THE BIZOP NEWS

There is a mystery associated with due diligence. Virtually all of the participants in a franchise fraud, business opportunity scam or some other scheme, did not do proper due diligence before the fact.

After they had discovered the fraud or scam, however, many of these individuals easily used the Internet to discover the relevant resources -which allowed them after the fact to perform the requisite investigations.

I have always puzzled over this mystery -until I read Nassim Nicholas Taleb's new book, The Black Raven.

The book is about confirmation bias, the tendency to tell confirming stories, or deciding what we want the evidence to be, and then finding it!

(The book should be read by many decision makers who have to make real decisions in the face of real uncertainty, but I suspect that this will not happen.)

Why should it be so hard to overcome the confirmation bias? Isn't it a mistake of thinking, easily corrected once we have labeled it a fallacy? After all, once we realize that 1 + 1 doesn't equal 3, we don't keep on making the same simple arithmetic error. So, this fallacy should be a surface error?

Nope. It is deeper than that.

Listen to Taleb's riff on this.

Assume that a legislator with courage, influence, intellect, vision, and perseverance manages to enact a law that goes into universal effect and employment on September 10, 2001; its imposes continuously locked bulletproof doors in every cockpit (at high costs to the struggling airlines) --just in case terrorists decided to use the planes to attack the World Trade Center in New York City. I know this is lunacy, but it is just a thought experiment. ...

This legislation is not a popular measure among the airline personnel, as it complicates their lives. But it would certainly have prevent 9/11.

[But] the person who imposed locks on cockpit doors gets no statues in public squares, not so much as a quick mention of his contribution in his obituary. 'Joe Smith, who helped avoid the disaster of 9/11 [which never happened] died of complications of liver disease.' Seeing how superfluous his measure was, and how it squandered resources, the public, with great help from airline pilots , might well boot him out office. ...

He will retire depressed, with a great sense of failure.

Preventing disaster by proper due diligence brings no rewards, no hero ceremonies --indeed some of the "heroes" of 9/11 earned their status simply by being there.

"Who gets reward, the central banker who avoids a recession or the one who comes to "correct" his predecessor's faults and happens to there during the economic recovery?

We human are not just a superficial race (this may be curable to some extent); we are a very unfair one."

So what should we make of this?

Simply this: when purchasing a franchise, business opportunity, or some other investment start your research in the world in which you have been defrauded. Imagine you found out that the whole scheme was a scam or fraud? What would you do in that world?

Chances are you would first search the internet for "scheme scam" or "scheme fraud". Then you might look up specialized lawyers, statutes or laws, that were there for your protection. You might try to find other victims -you would go to the police to find out that they had no interest. You might reconstruct why you fell for this piece of magical selling. But the key is: you would be highly motivated to uncover the fraud or scam.

So act as if you are in that world now, to prevent ending up there later.

Posted by michael webster at 7:25 PM | Permalink | Comments (0) | TrackBacks (0)

Ted Allen has an interesting but flawed story over at Institutional Shareholder Services -- Corporate Governance Blog, Analysis: The Role of Investors in Black's DownfallSubmitted by: Ted Allen, Director of Publications

After the conviction of media tycoon Conrad Black, it is worth recalling that it was investors who first questioned 'non-compete' payments received by Black and other Hollinger International executives. His case can also be seen as a cautionary tale about what can happen to CEOs who fail to respond to shareholder concerns.

On July 13, a federal court jury in Chicago found Black guilty of obstruction of justice and three fraud charges. Prosecutors accused Black and three other officers of using non-compete agreements to illegally pocket millions of dollars from buyers of Hollinger newspapers from 1998 to 2001. Prosecutors claimed the payments were a 'money grab' and said the funds should have gone to Hollinger shareholders.

The former Hollinger CEO and chairman faces up to 20 years when he is sentenced in November, but his lawyers plan to file an appeal. Black, who bought his first newspaper in 1969, rose to become one of Canada's most prominent businessmen and was named a British lord. At its peak, Hollinger was the world's third-largest publisher of English-language newspapers; its holdings included the Chicago Sun-Times, Canada's National Post, and the Jerusalem Post. The company is now known as the Sun-Times Media Group...

'He treated his master company, Hollinger, a publicly-owned business, as if it were a private bauble,' Randall wrote. 'And, perhaps the biggest error of all, he failed to spot a tide of shareholder activism, turning powerfully against tycoons who enriched themselves with other people's resources

(my emphasis)

This story is flawed because it presents Black as someone who simply made an incorrect calculation about the prevailing sentiments.

