Managerial Application 134

The Enron Debacle

In November 2001, Enron Corp. filed the largest voluntary Chapter 11 bankruptcy petition in U.S. history— a stunning collapse for a company worth more than $60 billion less than a year earlier. Historically, Enron's principal business was the transportation and marketing of natural gas and electricity to markets throughout the United States. More recently, the company built a large commodities trading, risk management, and financial services business that led to its eventual downfall.

Enron ran into trouble trading energy futures contracts. A futures contract is a binding legal document that commits the buyer to take delivery, and the seller to make delivery, of an underlying asset in a specified quantity and quality at a specific delivery time and place. Because futures contracts involve obligations to buy and sell a specific commodity for a preset price, both buyers and sellers of futures contracts are exposed to the potential for unlimited losses in the event of adverse market conditions. Like stock options and stock index options, futures contracts on commodities like natural gas are called "financial derivatives" because their economic value is derived from changes in the price of natural gas or some other underlying commodity.

To control risk and lend stability to futures markets, Congress enacted the Commodity Exchange Act in 1974 and established the Commodity Futures Trading Commission (CFTC), an independent federal regulatory agency with jurisdiction over futures trading. The CFTC strives to protect market participants against manipulation, abusive trade practices, and fraud. Critics contend that the Enron bankruptcy could have been averted had the company not won various regulatory exemptions in the Commodity Futures Modernization Act of 2000, a law that drastically reduced the power of government regulatory agencies overseeing futures markets. Without such exemptions, the CFTC might have regulated EnronOnline as an "organized exchange" and put controls in place to avoid financial disaster for Enron employees, investors, and trading partners.

See: Michael Schroeder and Cassell Bryan-Low, "After Enron, Congress Backs Off from Deregulation, Calls for Controls," The Wall Street Journal Online, January 29, 2002 (http://online.wsj.com).

Clearly the biggest and most controversial antitrust initiative undertaken in the networking area is the Justice Department's case against Microsoft Corp. The Justice Department claims that Microsoft has misused its dominance of the market for personal computer operating systems to maintain dominance of that market and to extend dominance to related markets, primarily the market for browser software. A browser is computer software that allows users to access and navigate the Internet. The Justice Department claims that Microsoft has unfairly required computer manufacturers to install the Microsoft browser as a precondition of their receiving licenses to install Windows (its dominant personal computer operating system) and that Microsoft has required computer manufacturers to display ISP icons on the main "pop-up screen" only when such ISPs agree to employ the Microsoft browser. For its part, Microsoft contends that integrating its browser with the Windows operating system enhances the functionality of both and that its contractual arrangements with computer manufacturers and ISPs are nothing more than standard cross-promotional arrangements.

The case against Microsoft, like actions against Visa and MasterCard and telecom mergers, represents historic initiatives designed to maintain vigorous competition in markets dominated by network externalities. The challenge for antitrust policy makers is to preserve competitive opportunities without punishing successful competitors. Striking the right balance between regulation and market pressure is essential for promoting innovation and protecting consumer welfare in fast-moving high-tech markets.

The need for regulation stems from economic and social factors that stimulate market failures due to incentive or structural problems. However, despite obvious benefits, there are costs to various regulatory methods. It is therefore useful to look closely at both the problems and the unfilled promise of economic regulation.

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