Following the Money: The Enron Failure and the State of Corporate Disclosure

Foreword

Only a few short years ago, after the Asian financial crisis of 1997–98, Americans held out their systems of corporate governance and financial disclosure as models to be emulated by the rest of the world. Thomas Friedman, in his best-selling book The Lexus and the Olive Tree, cited these features of the U.S. economic system with approval. It was with some embarrassment then, and no little dismay, that beginning in late 2001 American policymakers and corporate leaders found themselves facing the largest corporate accounting scandals in American history. Although accounting irregularities had shown up in several large corporations in preceding years, they paled in comparison to the abuses uncovered at Enron, WorldCom, and a handful of other American corporate giants. Both Enron and WorldCom went bankrupt. Criminal and civil investigations and lawsuits were pending in those and several other cases as 2002 drew to a close. The scandals led the Bush administration to call for far-reaching reforms in both the corporate governance and financial Foreword v 00-0890-FM 1/30/03 9:33 AM Page v vi  disclosure regimes. Congress quickly followed by enacting most of them, and others, in the Corporate Responsibility Act of 2002. Policymakers were not the only ones to take quick action in the wake of the scandals. The major stock exchanges—the New York Stock Exchange and the NASDAQ—made fundamental changes to their listing requirements . The private sector acted as well. Corporate boards of directors and managers now give disclosure issues far more attention and scrutiny than before. Accounting firms—watching in horror as one of their largest, Arthur Andersen, collapsed after a criminal conviction for document shredding—have tightened their auditing procedures. Stock analysts and ratings agencies, hit hard by a series of disclosures about their failings, have changed their practices as well. As embarrassed and shocked as Americans may have been about these events, they also can be proud that the U.S. political and economic system had enough strength to address the problems almost as soon as they were uncovered. But will these reforms be enough? Are some counterproductive? And are other shortcomings in the disclosure system, both in the United States and elsewhere, still in need of correction or at least serious attention by policymakers? These are among the questions that George Benston, Michael Bromwich , Robert E. Litan, and Alfred Wagenhofer address in this book. The authors had begun the project that has culminated in this book even before the Enron scandal broke. As they explain, even setting the scandals aside, the corporate disclosure system needs to be updated to reflect changes in the underlying economy and to make full use of new communications and analytical technologies, the Internet in particular. The series of accounting scandals in 2001 and 2002, however, prompted the authors to shift direction and to address specifically the nature of the problems those scandals revealed and the efficacy of the remedies that have since been adopted to address them. The broad message of this book is that while the various “fixes” should improve matters, some were unnecessary, and some problems remain unaddressed. The authors advance what are sure to be some controversial suggestions: that rather than attempt to craft a single set of accounting and reporting standards for all companies throughout the world, policymakers should allow a competition in standards, at least between the two major 00-0890-FM 1/30/03 9:33 AM Page vi  vii sets (Generally Accepted Accounting Principles, or GAAP, in the United States, and International Financial Reporting Standards); that policymakers should encourage experimentation in disclosure of a variety of nonfinancial indicators to better enable investors and analysts to ascertain the source and nature of intangible assets; and that policymakers should exploit the advantages of the Internet by encouraging more frequent financial disclosures in a form that will make them more widely accessible and more easily used. This book could not come at a better time—when accounting and disclosure issues are now at the top of the public policy agenda and very much on investors’ minds. The authors hope that the book will help contribute to better understanding of these issues. The authors are grateful to a number of individuals who have helped make this project and the book possible: to Sandip Sukhtankar and Chris Lyddy for research assistance; to Dennis Berresford, Robert K. Elliott, Robert Hahn, and Katherine Schipper for comments and...