Agency Costs Analysis of EnronEnergy derivatives: The principal-agency problems in Enron primarily started after mid-1980s when the natural gas industry was subject to deregulation. During this period, Enron began natural gas trading and selling energy derivatives developed by a consultant named Skilling. Enron used information asymmetry on energy projects to bet on contracts in the markets. The CEO of Enron hired Skilling on the basis of his work. Adverse selection on the part of the CEO is apparent as he hired Skilling in the first place and promoted such activities which would later bring the downfall of the company. Moral hazard is again on the part of the CEO as he was not giving his best ability to the job at hand instead encouraging risky business transactions.Special Purpose Entities: Fastow, promoted to CFO of Enron in 1998, used SPE (Special Purpose Entities) to minimize tax obligations, disclosures and consolidations. The debts or troubled assets of the company were offloaded to the SPEs in exchange for a notes receivable which showed in Enrons balance sheet. The investors in SPEs were compensated with promised issues of additional shares of Enron. However, decrease in value of assets in the SPEs created greater obligation to issue shares. The SPEs evaded agency monitoring mechanisms and only a vague reference of them was made in financial statements of Enron. Pay Incentives: The pay incentives for management at Enron constituted a lot of stock options. These stock options did not show up in the expenses sheet and also a tax deduction was available to the option holder when exercised. This motivated managers to pursue short term profits at the expense of long term gains. Information asymmetry was created between management and owners, stockholders and employees on the risky investments made by the management. Moreover, the culture at Enron was largely impacted by the Performance Review Committee designed by Skilling which encouraged profit at any cost and opportunism. Fair Value Accounting Principles: Fair value accounting principles were used by Enron beginning in the 1990s for the energy trading business in order to create an upbeat market scenario about Enrons stocks. Outstanding energy related contracts were overvalued and the unrealized gains were added to the income statement at the end of each quarter. Bull Market of 1990s: As new players in the market affected Enrons competitive advantage, the company increased its borrowings in order to maintain its lead over the others. Moreover, the highly favorable market conditions (Bull market) in 1990s allowed the high-risk short term profit behavior of the management to prosper. The bear market in the early 2000s exposed the high debts of the company as the stock prices started to fall.Inefficient markets: Arthur Anderson provided both auditing and non-auditing services to Enron (legal, etc.). The management of Enron arm-twisted the auditor (using the business of non-audit services) into compliance with non-disclosure of their risky investments. With their connivance, Enrons financial statements were positively endorsed. This possibly strengthened the misplaced faith of investors in the accounting information of Enron. This explains the escalation of share prices of Enron even when its margins were shrinking in early 2000s.