John C. Coffee, Jr.
Columbia Law School
Understanding Enron : it’s about the Gatekeepers, Stupid
Debacles of historic dimensions tend to produce an excess of explanations. So has it been with Enron, as virtually every commentator has a different diagnosis and a different prescription. Yet, in most respects, Enron is a maddeningly idiosyncratic example of pathological corporate governance, which by itself cannot provide evidence of systematic governance failure. Properly understood, however, the Enron debacle furnishes a paradigm of "gatekeeper failure" - that is, of why and when reliance may not be justified on "reputational intermediaries," such as auditors, securities analysts, attorneys, and other professionals who pledge their reputational capital to vouch for information that investors cannot easily verify. This comment shows that, during the 1990's, the expected liability costs associated with gatekeeper acquiescence in managerial misbehavior went down, while the expected benefits went up - with the unsurprising result that earnings restatements and earnings management increased. Diagnosing the circumstances under which "gatekeeper failure" is likely leads in turn to prescriptions focused on re-aligning the incentives of gatekeepers with those of investors.
What do we know after Enron's implosion that we did not know before it ? The conventional wisdom is that the Enron debacle reveals basic weaknesses in our contemporary system of corporate governance. Perhaps, this is so, but where is the weakness located? Under what circumstances will critical systems fail ? Major debacles of historical dimensions (and Enron is surely that) tend to produce an excess of explanations. In Enron's case, the firm's strange failure is becoming a virtual Rorschach test in which each commentator can see evidence confirming what he or she already believed.