Erik Lie, University of Iowa – Catching Cheats

Catching cheats in finance is a big deal.

Erik Lie, Amelia Tippie Chair and professor in finance at the Tippie College of Business at the University of Iowa, explores one way to do so.

Erik Lie is a professor of finance at the University of Iowa and author of Catching Cheats: Everyday Forensics to Unmask Business Fraud. In 2002, he began researching executive compensation, and using large databases, he documented strong patterns of manipulation of stock option grants. He brought them to the attention of the SEC and Wall Street Journal, which resulted in a massive SEC investigation, numerous lawsuits, congressional hearings, the firings of at least seventy corporate executives, and a Pulitzer Prize for Public Service for the Wall Street Journal. In 2007, Time magazine included him in its list of the 100 most influential people in the world.

Catching Cheats

We are surrounded by patterns. Most are innocuous— some even beautiful—like spirals on shells. But sometimes patterns, or breaks in them, reveal something more sinister.

In my research I explore how data patterns can expose systematic deception.

Consider this: the distribution of men’s heights forms a classic bell curve. Yet on online dating sites, men’s reported heights spike at six feet, with suspicious gaps just below. Apparently, men believe that a height of six feet generates more interest. A harmless fib, perhaps—but it illustrates how anomalies reveal deception.

In finance, such anomalies have uncovered major fraud. Decades ago, U.S. stocks traded in eighths, meaning the minimum bid-ask spread — i.e., the cut to dealers — was 12.5 cents. But researchers noticed something odd: prices clustered at quarter increments, with the eighths in between largely missing. Their conclusion? Dealers were colluding to double their profits. Once exposed, the missing eighths reappeared.

In my own research, I found another pattern: stock options were repeatedly granted to executives when prices were at their lowest. The clustering of grants around price troughs was the result of companies backdating grants, pretending they had awarded options on earlier dates when the price was lower, allowing executives to buy shares more cheaply in the future.

Patterns tell stories. Sometimes they whisper beauty; other times, they scream fraud. The key is knowing how to listen.

Read More:
[Penguin Random House] – Catching Cheats