Question

Read the following passage and answer the question that follows:
On Friday morning, Dieting supplement sales company Herbalife agreed to pay the US Federal Trade Commission a \$200m fine. The FTC said Herbalife cheated hopeful salespeople out of hundreds of millions of dollars with a high-pressure multi-level marketing scheme.
Herbalife's stock received an immediate 15% increase following the above news. The company also announced that it would hire a second former FTC commissioner in a press release describing the terms of the settlement.
Which of the following options would imply that the 15 percent increase in stock price is fair?

• A. Cheating results in increase in the company's stock price.
• B. When fraudulent companies are exposed, their stock price increases.
• C. When fraudulent companies are caught, their stock price initially goes down.
• D. Acknowledgement of deceit increases the stock price of companies.
• E. Compliance with court order increases the company's stock price.

Hint:

In critical reasoning questions, always identify the principle that best explains the situation. Here, the paradox of stock price rising despite fraud charges is explained by investor confidence gained from acknowledgement of deceit and resolution of uncertainty.

Answer 1

The Correct Option is D

Step 1: Understanding the context
The passage describes that Herbalife was fined heavily for cheating in its sales practices. Despite this negative news, the stock price rose by 15%. This suggests that the market interpreted the acknowledgement of wrongdoing and the settlement as a positive signal.


Step 2: Why did the stock price increase?
- Investors often react positively when uncertainty is resolved.
- Once the company acknowledges deceit and pays the fine, the risk of larger penalties or harsher punishments is reduced.
- Hiring a former FTC commissioner also shows compliance and an attempt to clean up its practices, further boosting investor confidence.


Step 3: Evaluating Options
(A) “Cheating results in increase in the company’s stock price.”
__________________ This is incorrect because cheating itself does not cause stock prices to rise. In fact, it usually causes them to fall.
(B) “When fraudulent companies are exposed, their stock price increases.”
__________________ Incorrect because exposure of fraud normally decreases investor trust and reduces stock prices, not increases.
(C) “When fraudulent companies are caught, their stock price initially goes down.”
__________________ This is true in general, but it does not explain the 15% increase seen here. Hence, not the right answer.
(D) “Acknowledgement of deceit increases the stock price of companies.”
__________________ This exactly matches the situation. Herbalife acknowledged wrongdoing, settled with the FTC, and investors rewarded the transparency and resolution by driving the stock price up. Hence, this is correct.
(E) “Compliance with court order increases the company’s stock price.”
__________________ This is partially logical, but the key factor highlighted in the passage is acknowledgement of deceit, not mere compliance. Thus, this is not the strongest explanation.


Step 4: Final Answer
Therefore, Option (D) correctly explains why Herbalife’s stock price rose by 15% despite being fined.