Monday, December 11, 2006
The Availability Heuristic Strikes Again: Generalissimo Francisco Franco is Still Dead,* But May Have Backdated Some Options
This is the "availability heuristic." You are in a rush to get some place. It seems like you hit every red light. You get to the destination, and say "my god, I hit every freaking light on the way over here." In fact, you didn't hit lights any more frequently than you normally do, but because you were focusing on it, it seemed like you did. I have already ranted as to the way in which scholars are apparently no less immune than others to the availability heuristic, at least when it comes to corporate governance.
The option backdating issue is a perfect example. I'm not condoning backdating for a minute. I don't know whether it's right that a general counsel takes the fall for option backdating, but I'm on record as saying that it was either wrong or colossally bad judgment for a GC to listen to somebody propose backdating an option grant and say "well, yes, there's an argument in favor of that...." (Or in Nixonian terms, we could raise $1,000,000 in hush money, but it would be wrong, wink wink.)
And, of course, it's not news to say "952,788 citizens here in Metropolis were not the victims of crime today," or "Paul Newman and Joanne Woodward remain happily married." So news itself plays to the availability heuristic. But we owe it to our constituencies as scholars rather than shills (for any position) at least to struggle with whether it's our theory or the facts that are the dog and the tail and which is doing the wagging.
Joann S. Lublin, who I think is a good reporter over at the Wall Street Journal on career matters, has a story today on several companies that have announced they will only issue options at a set time every time. What a shock! As I have pointed out, there are over 9,000 public companies in the U.S., and as Ms. Lublin observes, "There's no precise count of how many companies unaffected by the scandal are altering option-grant policies. But several executive-pay specialists estimate that more than two dozen [ed. note: two dozen equals 24 which is something like one quarter of one percent of all public companies] have acted so far. Option-backdating has sparked regulatory investigations at more than 130 concerns [ed. note, let's see, that's 1.5% or so] . . . ."
Two additional points. Apparently the Council of Institutional Investors is doing some empirical work to find how pervasive this problem by writing to the 1,500 biggest firms by market capitalization, and asking (it seems to me the academic paper posted on the CII website is fraught with correlation versus causation issues, and hence suspect, but at least you can point out its flaws!). In the kind of anecdotal evidence that passes for learning in this area, the letter from CII provoked Becton Dickinson, a large cap pharmaceutical company, to write down what had always been a perfectly legal and common sense, but informal, practice of issuing option grants on an annual basis.
*I realize I may be dating myself with this particular reference to the Saturday Night Live Weekend Update.