The Hindu Business Line : Lured by freebies

Consider this. You are a senior-level executive working for a mid-sized firm. You earn approximately Rs 3 lakh per month or Rs 10,000 per day. Saturdays and Sundays are holidays. So, you get paid on those days too, even if you do not work. The CEO now wants you to work on Saturdays. You are offered free lunch on that day. You accept the offer and eagerly look forward for the free lunch. What if the CEO offers to pay you Rs 2,500 instead of providing free lunch? Would you be willing to work on Saturdays? If you behave like a typical human being, you may refuse the offer. Why?

Rationale behind free lunches

The reason is that our mind is not geared to make rational economic decisions all the time. In the above case, a free lunch has more value to you than Rs 2,500. You feel insulted with the Rs 2,500-offer, as you already earn Rs 10,000 per day. Yet, you are economically better off with Rs 2,500 on Saturdays than a free lunch that may cost no more than Rs 500.

But we do not decide on alternatives so rationally. Besides, we like things that are free. We hardly evaluate the cost incurred to get the freebie. It is the same behaviour that we see in the stock market. Stock prices move up when companies announce stock-dividends (bonus shares). Why?

People like to receive free shares. In the process, they bid-up the stock price. Assume that the stock is now trading at Rs 50. A one-for-one bonus announcement will push the stock towards Rs 100. Why? People who sell are foregoing the right to get the free share. So, if you are buying, you need to compensate the seller for the loss. But why do we buy a share at twice the original price and then get a free share from the company? The reason is that we are lured by free lunches, just as the senior-level executive we saw at the beginning of this article!

(The author is a Chennai-based financial analyst.)

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