Superior Skills or Superior Information? Insider Trading and Entrenchment Effects in the Spanish Banking Sector

Transcription

1 Superior Skills or Superior Informaion? Insider Trading and Enrenchmen Effecs in he Spanish Banking Secor Esher B. Del Brio, Gerardo Gómez and Javier Peroe Correspondence for: Esher del Brio. Deparameno Adminisracion y Economía de la Empresa, Campus Miguel de Unamuno, Salamanca, Spain-España. ebrio@usal.es. Telephone: ; Fax: Gerardo Gómez. Deparameno Adminisracion y Economía de la Empresa, Campus Miguel de Unamuno, Salamanca, Spain-España. ggomez@usal.es. Telephone: ; Fax: Javier Peroe. Faculad de Economicas. Universidad Rey Juan Carlos. Madrid. Paseo Arilleros, s/n Madrid. javier.peroe@urjc.es Acknowledgmens: Par of his research was underaken while one of us was visiing he Universiy Carlos III (Madrid). We acknowledge helpful commens from Mikel Tapia, Manuel F. Bagues and he paricipans a he 2008 EFMA Conference held in Ahens. We acknowledge financial suppor obained from he Spanish Secrearía de Esado de Educación (Gran BEC ), Dirección General de Invesigación (Projec SEJ ) and he Juna de Casilla y Leon (Projec SA069A08).

2 Superior Skills or Superior Informaion? Insider Trading and Enrenchmen Effecs in he Spanish Banking Secor ABSTRACT We examine he casual relaionship beween insider rading and sock reurns for he banking indusry boh a he aggregae level and a he firm level so as o gauge wheher sock mispricing deeced by managers is caused by economy-wide facors (e.g., superior manager skills) or only by firm-specific facors (e.g., superior informaion). We find ha bank insiders are able o predic fuure sock movemens only a he firm level. Using panel daa esimaion, we find ha managers rade more severely on privae informaion for banks ha are less presigious, less capialized, have lower charer values and where he managers are more enrenched. Keywords: insider rading, enrenchmen, charer value, Granger causaliy, panel daa. JEL Classificaions: G14, G21, C4 1. INTRODUCTION The radiional explanaion employed in he lieraure on insider rading for insiders capabiliy of deecing and profiing excessively from share mispricing is because of heir knowledge of maerial privae corporae informaion. However, Seyhun (1988) suggess ha par of he share mispricing deeced by managers could be due o macroeconomic facors. Therefore, if insiders recognize he effecs of changes in economy-wide facors before oher marke paricipans, rade on hem and obain abnormal profis, his would no be due o heir privae informaion. Alhough his evidence is weak and his analysis is based on an Ordinary Leas Square regression, Seyhun uncovers a posiive relaionship beween curren aggregae insider rading and fuure sock marke reurns, which indicaes ha insiders are able o 1

3 idenify mispricing in heir own firm s shares even when par of ha mispricing is riggered by economy-wide facors. Thus, i could be evidence, prima facie, of superior skills. Chowdhury, Lin and Howe (1993) and Iqbal and Shey (2002) replicae he sudy applying a more accurae mehodology based on Granger causaliy and vecor auoregressive echniques. Boh sudies conclude ha curren sock reurns highly influence insider rading (ha is, insiders base heir rading on pas prices), bu causaliy in he oher direcion is raher weak, hus raising doubs on he insiders superior skills o deec share mispricing. The curren paper aemps o complemen previous lieraure by providing he firs es of he Granger causaliy beween sock reurns and several indexes of insider rading a boh he aggregae level and he firm level. The analysis is focused on he banking secor, where he causaliy beween insider rading and sock reurns has never been analyzed. This is despie he fac ha bank managers have poenially greaer access o privae informaion han in oher secors due o he sric conrol and monioring of heir corporae cliens solvency, he condiions of deb refinancing, and he flexibiliy when increasing deb losses (Slovin, Sushka and Polonchek, 1991). Furhermore, as noed by Basel and Sein (1979), bank managers usually conrol a subsanial porion on he bank s ownership and are members of he boards of direcors of oher non-financial companies. Thus, in a firs sep, we explore wheher bank insider rading is riggered by macro- or microeconomic facors, or a mix of boh. Our resuls uncover ha only microeconomic facors rigger bank insider rading. We hen focus on idenifying hose facors by examining several variables ha are crucial o undersanding manager behavior in he banking secor: he level of manager enrenchmen, he level of manager discreion, he level of managers risk-aking incenives and he effecs of boh exernal regulaion and self-regulaion. The use of monhly series of abnormal rading a he bank level allows us o build a panel of insider rading ransacions, which we use for esimaing he facors ha deermine insider rading. 2

