As noted in this previous post, the reason that Enron crashed was that its business model required that its customers rely on the company’s financial integrity and not necessarily on the company’s net worth. Accordingly, when Enron’s financial integrity came into question over a slew of questionable transactions with some equity funds run by Enron’s CFO, Andrew Fastow, Enron melted faster than an ice cream cone in a Texas summer.
Unfortunately for American International Group Inc., its business model is built upon the same sense of trust, and this latest public revelation is not going to help the company maintain that trust. Here is a sampling of earlier posts on AIG’s developing problems, including the questionable transactions between AIG and Berkshire Hathaway.
The report referred to in the NY Times article was prepared by two outside law firms — Simpson Thacher & Bartlett and Paul, Weiss, Rifkind, Wharton & Garrison — who are working for AIG’s board. According to the Times article, the report raises serious questions about the integrity of AIG’s financial-reporting systems. The report contends that recently retired AIG chairman and CEO Maurice R. “Hank” Greenberg and fired CFO Howard I. Smith controlled critical aspects of the company’s financial reporting without appropriste financial and accounting controls in place to oversee that control. The report’s conclusions sound remarkably similar to those contained in the Powers Report, which was the similar report that the Enron board commissioned when Enron’s questionable transactions with Mr. Fastow’s partnerships came to light.
Is AIG is headed for an Enronesque meltdown? My sense is that markets that have been seared by Enron, WorldCom and other big business meltdowns of the past five years will probably not flee AIG’s nest without more damaging revelations. AIG reported net income of over $11 billion on revenue of about $98.5 billion in 2004, so the accounting problems identified to date probably will not deplete shareholders’ equity by more than about 2%, which would leave the company’s net worth above $80 billion.
But as we saw with Enron, a company’s net worth will not always sustain investor trust in the face of damaging information regarding the integrity of the company’s financial statements. AIG faces precisely the same problem, and it is not clear by any means that it can succeed where Enron failed.