Abstract

Copyright 2002, all rights reserved. Over the last 30 years, financial economists and accountants have identified a number of information and incentive issues that both complicate and potentially resolve valuation questions: earnings growth, stock splits, dividend changes, free cash flow limitations, share price-based compensation and hedging of market risks. From its inception until the third quarter of 2001, the Enron Corp. appeared to most observers to understand these information, incentive and valuation concepts. Obviously, all was not as it seemed. At its end, Enron was drastically over levered. It’s off balance sheet debt more than doubled its reported debt. The fundamental drivers of Enron’s financial structures were derivatives, trading in own equity and partnership-subsidiary management. The standards associated with these activities are Statement of Financial Accounting Standards No. 133, 123 and 125/140, respectively. Basically, Enron parked losing investments in related partnerships and subsidiaries. Additionally, Enron transferred claims on its own equity into these partnerships. In concluding our review of Enron’s financial structuring, we present a conditional credit support note that rationalizes and implements a fair value asset sale of the type that Enron set out to achieve. Regarding policy, we advocate disclosure of any asymmetric reporting treatment for significant transactions between firms, greater disclosure of own equity transactions, and direct valuation fairness opinion statements with no hedging based on arbitrary rule compliance.

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