4 To implemen his sudy, we have chosen he Spanish coninuous marke, a coninenal-srucured marke where here is already evidence of abnormal profiabiliy associaed wih insider ransacions in non-financial firms (Del Brio, Miguel and Peroe, 2002) and where he banking secor is one of he mos profiable and efficien in Europe. In addiion, Spain is an example of a civil law counry in which invesor proecion is weaker han in US and oher European markes (La Pora, Lopez-de-Silanes, Shleifer and Vishny, 1998), ownership srucure is very concenraed, informaion asymmeries are very high, and higher insider ownership is quie ofen necessary o preven expropriaion by large shareholders (Pindado and De la Torre, 2006). Ou of he hree main ypes of bank insiuions savings banks, commercial banks and credi cooperaives we focus on commercial banks, as he oher wo are no lised companies. This paper makes four major conribuions o he insider rading lieraure. I is he firs paper o examine wheher bank insider rading aciviy could be riggered by managers knowledge of macroeconomic facors, raher han by knowledge of heir own firms. 1 Second, his is he firs sudy of bank insider rading in a Coninenal European counry, whose banking indusry differs from he US, and some differences from US sudies are herefore expeced. Third, we provide evidence on he relaionship beween insider rading and imporan variables characerizing monioring mechanisms, such as charer value, capializaion and insider ownership, highlighing he ineracion beween insider rading and he level of manager enrenchmen. Fourh, we apply he robus echnique of panel daa esimaion. Our resuls are conclusive. The causaliy analysis shows evidence ha insider ransacions have a srong effec on fuure sock reurns a only he firm level. Therefore, macroeconomic facors do no deermine bank insider rading, which seems o occur only for firm-specific reasons. Our resuls indicae ha insiders are able o predic fuure sock reurns 3

5 and are herefore able o deec he mispricing of heir own shares earlier han oher marke paricipans, bu his forecasing power does no seem o be based on superior skills. On he oher hand, resuls sugges ha insider rading in banks is no much based on pas reurns, since he causal relaionship beween curren sock reurns and fuure insider rading indexes is very sligh. As o he facors enhancing bank insider rading, we find evidence ha insider rading is posiively correlaed wih larger bank size, less presige, lower charer values for high levels of ownership and enrenched direcors. Enrenchmen seems o be clearly relaed o insider rading, hus indicaing ha managers may exrac wo-fold privae benefis. Furhermore, enrenchmen modifies he risk-aking incenives of managers, which in urn has a direc effec on financial coss, bank performance and firm value. In his sense, our resuls provide evidence agains he lower monioring of small caps. Acually, he posiive relaionship beween insider rading aciviy and size could be undersood as an achievemen of enrenched managers, ha no only inves based on privae informaion, bu also reach one of heir main perquisies firm growh. We also find ha banks are much aware of heir corporae repuaion and, hus, more presigious banks usually preven heir managers from rading based on privae informaion. The remainder of he paper is organized as follows: Secion 2 presens a review of he lieraure on bank insider rading. Secion 3 describes he samples and mehodology used. Resuls of he causaliy es are given in Secion 4. Secion 5 presens he hypoheses and he model used o idenify he facors ha explain insider rading in he Spanish banking indusry. The las wo secions presen and discuss he esimaion resuls and give conclusions. 4

