06 July 2016

This is the Least Surprising News in ……… Ever

One of the theories in modern economics is that people will engage in behavior that will provide them with a perceived benefit.

This is literally Economics 101. (Really. It's in the text books.)

It's called Rational Choice Theory, and it is a bedrock of Neoliberal (free market mousketeer) economics.

One of the blind spots amongst the followers of Rational Choice Theory is that whenever excessive executive compensation or control fraud is brought up, they suggest that managers operate in the best interests of the shareholders, and further argue that their bloated remuneration is what leads them to take this course.

Of course this has never happened in the history of ……… ever:
It won't surprise any market-watcher to learn that in the run-up to earnings season, companies tend to lower the bar for top and bottom line performance, thereby giving themselves better odds of exceeding analysts' expectations.

However, a new working paper suggests that the sins of omission that occur during the corporate "cheating" season, as it was dubbed by Societe Generale Global Head of Quantitative Strategy Andrew Lapthorne, are far more insidious.

Authors Kenneth Froot, Namho Kang, Gideon Ozik, and Ronnie Sadka conclude that managers mislead analysts and shareholders during earnings reports, and that their penchant for massaging expectations downwards may be employed in order to open up a window to buy their stock on the cheap in the near future.
It's not just about buying stocks, its about manipulating the price of stock options.
The researchers developed two hypotheses: either managers make disclosures in a timely matter (and their forward-looking information is quickly reflected in stock prices) or members of the C-Suite actively "lean against the wind" to understate good or bad news — or even offer the completely wrong impression of what's transpired since the last quarter ended.

Their findings suggest that guidance (or "bundled forecasts") provided by managers as well as the general tone of the conference call (analyzed using a "bag of words" approach) "point toward rejection of Timely Disclosure in favor of the Leaning Against the Wind alternative."
"Leaning against the wind," huh?

I would call it lying, and some would call it fraud, but I am an engineer, not a lawyer, dammit!*

*I love it when I get to go all Dr. McCoy!


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