Friday, April 22, 2005

Book Review: Conspiracy of Fools

I just finished reading Conspiracy of Fools by Kurt Eichenwald, an informative, entertaining, if somewhat fictionalized account of the Enron scandal. By fictionalized, I don’t mean falsified, but that it is written in the style of a novel, where all the characters glare at each other emotionally and the reader knows their every thought through dialogue on the page. While this may lessen its historical credibility somewhat it does tend to make some of the more drier subjects, namely corporate accounting, more readable.

As far as the story itself, Eichenwald largely portrays Andy Fastow, the CFO of Enron, as the arch-villain behind the whole scandal. The author details how he set up Special Purpose Entities (SPE) as special off book investment funds with the intended benefit of helping Enron dump bad assets, hedge investments, and used tricky accounting measures to hide losses and create false income. He also managed to then manipulate these entities and make tens of millions of dollars off them. Who says crime doesn’t pay? Ken Lay and Jeff Skilling, the off and on CEOs appeared to have largely been willing dupes of Fastow’s manipulation. From other accounts I have read this seems to a fairly accurate portrayal, although they certainly were “willing” dupes, and should have known better.

In a more general business sense this brings up the issue of corporate earnings and earning targets. Much of the trouble Enron got into was because they used shady dealings and accounting measures to manipulate earnings. They would do things like sell an asset temporarily with an explicit agreement to buy it back, then count that sale as quarterly earnings. This of course was unsustainable, because then the next quarter they could not only not count on that “income” but they then had the additional cost of buying back, at a loss, the asset that they had owned in the first place.

Although I certainly don’t propose using such methods, I believe part of the problem lies in culture of Wall Street. Corporations are under such ridiculous pressure to bring in predictable earnings by investors, no matter the business environment. At its most harmless it just leads to the silly expectations games that Microsoft plays every quarter, where immediately after they release their earnings they start downplaying their next quarters earnings (we aren’t selling a thing, we suck) so that they can manage to come in at or above earnings the next quarter. For some businesses though, this pressures them into more illicit activities, lest they be punished by Wall Street for missing their targets. More on that later.

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