Enron Do Executive Stock Option Solve Agency Problem Accounting Essay

“ When a company called Enronaˆ¦ascends to the figure seven topographic point on the Fortune 500 and so collapses in hebdomads into a smoke ruin, its stock worth pennies, its CEO, a confidante of presidents, more or less evaporated, there must be lessons in there someplace. ” – Daniel Henninger, Wall Street Journal.

On December 02, 2001, Enron Corporation filed for bankruptcy. Stockholders of Enron lost 10s of one million millions of dollars as the portion monetary value fell to about nothing. The Enron prostration shows that how information dissymmetry and timeserving behaviour of agents of the house ( executives, hearers ) and the inability of the principals ( proprietors and shareholders ) to command it, resulted in one of the biggest bankruptcy.

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Principal-Agent job:

Theoretically, involvement of the proprietors of the house or stockholders ( principals ) and directors ( agents ) are the same, but in practicality this is non the instance. Agency job arises when the stockholders ( principals ) hire executives or directors ( agents ) to do determinations that are in the best involvements of the stockholders, but agents pursued the activities for their self-interest and these activities or determinations reduces the stockholders ‘ value. Managerial involvement can be risk variegation, power, position, prestigiousness and the personal addition from the stock options etc.

To get the better of with the bureau job, stockholders attempt to aline the involvement of direction with that of their ain, by planing attractive compensation bundles for the top executives of the house. Bonuss, pay-raises, publicity, net income sharing, stock options and the menace of firing are some ways to work out the bureau job.

Reasons of Principal-Agent Problem:

Information dissymmetry: Agents have more information about the house than that of principals and agents use this information for their personal involvements which is non in favour of principals.

Differing hazard penchant: Hazard penchant of the agent and principal are different. Principals are risk impersonal but the agents are risk averse and this difference creates an consequence on the houses ‘ profitableness.

Company Introduction:

Enron was one of the universe ‘s prima companies covering in electricity, natural gas, communicating, and mush and paper industry. It was founded in 1985 and based in Texas. Company claimed that it generated about $ 101 billion gross in 2000. [ 1 ] It was named “ America ‘s most advanced company ” for six back-to-back old ages by the Fortune magazine. In October2001, company declared an accounting fraud and revised the fiscal statements and subsequently in December 2001, filed for bankruptcy. Enron portions dropped from over US $ 90.00 in the summer of 2000 to merely pennies. Stockholders lost about $ 11 billion because of misconduct of the executives at Enron. So we are analysing who were really responsible for this loss. The information dissymmetry and timeserving behaviour of agents ( executives and directors ) and the inability of the principals ( shareholders ) to command it, made the Enron prostration catastrophic. Our group will chiefly concentrate on the 3 top executives and their compensation bundles and these executives are: Kenneth Lay ( Chairman, CEO ) , Jeffrey Skilling ( President, COO ) and Andrew Fastow ( CFO ) .

Doctrine behind executive compensation at Enron:

Enron executives ‘ compensations were chiefly composed of salary, fillip and stock options.

A important part of compensation was tied to the public presentation of concern unit and that of Enron.

Bonus of the executives was based on the stock monetary value of Enron.

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Cause of the job & A ; Supporting Evidences:

The executives were paid generous fillip if the portion monetary value of Enron crosses a peculiar grade. So the executives ‘ merely aim was to increase the portion monetary value anyhow. They were besides rewarded by moneymaking stock options, which were besides traveling up with the portion monetary value. In the twelvemonth 2000, the entire compensation of K.Lay and Jeff Skilling was $ 132 million and $ 69 million severally and more that 90 % of it came from selling the stock options. [ 5 ]

To increase the portion monetary value, executives started taking high hazards, spread outing in many Fieldss whether relevant or irrelevant and pull stringsing the histories and statements.

In the last 3 old ages before Enron collapsed, 3 chief executives sold their major part of the stock options. Andrew Fastow ( CFO ) sold $ 34 million, Kenneth Lay ( Chairman, CEO ) sold $ 184 million and rewarded bonus payment of $ 14.1 million and Jeffrey Skilling ( COO ) sold $ 71 million and got bonus payment of $ 10.8 million. [ 7 ]

From mid 1999 to 2001, Enron executives sold portions of $ 1.1 billion, which shows that they all want to do speedy money from the stock options by increasing the portion monetary value in short term. [ 6 ] To run into the outlooks of the analysts, executives started pull stringsing histories, inflating net income figures and concealing the liabilities of the company. Andrew Fastow ( CFO ) created so many SPE ‘s ( Particular intent entities ) to reassign the liabilities of the Enron and therefore cut downing debt duties of Enron on documents. Furthermore, in some of the SPE ‘s he was the booster, which was a clear struggle of involvement, but the board of managers approved all these trades. Skilling ( President ) backed all the trades done by the Fastow and produced false paperss to the hearers to blow up the gross and net income. Lay ( Chairman, CEO ) neglected all the wrong-doings of the executives. Enron executives used the portions of Enron as the collateral for doing the trades and if the portion monetary value fell below a certain bound, they had to set more portions or hard currency. This was besides one of the grounds of maintaining the portion monetary value high in the market.

All the top executives encouraged everybody to purchase Enron portions but they were selling their portions in the market as they know the existent financials of the company. Below graph shows the portions sold by Skilling and the portion monetary value, which clearly shows that whenever the stock monetary value made an intermediate high, he sold a major part of his retention.

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Agency job can be solved by proper monitoring of the actions of the agents. Since it is really hard for the principals to supervise the agents, they link the compensation of the executives with the house ‘s public presentation. But at Enron the merely standard to mensurate the company public presentation was the portion monetary value, which based on the false consequences. The executives made a fortune by selling their stock options in the market due to the high portion monetary value. So the solution to the bureau job was non working at Enron or non implemented decently.

The executives should be rewarded based on the long term public presentation of the company and there must be multiple standards to mensurate the house ‘s public presentation. For illustration contracts should restrict the sum of net income that fillips will be paid on to cut down short-run profitable determinations over long term profitableness by agents. We besides have some recommendations, which houses should see to avoid such incidents.

While doing the contract house should explicitly advert

The activities that house wants to promote

The activities that the house wants to deter

Stock options should be granted merely on the footing of sustainable net incomes.

Principal should closely supervise the activities of agents.


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