DECEMBER 18, 2001

WASHINGTON WATCH

By Howard Gleckman

Enron's "Contagion
Effect"
If investors feel they can't trust companies'
financial disclosures, the cost of capital is sure
to go up for Corporate America

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Washington Watch
Everyone knows by now that Enron's collapse has cost
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shareholders and company employees billions of dollars.
But this fiasco contains a lesson about accounting and stock
pricing for the rest of Corporate America -- one that
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businesses ignore at their own peril.
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Why should other public companies care about the financial
business
mumbo-jumbo that wrecked the once high-flying Houston
contacts:
energy outfit? Because if widespread investor skepticism

sets in about the truthfulness of routine financial disclosures,

First Name :
every company that tries to raise money in the markets will
see its costs rise. "Its part of the cost of capital now," says
Barry Rogstad, president of the American Business
Conference, a Washington (D.C.) group of midsize
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companies. "As an investor, the potential for any company to
be in this situation is real to me." U.S. companies, he adds,
"have a truth-in-packaging problem."

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Just look at the stock prices of many of Enron's (ENE )

competitors in the energy business. El Paso Corp. (EPG )
shares have plunged nearly 20% since Enron began to
unravel in October. And El Paso has had to shift $2 billion in
off-balance-sheet partnership debt -- a financing
arrangement similar to Enron's -- onto its own books. The
stock of Dynegy (DYN ), which briefly toyed with buying
Enron, is down nearly 40%. Meanwhile, Calpine's (CPN )
stock price has been slashed in half, and its debt is under
review by the rating agencies.

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LOST CONFIDENCE. These companies' own deals may be
completely aboveboard. But jumpy investors are fleeing
executive
contacts

anyway. "Already, energy companies are suffering fallout," says Wharton finance
professor Jeremy Siegel. "They are suffering a contagion effect."
Enron itself collapsed because it lost the confidence of its investors. For years, it
used dozens of limited partnerships and other complex financing structures to take
some assets -- and $4 billion in debt -- off its balance sheet. Many of the
transactions were unknown to or little understood by shareholders. And when some
of the deals went south, Enron was forced to whack nearly $600 million from
earnings it had claimed over the past five years. It had to slash its net worth by a
staggering $1.2 billion.
If this were an isolated event, the capital markets might shrug it off. But it's just the
latest in a long string of financial razzle-dazzle that has investors increasingly
questioning the integrity of the U.S. markets. In recent years, two other clients of
Enron auditor Arthur Andersen -- Sunbeam Corp. and Waste Management Inc. -were caught doctoring their books. Investors in a high-tech, high-flyer,
Microstrategy, saw its stock price plunge from $300 to barely a dollar after it was
found to be overstating earnings.
FINANCIAL AIRBRUSH. Investors in the scores of companies that use so-called
pro forma financial statements to supplement their traditional disclosure are also
sliding down this slippery slope. These documents, built largely on wishful thinking
rather than hard numbers, allow companies with no earnings and even no
revenues, to look healthy. They're the financial equivalent of an airbrush.
Few things in this world are more mind-numbing than income statements and
balance sheets. But honest accounting is a big reason U.S. financial markets are
so strong. Markets are efficient and the cost of capital is low because every
investor believes that he has more or less the same accurate information about a
company as any other shareholder.
Once that trust is broken -- and investors begin believing they're being misled -they'll demand a premium for the increased risk of being lied to. Says Wharton's
Siegel: "If you start to distrust those earnings, that will cause a lack of confidence.
And that will cause a lack of demand for a stock."
BAD DEAL. And if investors start to believe that the problem is systemic and that
they can't trust any public company to tell them the truth, business will pay a heavy
price. It won't just be the murky book-cookers that'll get hurt. Honest companies will
suffer too, at least until the market eventually sorts out who's being straight and
who isn't.
That's a bad deal for us all. A boost in the cost of capital will hold down profits and
make less money available for companies to invest in new equipment or hire new
workers. The Enron virus hasn't infected the entire market yet, but a financial flu is
in the air.

Companies can begin to inoculate themselves and their shareholders by clarifying

the current system of disclosure. Or they can wait for regulators to do it for them.
It's their choice.

Gleckman is a senior correspondent in BusinessWeek's Washington bureau.

Follow his views every Tuesday in Washington Watch, only on BusinessWeek
Online
Edited by Douglas Harbrecht

After reading this article, answer the following questions:

1. What is the problem related to lack of disclosure that may affect other companies?
2. In what way could the problems at Enron affect other firm's cost of capital?