Case Study

Journal of Economic Perspectives—Volume 17, Number 2—Spring 2003—Pages 3–26

The Fall of Enron

Paul M. Healy and Krishna G. Palepu

F

rom the start of the 1990s until year-end 1998, Enron’s stock rose by

311 percent, only modestly higher than the rate of growth in the Standard

& Poor’s 500. But then the stock soared. It increased by 56 percent in 1999

and a further 87 percent in 2000, compared to a 20 percent increase and a

10 percent decline for the index during the same years. By December 31, 2000,

Enron’s stock was priced at $83.13, and its market capitalization exceeded $60 billion, 70 times earnings and six times book value, an indication of the stock market’s

high expectations about its future prospects. Enron was rated the most innovative

large company in America in Fortune magazine’s survey of Most Admired Companies.

Yet within a year, Enron’s image was in tatters and its stock price had plummeted nearly

to zero. Exhibit 1 lists some of the critical events for Enron between August and

December 2001—a saga of document shredding, restatements of earnings, regulatory

investigations, a failed merger and the company filing for bankruptcy.

We will assess how governance and incentive problems contributed to Enron’s rise

and fall. A well-functioning capital market creates appropriate linkages of information,

incentives and governance between managers and investors. This process is supposed

to be carried out through a network of intermediaries that include professional

investors such as banks, mutual funds, insurance and venture capital firms; information

analyzers such as financial analysts and ratings agencies; assurance professionals such as

external auditors; and internal governance agents such as corporate boards. These

parties, who are themselves subject to incentive and governance problems, are regulated by a variety of institutions: the Securities and Exchange Commission, bank

regulators and private sector bodies such as the...