The end of the affair: Musings on the Enron Corporation

When I was a fledgling assistant professor at this university 30 years ago, the precarious standards of business accounting and auditing were much in the news. As yesterday's Wall Street journal reports about that time, "one of the period's largest accounting firms, Peat Marwick and Mitchell, was disciplined by the SEC (Security and Exchange Commission) for failing to perform proper audits for five companies that collapsed."

Around that time, a reporter from The Daily Princetonian called to ask me, his instructor in ECO 333: Financial Accounting, whether firms hired to perform external audits of a business corporation's financial reporting should ever be allowed also to provide consulting services to that same firm. My curt reply: "No, never! Let them learn how to audit first."

A week or so later, then Princeton President William Bowen asked me to respond, however I wished, to an irate letter he had received from a Princeton shareholder (alumnus) in the employ of that accounting firm. The alumnus, and some 40 or so other Princeton alumni also working at the firm, had vowed never to give another dime to Princeton unless I apologized openly for my remark. Thus did a powerful accounting firm then try to squash a little, untenured country economist from rural New Jersey who had dared raise an objection to one of the many conflicts of interests that routinely make a mockery of the theory of corporate governance.

As someone who, as a youngster, had run away from Germany to Canada with $91 in his pockets just because, as a draftee into new West German army, I refused to salute the slightly sanitized and reappointed WWII generals who had saluted Hitler, I certainly was not about to kowtow to a bunch of hyper-sensitive accountants over a perfectly appropriate remark — even if they were Princeton alumni. Instead, I invited the irate alumnus to come before my class to persuade my students that I was out of line. He tried to do this valiantly, whereupon he was queried by my students for over an hour on every conceivable accounting shenanigan then widely in use in American business and thoroughly covered in my class. The discussion ended when one of the students — I remember his name to this date — posed to our visitor the highly technical question of how the accounting profession could defend the booking of "negative goodwill" onto a firm's balance sheet and the subsequent amortization of that oxymoron into revenue and profits. I never heard from the accountants again.

Sadly, the quality of business accounting and auditing has not improved in the intervening years. If anything, it has deteriorated further, as the sorry saga of the Enron Corporation and its external auditor, Arthur Andersen, illustrates so vividly. Here it must be recalled that just recently another big accounting firm peer-reviewed Arthur Anderson's work for Enron and did not find it wanting!

Over the years, thousands of students in ECO 333 have marveled with me at the "wondrous tales from the world of seasoned adults" that I have extracted from a never-ending supply of sorry accounting vignettes reported in the daily press. Students who have survived my course will certainly not be surprised by the Enron saga, nor by any of the other companies whose accounting now raises eyebrows at the SEC. Lay people would be amused, or chagrined, to learn what tall tales in the annual financial reports of business corporations qualify for the external auditor's certification that those reports "fairly and accurately represent the financial affairs of the corporation."

Most amusing, however, is the current feeding frenzy over Enron in the many hallowed hearings rooms of the United States Congress. That pious spectacle reminds me of nothing so much as Captain Louis Renault who, in the movie Casablanca, declared himself "Shocked, just shocked!" by the "news" that gambling was going on at Rick's Café, all the while calmly pocketing his share of the night's rake-off from that gambling. As former Security and Exchange Commissioner Arthur Levitt Jr. has noted, over the years, influential members of Congress have been well paid by the business lobby and its shills, the big accounting firms, to preserve the morally flexible Generally Accepted Accounting Principles (GAAP) within which the Enrons of this world can and do thrive. Indeed, federal legislation purchased by these lobbies from the Congress in 1995 will make it quite difficult for the innocent victims of the Enron debacle to recover some of their losses.

Fortunately, the Enron saga is not typical of American business. Though the recent rise and fall of the Nasdaq Index undoubtedly reflects many more companies with similarly "aggressive" (i.e., dishonest) accounting, just as many American companies are well governed, by any standard, and observe integrity in their financial reports. The problem is that, where it occurs, good corporate governance and honest accounting relies mainly on the professional pride and personal ethics of managers and boards of directors. Neither the hallowed GAAP, nor our security laws, nor what is called "due diligence" on Wall Street provide sufficient constraints to shield us from the shady characters who look upon the corporations entrusted to them as feudal fiefdoms to be plundered for their own benefit and that of a select few fellow corporate aristocrats. In the process, these latter-day robber barons and their servile external auditors and investment bankers impair one of America's most precious intangible assets: the reputation of its capital market. While a few brave young men and women are asked to risk their lives to keep America prosperous and free, these corporate aristocrats busily harm their own country, cynically sporting the stars and stripes in their lapels to herald their patriotism. Their shenanigans can be an even worse burden upon our economy than taxes.

How refreshing it would be if, for the love of our country, prominent American business leaders with integrity openly and vehemently castigated their lesser peers, in print and on TV. I am dreaming, of course. When distinguished business executives criticize, the target invariably is government and those who work for it but never those among their dubious peers who play fast and lose with the wealth of their shareholders, of their employees and, indeed, of these United States.

Uwe Reinhardt is the James Madison professor of Political Economy.