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Smart Guys and the Principal Agent Problem

Tuesday, October 07, 2008
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Marshall Blundell considers whether the downfall of businesses such as Enron, Northern Rock, HBoS and Bradford and Bingley can be related to the principal agent problem.

“When a company called Enron…ascends to the number seven spot on the Fortune 500 and then collapses in weeks into a smoking ruin, its stock worth pennies, its CEO, a confidante of presidents, more or less evaporated, there must be lessons in there somewhere.” – Daniel Henninger, Wall Street Journal. 

Enron Corporation filed for bankruptcy on July 22, 2002.  The price of Enron stock had sank from its peak of $105 to just cents when it was delisted by the NASDAQ, resulting in employees and retirement accounts across America losing hundreds of millions of dollars.  Through unrecorded transactions with Special Purpose Entities (SPEs) and “creative accounting techniques” (Arthur Anderson also went under after it was convicted for Obstruction of Justice in the auditing services it provided to Enron) Enron both concealed masses of debt and collateralized that debt into Enron stock. 

The collapse provoked many questions about the nature of corporate governance in America but to both understand how a company such as Enron could come to collapse, and to learn anything from this, and similar events we need to understand the principal agent problem. 

The rest of his piece can be read here:

Principal_Agent_Problem.pdf




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