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Columnist Writes About Lie Backdating Study

A few years ago ERIK LIE, an associate professor of finance at the University of Iowa, analyzed a weird pattern in stock prices just before and after unscheduled option grants, that is, options not issued on predetermined dates but at the discretion of the company. Stocks were in the habit of plunging just before executives got grants -- thus giving the grants an abnormally low strike price. And stocks tended to rise sharply right after the grants, making them immediately valuable. Even if the executives didn't cash in the options for years, the low strike price made them much more lucrative than they otherwise would have been. Two explanations suggested themselves. Perhaps executives had suddenly become financial clairvoyants, able to consistently predict short-term stock increases. Or maybe they were manipulating the process. Both explanations might have seemed unlikely. Would executives owing a great fiduciary duty to shareholders game the system to the shareholders' detriment? Surely not. Can executives really predict the financial future when dozens of academic studies and a million floundering day traders have proven this impossible? Surely not. As Sherlock Holmes said, if you eliminate the impossible, whatever remains, however improbable, is the truth. In what turned out to be a brilliant piece of inductive reasoning (in which investigation of evidence leads to a broad theory, which can be tested by further evidence), Lie figured bosses must be backdating their options.


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