Research Wire

ARE COMPANIES MASKING HIGH EXECUTIVE PAY?

Under intense lobbying pressure from corporate America, the Financial Accounting Standards Board (FASB) recently aborted its proposal to require firms to expense the cost of options awarded to employees. Corporate America argued that by lowering reported earnings, the proposal to expense employee stock options would make U.S. companies less attractive to investors.

According to a recent study by researchers from Wharton and Harvard Business School, there is no systematic evidence that expensing employee stock options would make companies less attractive to investors. However, the researchers did find that opposition to the proposed accounting came primarily from firms making relatively large option grants to top executives, but not to other employees. The findings, says Wharton’s Richard Sloan, suggest that the concerns expressed by corporate America about attracting investors may have been a smoke screen to avoid publicizing high levels of top executive compensation.

Patricia M. Dechow, Richard G. Sloan and Amy P. Sweeney; Economic Consequences of Accounting for Stock-Based Compensation

NIFTY-FIFTY WERE NIFTY AFTER ALL

When the high-growth “nifty-fifty” stocks crashed in the 1973-74 market, investors concluded that high price-to-earnings ratios were a sign of danger. Not so, according to Finance Professor Jeremy Siegel, who found that the long-term performance of the “nifty-fifty” justified price-to-earnings ratios of 40, 50 or even higher. The stocks were, in fact, not overvalued, he concluded.

“Many of today’s star performers, such as Coca-Cola, Disney and McDonald’s, were members of the nifty-fifty,” Siegel says.

Jeremy Siegel, “The Nifty-Fifty Revisited: Do Growth Stocks Ultimately Justify Their Price?” Journal of Portfolio Management, Summer 1995

CONSENSUS BIAS LEADS TO ERRORS IN LAUNCHING NEW PRODUCTS

Why was the demand for low-fat foods and “green” environmental products overestimated while the popularity of value brands was underestimated? It could be because of consensus bias: The products that are well-liked by well-educated brand managers making decisions are not the same as those that appeal to the market.

In a recent study, Professor Eric Johnson and colleagues found they could reduce another decision-making bias — over-confidence in forecasts — simply by asking people for the reasons they may be wrong, along with explicitly asking for estimates of uncertainty.

The bias from false consensus, on the other hand, was much more intractable. Even after providing subjects with more “relevant” information to use in the judgment, there was no reduction in false consensus. The results show that managers need to follow the basic principle of: “Get close to your customers. What our results suggest is that the distance might be further than we believe,” the researchers write.

Deborah Mitchell, Marjorie Adams, Eric Johnson: “Your Preferences May Be Hazardous to Your Wealth: How False Consensus and Overconfidence Influence Judgments of Product Success,” March 1995.

BALANCED BUDGET RULES CAN WORK

Despite the political rhetoric in Washington surrounding balanced budget agreements, governments can balance their budgets, according to a new study co-authored by Wharton Professor Robert Inman. The researchers analyzed budget data from 47 U.S. states over a 21-year period and found that “states with balanced budget rules (appropriately constructed and enforced) do reduce the propensity of states to run deficits.”

The authors reached several major conclusions such as: balanced budget constraints that apply to an audited, end-of-year fiscal balance are significantly more effective than constraints requiring only a beginning of the year balance. Also, all state balanced-budget rules are ultimately enforced by a state’s supreme court, and those states whose supreme court justices are directly elected by the citizens have “stronger” constraints (i.e., lead to larger average surpluses) than those states whose supreme court justices are direct political appointments of the governor or legislature.

The authors write that “from the states’ evidence, we conclude that a workable and enforceable balanced budget rule for the federal government can be written.” Inman cautions, however, that knowing that a fiscal rule will work doesn’t necessarily mean that it should be adopted.

Henning Bohn and Robert P. Inman; Balanced Budget Rules and Public Deficits: Evidence from the U.S. States

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