6 2. REVIEW OF PREVIOUS STUDIES Since Seyhun s (1988) analysis of he relaionship beween aggregae insider rading and sock marke reurns, several sudies have aemped o find new evidence on his causal relaion. Seyhun saes ha if insiders recognize he effecs of changes in economy-wide facors and rade on hem, hen a posiive and conemporaneous relaionship should be expeced beween aggregae insider rading and sock marke reurns. However, if insiders recognize he effecs of changes in economy-wide facors before oher marke paricipans and rade on hem, hen a posiive relaionship beween curren insider rading and fuure excess reurns should be expeced. This saemen is essenially based on previous lieraure ha has radiionally documened he abiliy of corporae insiders o deec he mispricing of heir own firm s shares. Chowdhury, Lin and Howe (1993), and more recenly Iqbal and Shey (2002), apply Granger causal ess and vecor auoregressive mehodologies for he same purpose, obaining somewha differen resuls. Boh papers conclude ha here exiss a srong relaionship beween pas reurns and fuure insider rading a he aggregae level: sock price decreases are followed by more insider purchases and price increases are followed by more insider sales. However, heir resuls conradic previous lieraure regarding he predicabiliy of fuure prices by insiders, since hey conclude ha insiders canno predic fuure prices or can only predic wih minimal success. A he firm level, Iqbal and Shey (2002) deec a srong relaionship beween pas reurns and insider rading and also conclude ha here is no noiceable difference beween he resuls of insider purchases and sales. However, none of hese sudies focuses on bank insider rading. In fac, lile can be said abou insider rading in he bank indusry, since financial firms are usually dropped from he sudies on insider rading due o heir paricular characerisics. Mos research on bank insider rading applies he even sudies mehodology o calculae he abnormal reurns associaed 5

7 wih insider dealings, and unanimously conclude ha bank insiders obain abnormal reurns in heir open-marke ransacions hanks o heir access o relevan privae corporae informaion (Baesel and Sein, 1979; Madura and Wian, 1995; Jordan, 1999; Ramirez and Yung, 2000; Slovin, Sushka and Polonchek, 1991; and Madison, Roh and Saporoschenko, 2004, among ohers). Baesel and Sein (1979) and Madura and Wian (1995) find ha banking insiders obain abnormal reurns when rading in heir own firms shares on Canadian and US markes, concluding ha purchases have greaer informaional conen han sales. Baesel and Sein (1979) analyze bank insider rading for Canadian markes. They conclude ha bank direcors have unbeaable access o privae informaion and are in a beer posiion han corporae insiders in oher indusries; he reasoning being, among oher hings, ha hey conrol a subsanial porion of he bank s ownership and are members of he boards of direcors of oher non-financial companies. Madura and Wian (1995) also analyze he characerisics of banking firms ha may enable insider rading. They single ou bank size as one of he main variables, as small banks are less conrolled by analyss and invesors, so heir direcors have access o a greaer volume of reserved informaion han large banks. Ramirez and Yung (2000) show ha he bank s repuaion is such an imporan asse ha i can resric he rading behavior of he insider. Thus, he insiders of he mos presigious banks are less likely o rade on privae informaion. In any case, mos of he exising sudies deec ha bank insiders obain abnormal profis from heir privae informaion. Abnormal profis are also deeced for he banking indusry when analyzing insider rading around corporae announcemens such as mergers and acquisiions (Madison, Roh and Saporoschenko, 2004), when analyzing invesmen banking repuaion in iniial public offerings (Ramirez and Yung, 2000) and when analyzing sales of corporae asses (Hirschey, Slovin and Zaima, 1990). 6

