January 26, 2002
My take on Enron

My take on Enron:

Scandal of course would be an understatement in describing Enron. While the corruption in Enron itself is bad enough, I have been more fascinated by Anderson's failure to raise the alarm. To my mind, the complicity of the accounting firm is symptomatic of a systems failure that was waiting to happen.

'Lynn E. Turner, former chief accountant for the SEC and now a professor at Colorado State University, calculates that in the past half-dozen years investors have lost close to $200 billion in earnings restatements and lost market capitalization following audit failures. And the pace seems to be accelerating. Between 1997 and 2000, the number of restatements doubled, from 116 to 233.'

(Business Week in 'Accounting in Crisis')

The same article goes on to say:

That accountants have become increasingly dependent on consulting is clear. In 1993, 31% of the industry's fees came from consulting. By 1999, that had jumped to 51%. In 2001, for example, PricewaterhouseCoopers earned only 40% of its worldwide fees from auditing, 29% coming from management consulting and most of the rest from tax and corporate finance work..... More telling, in a study of the first 563 companies to file financials after Feb. 5, 2001, the University of Illinois' Bailey found that on average, for every dollar of audit fees, clients paid their independent accountants $2.69 for nonaudit consulting. Puget Energy (PSD ), based in Bellevue, Wash., had the greatest imbalance, paying PricewaterhouseCoopers only $534,000 for its audit, but over $17 million in consulting fees. "That's 30 years of audit fees in one year for nonaudit," points out Bailey. Marriott International Inc. ...paid Andersen just over $1 million for its audit, but more than $30 million for information technology and other services.

I suspect organizations and people who are willing to be compromised would be compromised no matter what. And even if Anderson didn't make $27 million in consulting from Enron in 2000 (as opposed to $25 million in audit fees), the same thing might had happened. Since there is a regular procession of auditors who join their client companies, individual auditors may still be tempted to go out of their way to please clients. But without the temptation of consulting fees that encourages auditors to go out of their way to keep clients happy, organizational objectivity of auditing firms would probably not be as severely compromised. While the BW article also recommends limiting auditors move to client companies, I think that it is impractical. It is probably better to try to force a gap of 2-3 years before a consultant can move into a client company that he consulted for.

NYT in a front page story Jan 24th expressed reservation about Washington's ability and inclination in enforcing closer supervision of accounting firms. Arthur Levitt, the former SEC chairman battled very publicly and ultimately unsuccessfully in 2000 with the industry over his proposal to limit consulting by auditing firms.

Let us pray that the momentum of the Enron scandal ensures at least some much needed reforms.

While I am on the subject of consulting: I also feel that one of the reasons technology consulting companies are trusted so much less by their clients is because tech consulting is badly compromised by their alliance partnerships. There are very few consulting companies that doesnt pitch (subtly or directly) products in which they have a vested interest to their clients. It has now come to a stage where many good product company will not look to ally itself with a technology consulting company if it does not bring in business to the product company. In many case, it would need to commit sizeable revenue to the product company to be accepted as a partner. As a result, most consulting companies today are becoming more hustler than consultants. Most of the clients who went for the big-buck e-business roduct implementations in the last few years simply did not need to go into that kind of expenses to achieve what they needed. They allowed themselves to be steered them towards the big ticket items by the consultants. The chicken is now coming home to roost.

Posted by Kaushik at January 26, 2002 01:53 AM
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