The Enron effect in the electric services and natural gas industry on accounting choices

The political cost explanation of positive accounting theory suggests that the accounting choices and reactions of managers to a perceived crisis are impacted by expected responses of regulators and politicians. During the early months of 2001, the Enron failure and the rolling blackouts that affected many communities in California had captured the attention of the California Governor, the media, and the regulators. In this study, I examine whether the intense level of scrutiny caused by Enron, operating in the western region, had a spillover effect on accounting choices of firms within and beyond its region in the electric services and natural gas industry that is consistent with the political cost explanation [Watts, R., & Zimmerman, J. (1986). Positive accounting theory. Englewood Cliffs, NJ: Prentice Hall]. The regulators, the Federal Energy Regulatory Commission (FERC) and the Securities and Exchange Commission (SEC), were concerned about the depth of Enron’s trading schemes, financial reporting credibility, as well as the involvement of other firms. I find evidence consistent with the political cost explanation and that accounting choices vary systematically within and beyond the western region.