8 Conversely, Jordan (1999) concludes ha rading by bank insiders helps o reduce he agency problem, since, by exploiing specific privae informaion, bank direcors increase he rae of reurn and reduce he riskiness of heir invesmens in heir bank. 3. SAMPLE AND METHODOLOGY This sudy analyses he legal open marke ransacions carried ou by presidens, vicepresidens and direcors in Spanish commercial banks beween January 1994 and December 2003, ha were repored by he insiders hemselves o he Comisión Nacional del Mercado de Valores (CNMV) as required by he Spanish Securiies Marke Law. The daa were obained from he Insiders Dealings Records provided by he CNMV. The sample analyzed comprises 4,623 insider ransacions in 18 commercial banks quoed on he coninuous marke. Ou of hese ransacions, 3,089 were purchases and 1,534 were sales. Sock prices and oher daa needed o consruc he insider rading indexes, as well as he explanaory variables of he model esimaed in Secion 5, were obained from he Daasream and Bankscope daabases. Table 1 gives he descripive saisics of he banks in our sample. The annual financial daa from 1994 o 2003 were averaged and he mean, median, sandard deviaion, and maximum and minimum values of hese averaged values were obained. Resuls are shown in Panel A. Panel B shows he esimaions of he annual sock reurns and insider ransacions from 1994 o The sock reurns during his period were generally posiive, wih he highes average reurns in 1997 and negaive average reurns in 1994 and The average number of purchase ransacions by insiders were subsanially lower in 1997 and 1998 han in he res of he sudy period, while he average number of sale ransacions were significanly lower from 1997 o 2000 compared o he res of he sudy period. The average number of shares bough by bank insiders increased enfold from 1994 o Likewise, he average number of shares sold increased almos 14-fold over he sudy period. 7

9 [INSERT TABLE 1 HERE] To examine he relaionship of causaliy beween insider rading and sock marke reurns, we rely on four differen measures of bank insider rading. The firs wo indicaors are radiionally employed in sudies on insider rading. They examine purchases and sales separaely in order o es wheher here is more informaion conen in sales or in purchases. The monhly purchase index (PI ) is defined as (1) PI P /( P S ), where P is he volume of purchases for monh, S is he volume of sales in monh, and he monhly sales index (SI ) is defined as (2) SI S /( P S ). The oher wo indexes are no as commonly used, bu have proven o be significan when explaining insider rading inensiy (Karpoff and Lee, 1991; Yur-Ausin, 1998). 2 Thus, he hird insider rading index is calculaed as he absolue value of he difference beween he euro volume of insider purchases minus sales, sandardized by he earnings-per-share raio in a cerain monh: (3) SNVI NV / EPS P S / EPS, where SNVI represens he EPS Sandardized Ne Euro Volume Index for period, NV is he difference beween purchases and sales for period (also referred o as volume of ne purchases) and EPS is he earnings-per-share raio for period. Karpoff and Lee (1991) and Del Brio (2006) suppor he sandardizaion of insider rading indexes by EPS, since i has been proven o be he main feaure of he firm ha should be conrolled for when measuring he severeness of insider rading. The forh index sandardizes he volume of ne purchases by he oal volume of purchases and sales in a given monh, as used by Yur-Ausin (1998), Iqbal and Shey (2002) and Ke, Huddar and Peroni (2003), among ohers: 8

10 (4) NVI NV /( P S ) ( P S ) /( P S ), where NVI is he ne volume index for period and he res of he variables coincide wih hose of previous equaions. This sudy applies Granger causaliy ess o examine he relaionship beween sock reurns and differen measures of insider rading. We follow Iqbal and Shey (2002) and analyze insider rading boh a he aggregae level and a he firm level, while Chowdhury, Lin and Howe (2003) focus only on he aggregae level. The Granger mehodology allows us o deermine wheher bank insider ransacions have a causal relaionship wih sock reurns in any direcion. Monhly sock reurns ( R ) are defined as he logarihm conversion of sock reurns in wo consecuive monhs, adjused by dividends and subscripion righs. To proxy insider rading ( X ), we use he four insider rading indexes described above. The sock reurns, as well as hose indexes, are saionary series as revealed by he Dickey-Fuller and Phillips-Perron ess, hus fulfilling he a priori requiremen for applying he Granger causaliy ess. Granger causaliy defines a variable, R, o be causal for anoher ime series, X, if he former helps predicing he laer. Therefore, he causaliy relaion beween hese variables can be esed from he following VAR (vecor auoregressive) model represenaion: R k 1 j j R 01 1 j 1 (5) X j1 2 j 2 j X 02 j 2 by esing he null hypohesis of eiher 0 j=1,2,,k or 0 j=1,2,,k. If he 1 j 2 j former hypohesis is rejeced we conclude ha X Granger causes R, and he reverse relaion is obained if he laer hypohesis is rejeced. Following Iqbal and Shey (2002), we consider a horizon of k-monh lengh lags, where k akes he value of 1, 3 and 6. For esing purposes, we use sandard Wald ess. 9

