial postings on the site.
In Following the Money, Benston and co-authors explore the strengths and weaknesses of U.S. corporate accounting and auditing—illustrated through a careful study of the Enron debacle—and ways in which the U.S. system of corporate disclosure and governance is changing, for the better and the worse. “The key thing about accounting numbers is not that they be correct in the sense they tell you how to make an investment, but that they not be deliberately wrong,” explains Benston. “Enron said they were doing fantastically well, and they weren’t. The numbers were simply wrong.”
Benston and colleague Al L. Hartgraves, professor of accounting, published an article on Enron’s creative misuse of accounting entitled, “Enron: What happened and what we can learn from it” (Journal of Accounting and Public Policy, 2002). The article described the banking transactions conducted by J.P. Morgan Chase & Co. and Citigroup. Both firms later agreed to pay a combined $236 million to settle charges that they helped Enron manipulate its books to appear financially healthy.—Diana Drake
Here is a more indepth story on Following the Money from Goizueta's online business publication Knowledge@Emory:
Accounting Scandals: The Source and the Fix
The Enron debacle, in which accounting and consulting giant Arthur Andersen's alleged accounting improprieties are believed to have contributed to the stock crash and ensuing bankruptcy at the energy trader, is a turning point in history for many reasons. But perhaps the most lasting legacy will be its effect on the laws governing the accounting profession.
It was also a turning point for George Benston , professor of accounting, finance, and economics at Emory University's Goizueta Business School , and three colleagues, who set out to study systems of corporate governance and financial disclosure. As they studied differing accounting standards in the increasingly international marketplace, one point was clear. The U.S. held itself out as a model to be emulated by the rest of the world. The events of late 2002 changed all that. "The United States put itself forth as being the best. Enron seems to indicate maybe not," notes Benston. "The question then becomes, 'What did happen there?'"
The four academics decided to tackle the question. With the help of co-authors Michael Bromwich (London School of Economics), Robert E. Litan (Brookings Institution) and Alfred Wagenhofer (Graz University, Austria), Benston researched the particulars of the Enron scandal and set out to address specifically the nature of the problems those scandals revealed in their book Following the Money: The Enron Failure and the State of Corporate Disclosure. The authors say they share the view that the U.S. system of corporate disclosure and governance has problems and is in need of change. But they also have concerns. They observe, "In the rush to assign blame for Enron and the other accounting debacles, policymakers may be overreacting in some areas, and taking actions in others that may prove to be ineffective or even counterproductive."
Benston and his co-authors first set the foundation for their book by explaining why they feel readers should pay attention to corporate disclosure issues. Of primary concern, they say, is the appropriate disclosure of information to equities investors, whose numbers have been rising in recent years. According to their research, the share of households investing in stock directly or through mutual funds rose from 32% in 1989 to more than 50% in 2001. Shareholders need to be able to trust the information that is provided to them. As Enron and similar accounting scandals, including WorldCom, suggest, equity holders have reason to be concerned about the validity of reported numbers.
The authors begin their analysis by looking at what's wrong--and right--with corporate accounting and auditing in the U.S. They do so, in part, by detailing what went wrong at Enron. They focus on five types of accounting failures made public through the Powers Report, released in February 2002 following a three-month investigation by a special committee of Enron directors. Four out of the five failures, note the authors, involved violations of the provisions of U.S. Generally Accepted Accounting Principles (GAAP) and Generally Accepted Auditing Standards (GAAS). One incident found Enron exploiting the rules involving so-called fair value accounting. Fair values are not always market values. They are often calculated from managers' estimates of the present values of expected cash flows. Enron used fair value accounting to overstate the values and, hence, reported net income, on many financial assets that did not have reliable market values.
This, suggests Benston, reveals a flaw in GAAP. "The key attribute of accounting numbers is not that they be correct in the sense they tell you how to make an investment, but that they not be deliberately wrong," he explains. "The problem with Enron is that they said they were doing fantastically, and they weren't. The fair-value numbers were simply wrong. In their attempt to get numbers that appear to represent economic values, Securities and Exchange Commission (SEC) and the Financial Accounting Standards Board (FASB) allowed Enron to produce numbers that appeared designed to mislead investors. Other companies may similarly be misusing fair-value accounting; we do not know." With respect to the other issues, the authors argue that the major problem revealed by Enron does not lie in the accounting standards themselves, but in how those standards are applied and enforced.
The Enron disaster has led to many proposals, and new laws, designed to fix the U.S. corporate disclosure system. Benston and his colleagues agree with some of these solutions, and disagree with others. Broadly, they argue against the notion of moving to a single, worldwide set of accounting standards. They fear the imposition of a single set of standards by a monopoly standard setter that would leave little scope for useful innovation and would memorialize costly or inadequate procedures. Furthermore, they point out that the quest for an accounting standard that would result in directly comparable numbers is fruitless, because of both conceptual and political difficulties.
The authors respond to the legislative fix to the system of overseeing the auditing profession (which was shown to be especially inadequate following the fall of Enron) that was enacted in the Sarbanes-Oxley Act of 2002. They agree with the concept of better oversight and control of external auditors by the audit committees of boards of directors, which now have the power to hire and fire the external auditors. But they disagree with the creation of the Public Company Accounting Oversight Board, made up of five individuals charged with monitoring accounting professionals. "The problem is that the SEC has always had the authority to discipline accountants and they haven't used it," notes Benston. "Now we've set up another bureaucracy to do what the SEC was already charged with doing. The SEC is shuffling it off to this new agency, and the problem is that you get a double bureaucracy, which is costly.
What's more, Benston and his colleagues challenge Congress's decision to prevent accounting firms from simultaneously handling consulting work for the same clients. "I don't think that was a good thing," explains Benston. "There is no evidence whatsoever that that consulting had anything to do with audit failures. Although Andersen was getting some $29 million in consulting fees, which they probably did not want to lose, even more importantly Andersen's auditor-in-charge did not want to lose a similarly large audit fee. Did consulting fees push auditors to compromise their integrity? There is no evidence to support that claim, which has been studied many, many times." Benston also points out that combining auditing and consulting services leads to many efficiencies. Without that combination, stockholders will inevitably pay the extra costs.
The accounting profession is trying to regain its footing during this time of accounting and auditing reforms. But the Enron case still leaves many questions unanswered, notes Benston, who refers to his recent analyses of Enron and related accounting issues, (including two papers with Al Hartgraves, professor of accounting at the Goizueta Business School before, and three papers following, the publishing of his book) as "an industry." Challenges in corporate disclosure remain, the most urgent of which involves increased use of the Internet, enabling companies to provide information almost instantly to their investors. Policymakers who are interested in improving the information system for the capital markets, notes Benston and his coauthors, must find ways to adapt and harness these new developments. "There is more to fixing corporate disclosure than ensuring that more Enrons or WorldComs do not happen in the future," caution the authors. In the meantime, these scandals have set the wheels of change in motion.