Monday, August 07, 2006

Stewart settles: smart

So Martha Stewart has finally settled her insider trading case – agreeing to pay $195,000 and accept a ban as serving as a director of a public company, and limiting her ability to serve as an executive at Martha Stewart Omnimedia.

I thought she would settle because her odds of winning at trial were not great and that it would be better for potential advertisers if she could get the charges behind her.

This settlement sends a tough message to executives but it also lets her maintain her current role.

This May I gave some thoughts to a Business Week reporter on two key questions. Stewart evidently came to the same conclusion I did then – her best option was to settle.

Here are the questions:

If she pleads not guilty, and appears for a deposition, do you think this “precarious” legal position is worth regaining her title and clearing her name for Martha Stewart Omnimedia?

Martha Stewart’s legal situation would make an excellent case study for a class on decision analysis. What she must do is estimate the expected value of the financial outcomes that would result from taking each of the branches of a decision tree. That is, she must estimate both the likelihood (say, 40%) of each outcome and the value of that outcome (e.g., a $50 million drop in MSO market capitalization). To calculate the expected value, she would multiply the likelihood by the value (e.g, $20 million).

I am not a lawyer so it is hard for me to assess the odds of her prevailing at a trial. But last time when she went to trial, there was a very unexpected result -- her company’s stock price quadrupled from $9 in December 2003 to $36 in March 2005 when she went to jail. I think the reason was that a lot of her fans bought the stock as a sign of support for her. I don’t know if this would happen again. Nor do I think that it really matters to her company whether she regains her title.

If she appears for a deposition, it will remind corporate advertisers that she is in legal trouble. Especially in light of today’s Enron convictions, many of these corporate advertisers might fear being associated with a publication owned by someone in such visible legal trouble. So it could hurt her business. And my hunch is that I don’t think she will get the same stock market support this time as she did before – her stock is now way down from its peak. And investors may realize that they may have overestimated the importance of Martha to the company’s performance

What do you think the effects of (1) Settling (2) Denying or (3) Asserting her 5th Amendment right would be on her empire?

These three are the key branches of the decision tree. I think the best option would be to settle and get the whole matter behind her. Even though it will cost money, settling would get the legal uncertainty behind her which would thus limit corporate-advertiser-skittishness-due-to-her-legal-problems as a factor in the value of the magazine and TV businesses.

Denying the allegations might fail as they did earlier. They would cost legal fees and generate bad publicity for her company. And it would take time away from her TV programs and other business promotion activities.

Asserting her Fifth Amendment right would have a similar effect from legal, PR, and business opportunity cost standpoints.


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