January 29, 2007

Business School Students Caught Enron Early

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Enron’s spectacular crash in 2001 shook the financial world and left Wall Street analysts scrambling to find out what exactly went wrong — not only with Enron, but with their own assessments of the company. According to the Wall Street Journal, fifteen of the seventeen analysts looking at the company called its stock a “buy” or “strong buy” just six weeks before Enron filed for bankruptcy. However, after extensive analysis in the spring of 1998, six students at Cornell’s Johnson Graduate School of Management recommended selling the stock.

“At the time Enron was a very admired company,” said group member Juan Ocampo M.B.A. ’99. “What we found … is that all the hype behind the company had its stock overvalued.”

Ocampo worked with other business school students on the six-week analysis, which he said was well-received. The students prepared the report, which was recently mentioned in The New Yorker, for a class with Prof. Charles Lee, accounting.

“I think it speaks well to the level of education and caliber of students at Cornell,” Lee said.

The analysis accounted for the probability of energy deregulation, the prospects of international power projects, and the actions and outlooks of Enron’s main competitors. According to Ocampo, it was not easy.

“Enron was a complex company difficult to analyze and understand,” he said.
In their analysis, they did find some cracks. The students concluded that Enron’s stock was overpriced and that the company might have been manipulating its earnings figures.

Although the analysis was done in 1998, three years before Enron’s bankruptcy, some say that’s when the trouble began. Internal documents show that Enron began manipulating California’s electricity market that year. Also, Enron embarked on several large ventures that later proved to be economic debacles, including a deal to distribute electricity in Brazil.
The Cornell students were concerned about Enron’s foreign ventures.

“In addition, our analysis has found that Enron takes more marginal risk than its competitors, in part to set up a high fixed-cost platform for anticipated new markets internationally and in electricity, without a corresponding return to balance the risk. This is risky. Time will tell if it’s prudent,” they wrote.

Since the mention in The New Yorker, Lee said, he has gotten several calls about the work. A professor at the University of Chicago wanted to use the analysis and subsequent media coverage to encourage her students to read the financial statements and footnotes. Lee said that most students dread fine print and need to learn to read beyond what he called “the CEO’s fancy headlines.”

“All the facts were hiding in plain sight,” Lee said.
“With the right tools and motivation it was no real mystery.”