An excerpt from Philip Greenspun:
The true health of a company is measured by its long-run stock price. That is tough to manipulate and reflects what investors are willing to pay for the enterprise, taking into account all risks, all news, and any deferred expenses. At Enron, following the advice of the best minds of McKinsey, employees were compensated for book profit, as certified by Arthur Andersen, and EBITDA (earnings before income tax, debt, and amortization). The result was a company with tremendous reported profits, strong EBITDA, and an ultimate market value of less than zero. Conspiracy of Fools chronicles one of the discussions about EBITDA among Enron senior managers. One guy pointed out to Rebecca Mark, a Harvard Business School graduate star of the company, that EBITDA was meaningless because one could improve EBITDA simply by borrowing money at 10 percent and investing it in T-Bills at 5 percent and that was essentially what Mark was doing. She was borrowing money at X% to purchase businesses that would return no more than (X-4)% in a best-case scenario. This fattened her paycheck, but led the company towards bankruptcy. Another McKinsey idea was to set up a bonus as a percentage of profits; the employees went to the Clinton administration’s SEC and got permission to account for 20 years of future profits in the year that a gas contract was signed. This resulted in a 20X pay increase for employees in that division, but resulted in the company having no profits to report in future years, even if they continued to make cash profits on those gas contracts. The prospect of going to Wall Street and saying “we’ve already recorded all of our profit for the next 20 years” was so grim that the senior executives resorted to accounting fraud instead.