Capital Markets

Betting the Ranch on Your Company

While ''prediction markets'' offer a venue to wager on the rise of a politician or the fall of a business executive, they might also provide a basi...
Helen ShawMarch 6, 2006

How much would you be willing to bet that former Enron chief executive officer Kenneth Lay will be found guilty of at least four charges?

At press time, some people were betting in $7.09 contracts (or 70.9 points with one point equivalent to 10 cents) on Intrade.com, a Dublin, Ireland-based online exchange, that such a fate will befall Lay.

The 70.9 quote means that markets are betting on a 70.9 percent probability that the jury will find him guilty on at least four counts. And some were betting on a 72.6 percent probability that former Enron CEO Jeffrey Skilling will be found guilty of at least 16.

“The bad news for them is that our markets are generally correct,” says Mike Knesevitch, a spokesman at Trade Exchange Network Limited, the parent company of Intrade. The good news for Lay and Skilling is that some contracts aren’t as accurate as others—particularly those that hinge on court cases in which cameras aren’t present, he says.

Intrade.com enables people to trade and bet on such things as the level of the S&P 500 Index, the Academy Award winners, and the timing of the arrival of bird flu in the United States. Contracts vary in value from 0 to 100 until the event occurs. The difference between Intrade and a public opinion poll is that in prediction markets people put their money where their mouths are, notes Knesevitch.

Starting with the introduction of the Iowa Electronics Market in 1988, such “prediction markets” have been a popular way to place political bets. Even though it’s a research tool for the University of Iowa, the Iowa market is a real-money venue where bettors can trade U.S. presidential-election futures contracts.

But prediction markets might be more than a place to bet on the rise of a president or the fall of a business executive. They might, in fact, provide a venue for useful corporate decision-making, experts say.

For instance, pharmaceutical companies might be curious about the current Intrade contract on the Asian bird flu, Knesevitch contends. The contracts are trading at a higher likelihood that the dreaded virus will be discovered in the United States by December than in June.

Indeed, the judgments of a group of bettors within a company itself can supply useful information on business operations that lack systematic ways of culling data, a study found. Hewlett-Packard employees bet on twelve predictions concerning HP’s product sales and profit-sharing bonus level over three years, according to the study, which was conducted by Hewlett-Packard Laboratories and economist Charles Plott at the California Institute of Technology in 1996.

The selected employees came mainly from marketing and finance, but some HP Lab employees with little information were included, mimicking the uninformed investors in equity markets. Thus, the participants had different kinds and amounts of information about monthly sales and other of the events on which they bet.

The incentives were real: the participants received cash to engage in the betting sessions, and they were paid at the end of each exercise. Further, the employees, who took part anonymously, were told that their participation was important for the company.

When the windows had closed, the overall pattern was striking: the predictions represented by the employee bets were closer to the actual outcome than the official company forecast. (Hewlett-Packard had not returned a call for comment at press time.)

Wisdom gleaned from employees in such ways can temper executive decisions. For instance, a production worker who believes a machine will malfunction or that a supplier will fail to deliver might expect a production number different from what a C-suite executive might forecast, according to Knesevitch. Employee forecasts below what the CFO expects could suggest that there’s useful information that the executive didn’t factor into her forecast.

Currently, in fact, Trade Exchange Network is discussing a pilot project with a large electronic retailer to enable the rank and file to wager on the wisdom of finance chiefs, says Knesevitch, who declined to name the company. “There is now a growing body of thought that if we allow [employees of] large, multinational corporations to bet on the projections of CFOs, you will increase communication up and down the chain of command,” he adds.

Intrade is also about to list a contract that depends on the likelihood of a downgrade, a restructuring, a technical default, or missing payments at one prominent, if wobbling, corporation. Will you place your bets on General Motors, please?