Agency Problems: Lessons from Enron

The company which established by some business goals consists of several stakeholders that have their own interests. They need financial report as an important source of information that are useful, and can be used for deciding their investment planning and any decisions for the company. Management realizes that this information is really important for shareholders, so there are some tendencies from the management to make “good-looking” financial report, so the management hopefully can satisfy shareholders in their performance appraisals. This conflict of interest between management and shareholders then spread and develop new problems in a company, called agency problems.

The financial report’s users are: management, shareholders, creditor (lender), supplier, employees, government, and consumers. They usually separate as two big areas, which called internal and external sides of the company. Internal parties such as managers, employees, and others. Besides that, the external parties such as government, consumers, suppliers, and others. These problems come from agency theory which published firstly by Jensen and Meckling (1976) in their article “Theory of the Firm: Managerial Behaviours, Agency Costs and Ownership Structure”.

The case of Enron is one of the main cases that happened because of the agency problems. In America, companies are owned by shareholders, and in every company has many parties who hold the shares. Shareholders have limited controls to value their managements. Managers freely arrange, operate, and make decisions for the company. But who knows that insiders like them are doing that in their private interest, and ignore the shareholders’ wishes to get benefits. What happened in Enron shows us that always there is a chance to do the fraud in a company. Manipulation of financial report, corruption, collusion, are examples of agency problems occurred in Enron.

Agency problems can be avoided through improved morale, morals, ethics, behavior, and others. Enron’s business practices that make it go bankrupt and destroyed as well as negative implications for many disadvantaged sides. According of this case, they are not only Enron’s investors, but particularly the Enron employees who invested his retirement funds in company stock, and investors in capital markets in general.

The U.S. government issued the Sarbanes-Oxley Act (SOX) to protect investors by improving the accuracy and reliability of corporate disclosures made for public. In addition, PCAOB (Public Company Accounting Oversight Board) is also established, in charge:

1. Register Public Accounting Firm that audited the company.
2. Establish or adopt auditing standards, control quality, ethics, independence and other standards related to audit public companies.
3. Investigate the firm and its employees, conduct disciplinary hearings, and impose sanctions if necessary.
4. Carry out other obligations necessary to improve professional standards in the Public Accounting Firm.
5. Improve compliance with SOX, PCAOB rules, professional standards, capital market regulations relating to audit public companies.

The changes specified in the Sarbanes-Oxley Act are to guarantee the independence of auditors, the Accounting Firm is prohibited in provide non-audit services to the company being audited

In this case, independent firm should not be done by the Accounting Firm Arthur Andersen. Because this is what they have done, both reap destruction where Enron bankruptcy, leaving billions of dollars of debt instead of Arthur Andersen Public Accounting Firm lost their in-dependency and trust of the community against the Accounting Firm, also have an impact on employees working in the Accounting Firm Arthur Andersen where they become difficult to find a job result because of this incident.