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How ENRON Proved Financial Experts Can Be Useless

Enron showed some of the best financial indicators…but the data was false…
Certain financial models for whether or not to invest in a company succeed or fail by the quality of the data they receive for investors to make investment decisions about. Have investors forgotten this basic principle before trusting numbers they plug into a model like CAPM?

I look at CAPM and the Beta methods as intelligently developed models. They have their value as well accepted standards that can be used for decisionmaking, to project things based on past performance. Therefore, I would use them as one of the tools for investment decisionmaking, but not as the only tool. Professional investment firms also use it, and this is no accident.

Credit Score Analogy for Risk Decisionmaking in the Financial World

To me, the model is somewhat analogous to a credit report score, used to evaluate risk by financial institution when making decisions to whom to extend credit. Though not always correct, we can be sure most of the time such models can be. However, there can be drawbacks for such models, as discussed, such as the element of TRUST in the data itself as well as such as future decisions and steps taken that are different from the past when considering the risk, decisions that could actually reduce risk, etc.

Nevertheless, this is less likely for individuals with credit scores although somewhat more likely, at best, for companies evaluated by CAPM, and therefore I think it’s a good tool and a safe bet to use as long as confidence is high that Big Business is honest. Then comes ENRON and Worldcom and so many others that have shown they’re dishonest.

More about CAPM and Enron…Should It Have Provided Warnings and Indicators of Trouble for the Company and For Investors?

The thought is this: With CAPM, what can be said as applied to Enron, and specifically using data before the company fell, to show how the company looked, because wouldn’t CAPM, Beta or other analysis have provided due warning in advance? I have seen reports that when using Beta, Enron looked fine.

Risk and Trust Security Model

Maybe that also had to do with the numbers Enron provided, which were misleading. The point here is, the model is only as good as the data, and then the interpretation, people’s willingness to believe it, etc. Thus no model as far as I can see, has been infallible, for various reasons and mainly the reason of TRUST and RISK, and these things must be considered for investment decisionmaking.

Maybe they should have used a “trust but verify” approach to the whole risk trust and security model the investors were basing their decisions on…investors will tell you that there is no oter data than that given…so I say…how can any you receive then be trusted…what do you base this trust on if you can’t verify it? Does Sarbanes Oxley (SOX) really verify it? Thoughts?