Get-evenitus or “Damn the Man, Save the Empire"?
Sooner or later, you are going to make a financial decision that winds up costing you (and possibly your employer and/or shareholders) a LOT of money. (Ross 8e, p. 704)
The area of behavioural finance attempts to understand and explain how reasoning errors influence costly financial decisions. Often called cognitive errors, they can be divided into three main categories: biases, framing effects and heuristics. Chapter 22 of the new edition of Ross, Fundamentals of Corporate Finance, explores these judgement errors and how destructive they can be.
You are susceptible to framing effects if your decisions depend on how a problem or question is framed. (Ross 8e, p. 706)
I want to focus here on framing effects, namely the phenomenon known as loss aversion or get-evenitus. Have you seen the 1995 US film called Empire Records? It reached cult status – people even celebrate *Rex Manning Day on April 8 - even though it was a total flop at the cinemas (Donoughue, 2020). The film is about an independent music store facing corporate takeover. It starts with a character called Lucas taking the days cash, a total of $9000, to Atlantic City, to double it and save the store. He doubles the money on his first roll, but loses it all on the second (Donoughue, 2020). Where am I getting to with this? By thinking that he could double the money to save the store, Lucus was focusing on gains, rather than what really mattered - the consequences of gambling away the money, and the impact this would have on the planned takeover.
While there was light at the end of the tunnel for Lucus and Empire Records - the employees pull together to recoup the loss by contributing their individual savings and throwing a party to raise the money and ultimately ‘stick it to the man’ – many poor decisions do not end so well. In chapter 22 of Ross, Fundamentals of Corporate Finance, 8e, the authors discuss with examples how this type of narrow framing leads to poor decision making.
How destructive is get-evenitus?
Perhaps the most famous case occurred in 1995, when 28-year-old Nicholas Leeson caused the collapse of his employer, the 233-year-old Barings Bank. At the end of 1992, Mr Leeson had lost about £2 million, which he hid in a secret account. By the end of 1993, his losses were about £23 million, and they mushroomed to £208 million at the end of 1994 (at the time, this was about $420 million).
Instead of admitting to these losses, Mr Leeson gambled more of the bank’s money in an attempt to ‘double-up and catch-up’. On 23 February 1995, Mr Leeson’s losses were about £827 million ($1.79 billion), and his trading irregularities were uncovered. Also, his wife divorced him.
(Ross 8e, p.708)
Learn more about get-evenitus and judgment errors in Chapter 22 of Ross, Fundamentals of Corporate Finance, 8e.
* Rex Manning is “the heartthrob singer [in leather pants and puffy sleeved shirt] who stops by for an instore promotional appearance.” (Donoughue, 2020).