Impact of Unethical Behavior Article Analysis - Essay Example

The Enron fraud case is perhaps the most recognizable and notorious cases of unethical (and illegal) accounting of the early 21st century, serving both as the root motivation for the Sarbanes-Oxley Act and a jumping point for public suspicion of corporate ethics. In their article “Applying the Agency and Stakeholder Theories to the Enron Debacle,” Professors Refik Culpan and John Trussel give a theoretical perspective on that case study and, in doing so, illuminate some general cases in which similar sorts of circumstances may apply in a completely different situation.

The authors first give some theoretical background by describing the agency theory and the stakeholder theory. Agency theory is the thought that the firm is based around contracts between a principal and an agent, the latter of whom is a manager; the agent is bound by contract to fulfilling his obligations as it pertains to the firm’s objectives. Stakeholder theory is the thought that all stakeholders in a firm bear some moral responsibility for consequences of a firm’s actions. With those two theories in mind, the authors begin to analyze the kinds of breakdowns that occurred within a well-known case of accounting fraud.

“Monitoring costs” is a term in agency theory that refers to the need for an independent third party to make sure the agent in a contract with a principal is living up to his end of the bargain. In cases where an independent monitor does not exist, the potential for fraud arises. In the Enron case, its alleged external auditor, Arthur Andersen, did not live up to the duties of a monitor. Because Andersen served as both a consultant and an auditor, a conflict of interest occurred that perhaps led Andersen to partake or encourage unethical accounting practices.

In a general sort of case, this would be true for any other business that decides to rely on the same external organization for both financial support and to serve as its external auditor. Although Sarbanes-Oxley forbids this comingling of services, and it requires attesting to the effectiveness of clients’ accounting practices, it does not establish generally accepted auditing standards (GAAS), which the authors claim are general and open to manipulation. The authors question whether these standards are objective or not and, within that ambiguity, one may reasonably fear that conflicts of interests like those seen in the Enron/Andersen case may arise.

From the stakeholder perspective, a case such as Enron is widely applicable to other companies. Throughout the 1990s, Enron went through a period of rapid growth to become a conglomerate of not only energy interests, but also broadband interests, commodities, financial services, and so on. However, when that growth accelerated beyond control, the top management began to hide things from regulators and the public in general. The culture of secrecy infiltrated Enron’s accounting practices, which developed deceptive internal auditing practices designed solely to show the public that the company was successful.

Ultimately, from stakeholder theory, every stakeholder in Enron was responsible for these deceptive accounting practices in one way or another. From executives to auditors to government agencies, the authors claim the moral responsibility falls on all. When stakeholders default on this responsibility, situations arise in which unethical accounting is possible. In addition, one can abstract from this extreme case some situations in which deceptive and unethical accounting occurs: under the pressure of the public to remain solvent, and in periods of unsustainable growth, companies manufacture their own internal auditing standards to show themselves in the best possible light.

The Sarbanes-Oxley Act of 2002 (SOX) is widely praised for its protections against bad accounting practices such as those that precipitated the Enron debacle. Title IV of the Act specifies improvements to financial disclosures, a number of which came directly from the effort to prevent another Enron. For instance, after SOX, companies are required to report off-balance sheet transactions, which can be used to hide debt levels. Enron, in particular, used Special Purpose Entities (SPEs) to hide its debt.

After selling its liabilities to these allegedly independent interests allowed Enron to not report them on its balance sheet; SOX, however, requires companies to still report these liabilities, even though they are sold to supposedly independent agencies. Part of the praise of SOX comes from its provision that the balance sheet should not only reflect the present condition of a company, but also its future financial condition, which has a significant impact on the financial statements. SOX also makes provisions related to pro forma calculations, which are made under the assumption that a certain transaction will take place.

Prior to SOX, pro forma calculations were used to inflate earnings and create an unlikely picture of a company's performance. Instead of providing misleading calculations, SOX requires the financial statement to ground its calculations in reality. Lastly, SOX prohibits certain corporation-to-executive transactions, such as multi-million dollar, zero-interest loans. Although each theory of the firm is helpful for understanding why unethical accounting practices occurred at Enron and other companies, which theory is more helpful for understanding why unethical accounting situations arise in general?

Is the Sarbanes-Oxley Act aimed primarily at agents (in agent theory) or at stakeholders (in stakeholder theory), or both? Work Cited Culpan, Refik and John Trussel. "Applying the Agency and Stakeholder Theories to the Enron Debacle: An Ethical Perspective." Business and Society Review, 110 (2005): 59-76.