Behavioral Finance lessons from BP


New York – A forthcoming paper analyzes BP from a behavioral finance perspective. One of the main findings is that insufficient knowledge, or acknowledgment, of BP’s corporate culture led analysts and investors to underestimate the risks involved. The paper is titled BP’s Failure to Debias: Underscoring the Importance of Behavioral Corporate Finance, and will be published in the Quarterly Journal of Finance, Vol. 1, Issue 1, 2011.

The authors examined over 130 reports from 27 brokerage firms between august 2009 and September 2010 –before and after BP’s well explosion in April 2010 which caused the worst environmental disaster in US history, and found that an overwhelming majority of analysts’ recommendations were upward biased in regards to BP. The paper suggests that analysts lacked a robust framework for assessing BP’s risk management practices and corporate culture, leading them to fall into what the authors call availability bias (overconfidence in available and salient company narratives) and confirmation bias (a form of groupthink which inadequately assesses pros and cons of competing alternatives).

But not only analysts published excessively optimistic recommendations on BP. Annual rankings of the world’s most responsible companies in 2007 positioned BP as a top ranking firm (i.e. Fortune and AccountAbility). In addition, Dow Jones indentified BP as a “sustainability leader”. The paper in question argues that the financial community’s shortcoming in evaluating BP was to overlook the risk-assessment tools offered by behavioral sciences, as well as overweighting public information.

After a detailed description of BP’s operations over the last decade, the paper concludes that BP’s corporate culture supported, if not encouraged, its high risk profile and ultimately the April 2010 disaster. Furthermore, it highlights the multiple signals that reflected the risks involved in the energy company – despite the over-optimistic environment around it. These signals however, were consistently excluded from the majority of the analyst reports evaluated by the authors. Some of BP’s attitudes that should have been more carefully considered by analysts and investors, according to the paper, include excessive optimism, overconfidence, confirmation bias (a form of groupthink which inadequately assesses pros and cons of competing alternatives), and aversion to a sure loss.

Behavioral finance is an area where independent research firms have offered great value to financial professionals. And Integrity Research will keep tracking these firms to help our clients uncover paramount research for their ventures.



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