Black looted a publicly owned company; he didn't make a mistake in rational calculation. He is a noted bully, filing libel suits when he didn't like how the press portrayed his business dealings -when they correctly identified him as a dubious sort.

But Black is just an example of a long line of individuals who may have risen to the top of their corporate ladder because of their ability to both bully and cajole.

Galbraith, and now Taleb, used to warn us about anointing the winners of economic lotteries with wisdom: but fraud criminals demonstrate a more sinister truth, they triumph the social proof about their "business wisdom" with the intent of bankrupting their company, just because they can.

We cannot continue to treat them as individuals who have made flawed rational calculations; they are animals in human form who must be expelled from social society.

Posted by michael webster at 9:00 AM | Permalink | Comments (0) | TrackBacks (0)

I have created a new sub-category, which will contain articles about research into brain behaviour and decision making.

Here are three interesting research developments.

At ScienceDaily: Dopamine-related Drugs Affect Reward-seeking Behavior, we learn that the brain processes rewards differently than losses.

""The results show dopamine drives us to get what we want, but not avoid what we fear," said study author Mathias Pessiglione, PhD, who now works at the Salpetriere Hospital in Paris, France."

This is an interesting research observation. Seekings gains is not automatically associated with avoiding losses. Expected utility theory, on the other hand, treats both of these processes as unitary.

From a due diligence aspect, you would do well to concentrate on eliminating that which you fear before getting too high on dopamine rewards.

The second paper has a different take on rewards versus losses, Scientific American: The Prospects for Homo economicus

"In “The Neural Basis of Loss Aversion in Decision-Making under Risk,” in the January 26 Science, Poldrack, Fox and their colleagues Sabrina M. Tom and Christopher Trepel presented the results of their fMRI study, in which they offered subjects a prospect of accepting or rejecting a gamble that offered a 50–50 chance of gaining or losing money. As the potential for gains rose, they found increased activity in the mesolimbic and mesocortical dopamine systems (dopamine is a neurotransmitter substance associated with motivation and reward). As the potential for losses increased, they found decreasing activity in these same reward-sensitive areas. Interestingly, it appears that losses and gains are coded by the same brain structures—the ventromedial prefrontal cortex, associated with decision making and learning in the context of reward and punishment, and the ventral striatum, associated with learning, motivation and reward. Individual differences in loss aversion were predicted by how much more the brain was turned off by losses than it was turned on by gains."

Finally, the last paper discusses what is happening in the brain when individuals play the ultimatum game. This game is fairly simple to describe. There are two players, A and B. A moves first and proposes a split of $100; B can either reject or accept A's proposal.

Generally, most economists believe that if A proposes a split of $99 for him and $1 for B, then B would be irrational not to accept the proposal.

Yet most offers are in the $45 to $50 range. The challenge is to explain B's power in extracting such offers.

According to this research, described in the Economist

"One explanation of the rejectionist strategy is that human psychology is adapted for repeated interactions rather than one-off trades. In this case, taking a tough, if self-sacrificial, line at the beginning pays dividends in future rounds of the game. Rejecting a stingy offer in a one-off game is thus just a single move in a larger strategy. And indeed, when one-off ultimatum games are played by trained economists, who know all this, they do tend to accept stingy offers more often than other people would. But even they have their limits. To throw some light on why those limits exist, Terence Burnham of Harvard University recently gathered a group of students of microeconomics and asked them to play the ultimatum game. All of the students he recruited were men.

Dr Burnham's research budget ran to a bunch of $40 games. When there are many rounds in the ultimatum game, players learn to split the money more or less equally. But Dr Burnham was interested in a game of only one round. In this game, which the players knew in advance was final and could thus not affect future outcomes, proposers could choose only between offering the other player $25 (ie, more than half the total) or $5. Responders could accept or reject the offer as usual. Those results recorded, Dr Burnham took saliva samples from all the students and compared the testosterone levels assessed from those samples with decisions made in the one-round game.

As he describes in the Proceedings of the Royal Society, the responders who rejected a low final offer had an average testosterone level more than 50% higher than the average of those who accepted. Five of the seven men with the highest testosterone levels in the study rejected a $5 ultimate offer but only one of the 19 others made the same decision.

What Dr Burnham's result supports is a much deeper rejection of the tenets of classical economics than one based on a slight mis-evolution of negotiating skills. It backs the idea that what people really strive for is relative rather than absolute prosperity. They would rather accept less themselves than see a rival get ahead. That is likely to be particularly true in individuals with high testosterone levels, since that hormone is correlated with social dominance in many species."

Posted by michael webster at 6:01 PM | Permalink | Comments (1) | TrackBacks (0)