Economic Analysis of Enron



Enron is commonly trotted out as the poster child of corporate greed and arrogance. This is a misreading of the record and a misreading of history.

Back in 2003, Christopher L. Culp, then adjunct professor of finance at the Graduate School of Business at the University of Chicago and senior fellow in financial regulation at the Competitive Enterprise Institute, and Steve H. Hanke, then professor of applied economics at the Johns Hopkins University and a senior fellow at the Cato Institute wrote this analysis of Enron and its businesses. (At the time, both authors were also principals in Chicago Partners, LLC.)

They conclude that Enron’s basic, "asset-lite" business strategy in the otherwise capital-intensive energy business, which the company knew well, was both legitimate and beneficial to the economy.

Ultimately, however, Enron diversified into other businesses it did not know well. These businesses, such as telecommunications, either were not as capital intensive as the energy business (and, therefore, did not offer economic advantage to the "asset-lite" strategy) or were highly regulated utilities, such as public water systems, not fully susceptible to market forces.

In diversifying, Enron incurred substantial costs to acquire information on its new markets, and was forced to deviate from its basic strategy. It adopted improper and illegal accounting policies to hide the resulting losses.

Culp and Hanke argue that Enron should recognized and commended for its success in the energy business, but prosecuted for the illegal activities arising from its failed diversification efforts.

I post this piece in support of my argument that dividends should be deductible at the enterprise level as a legitimate cost of capital. Inability to distribute earnings tax-efficiently causes misallocation of capital through ill-conceived diversification.

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DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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