Corporate scandals could cost US economy up to $42 billion

A recent report from the Brookings Institution estimates that the Enron and WorldCom scandals will cost the US economy approximately $37 to $42 billion.

A new report from the Brookings Institution estimates that the Enron and WorldCom scandals will cost the US economy approximately $37 to $42 billion off Gross Domestic Product (GDP) in the first year. This is assuming the market does not recover from its July 19 level or drop substantially below it. Even with the July 24 rebound, the market remains close to that level.

The study, entitled ‘The Bigger They Are, The Harder They Fall: An Estimate of the Costs of the Crisis in Corporate Governance,’ is said to base its findings on conservative estimates of the effects of the crisis on stock market wealth. The estimates are calibrated according to the Federal Reserve Board’s model of the US economy.

Carol Graham, vice president and director of Governance Studies, Robert E. Litan, vice president and director of Economic Studies, and Sandip Sukhtankar, research assistant in Economic Studies, co-authored the report.

While the authors recognise that there is considerable uncertainty surrounding their estimates and predictions, they assume that investors will adopt a ‘wait and see whether they work’ attitude toward current reform initiatives on corporate governance and accounting.

They also say that it could be a year or longer before investor confidence in the market is restored. While historically stocks have quickly bounced back after sharp, sudden drops in stocks, stocks have taken years to recover after prices have steadily dropped over time.

The authors also describe the likely effect of the corporate governance scandals on other aspects of the economy, including unemployment, inflation, and foreign investment in the United States as well as possible spillover effects beyond US borders.

For example, because the crisis has almost certainly discouraged foreign investment into the United States, the result has been a decline in the value of the dollar. Between March 19 and July 19, the trade-weighted value of the dollar fell by 5.2 percent.

‘The Enron and WorldCom bankruptcies resulted from corporate mismanagement and accounting malpractice and symbolise the broader crisis in corporate governance – a crisis that involves top blue chip companies, has reached political leaders at the highest levels of government, and has resulted in high levels of volatility in US stock markets,’ write the authors.