Managerial Economics
MBA ZC 416
BITS Pilani MODULE 2
Pilani Campus
BITS Pilani
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Managerial Economics
Theory of the Firm
and Related Concepts – Part 2
Firm’s Profit
Measurement of profit Manipulation
• Two problems associated with the measurement of profit • Scope for managers to manipulate the firm’s accounts
– Ambiguity in measurement – boost the share price
– Restriction to a single time period – personal earnings of the managers (CEO and
CFO)
• It is difficult for shareholders to comprehend easily
• Bankruptcy of Enron in 2001 highlights these issues
• an agency problem combined with moral hazard
• Restating their earnings
• Auditing: protect shareholders and potential investors
• Accounting profit is an ambiguous term
• Restriction to a single time period
– gross profit; net profit; operating profit; earnings
before interest; depreciation and tax – It is more appropriate to consider the long-term
profits of a firm
– The stream of profits over some period of time
• The above definitions involve estimates rather than
precise measures for a number of reasons relating to – Value of the expected future cash flows
GAAP – Discounting
BITS Pilani, Deemed to be University under Section 3 of UGC Act, 1956
Enron: The Fall Of A Wall Street Darling
Managerial Economics (MBA ZC416)
4
BITS Pilani, Deemed to be University under Section 3 of UGC Act, 1956
The Case of Enron
The rise of Enron: a brief history Growth of Enron
It was founded by Kenneth Lay, former CEO of Growth for Enron was rapid.
Houston Natural Gas
Transporting and selling gas In 2000, the company's annual revenue
In 1990, Lay hired Jeffrey Skilling, a consultant reached$100 billion US.
with McKinsey & Co., to lead a new division --
Enron Finance Corp.
It ranked as the seventh-largest company on
Skilling was made president and chief operating the Fortune 500
officer of Enron in 1997
From the pipeline sector, Enron began moving
into new fields And the sixth-largest energy company in the
world.
In 1999, the company launched its broadband
services unit and Enron Online, the company's
website for trading commodities, which soon The company's stock price peaked at $90 US.
became the largest business site in the world.
BITS Pilani, Deemed to be University under Section 3 of UGC Act, 1956
The Case of Enron
Enron: Revenue Fall of Enron
Cracks began to appear in 2001
In August of that year, Jeffrey Skilling announced
his departure
Lay resumed the post of CEO
Chief financial officer Andrew Fastow was
replaced. Many new entities were created, and
debts were kept separate from Enron's books
In October 2001, Enron reported a loss of $618
million— its first quarterly loss in four years
BITS Pilani, Deemed to be University under Section 3 of UGC Act, 1956
The Case of Enron
Enron’s stock price Enron’s Stock price falls
Bankruptcy of Enron
Tried to negotiate with its rival Dynegy but the negotiations failed
The company was left with no choice and on Dec. 2, 2001, it filed for bankruptcy protection
More than 4,000 people were laid off at Enron's Houston headquarters
Arthur Andersen, who had a large portion of their revenue coming from Enron’s audit and consulting fee, was tempted to
ignore the issues
BITS Pilani, Deemed to be University under Section 3 of UGC Act, 1956
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BITS Pilani, Deemed to be University under Section 3 of UGC Act, 1956