Accounting for Corporate Behavior

T he year 2002 was one of great tumult for the American corporation. As the year began, news of accounting irregularities at energy giant Enron was unfolding at a rapid pace. These revelations would ultimately lead to the demise of that firm and its auditor Arthur Andersen. But Enron was not an isolated case, as other accounting scandals soon followed at WorldCom and Global Crossing in the telecommunications industry and at other prominent companies in different sectors. In July of 2002, Forbes.com published a “corporate scandal sheet” listing some twenty companies that were under investigation by the Securities and Exchange Commission (SEC) or other government authority.1 Of these cases, the vast majority involved misreporting of corporate earnings. These allegations certainly created the appearance of a general phenomenon in corporate finance, and the resulting loss of confidence in financial reporting practices arguably contributed to the weakness of markets for corporate securities. The fact that many of the problems were surfacing in industries that had been at the center of the new economy euphoria of the late 1990s contributed to the sense of malaise by shaking investor confidence in the economy’s fundamental prospects. In most of the recent cases, the discovery of accounting improprieties was accompanied by a spectacular decline of high-flying stocks and, in a number of cases, criminal charges against corporate executives. Consequently, the state of corporate governance and accounting became the dominant business news story of the year. To some observers, the recent events confirm a sense that the stock market boom of the 1990s was artificial—a “bubble” backed solely by unrealistic