11 The VAR mehodology allows us o address no only formal Granger causaliy esing, bu also o analyze he response of he model variables o differen shocks (impulse response funcions) or decompose he forecas error variance among he differen sources (variables). 4. RESULTS OF THE CAUSALITY TESTS Our resuls show ha, a he aggregae level, here is no evidence of a Granger causaliy relaionship beween insider rading and sock marke reurns in any direcion. These resuls clearly conradic prior evidence in suppor of a causal relaionship running from curren aggregae sock reurns o fuure insider ransacions. Resuls are, however, consisen wih he lack of predicive power of insiders when he mispricing of heir firms shares is due o macroeconomic facors, as deeced by Iqbal and Shey (2002) and Chowdhury, Lin and Howe (2003). Therefore, for he Spanish banking indusry, we conclude ha insiders neiher base heir rading on pas prices nor are hey able o predic fuure prices when he socks mispricing is due o macroeconomic forces. The resuls for he aggregae level are no significan for he insider rading measuremens nor for he lag horizons. For he sake of breviy, hey are no shown, bu are available upon reques from he auhors. When analyzing he causaliy a he firm level, resuls vary significanly. When he mispricing of insiders firms are due o firm-specific variables raher han macroeconomic ones, insiders are beer able o boh idenify he mispricing and profi abnormally from i. Tables 2 and 3 show he empirical resuls of he VAR models for he four insider rading indexes. [INSERT TABLE 2 HERE] For any insider rading index and for any of he lag horizons considered, he null hypohesis ha insider rading does no Granger cause sock reurns is rejeced, especially 10

12 when SNVI is used o proxy insider rading. A clear causal relaionship is found for all he indexes, running from curren bank insider rading indexes o fuure sock reurns, and his relaionship is no sensiive o he insider rading measure employed, alhough he sronger relaionship is found for he SNVI index. However, for he hree-period horizon, causaliy seems o be less definiive. Furhermore, he firs lag of SNVI is always significan and posiive, reinforcing he idea ha insider rades precede increases in sock reurns bu, for greaer lag horizons, insider rading indexes do no affec sock reurns (wih he excepion of he fifh lag). As far as causaliy from sock reurns o insider rading indexes is concerned, here does no seem o be evidence ha bank direcors sysemaically make invesmen decisions based on pas prices, given ha he null hypohesis of he Wald es is acceped for he hree lag horizons considered and for all he indexes, he only excepion being a negaive correlaion on he hird lag. Resuls, however, vary when analyzing purchases and sales separaely, since, in his case, boh purchases and sales scarcely depend on pas sock reurns. Similar resuls are drawn from he analysis of he impulse response funcions, defined as he lagged responses in boh he sock reurn and he insider rading index o a onesandard-deviaion shock in each of wo variables. Figure 1 shows ha a posiive shock in he insider rading index (i.e., an increase in purchases) is followed by an increase in fuure sock reurns for abou 6 monhs. However, he innovaion on he insider rading index is no followed by more innovaions in he index, which reflecs a lack of serial dependence on insider rading daa. On he oher hand, a posiive shock in sock reurns (shown in Figure 2) posiively affecs insider rading only for he firs lag. [INSERT FIGURES 1 AND 2 HERE] When analyzing he response impulse separaely for insider purchases and insider sales (shown in Figures 3 and 4, respecively), we find ha, in boh cases, a posiive 11

13 innovaion highly affecs sock reurns. Figure 3 reflecs he response o one sandard deviaion in insider purchases, measured as he volume of shares raded. An increase in purchases is followed very closely by an increase in sock reurns, mainly for he firs lags. I also represens ha, for very shor periods of ime (abou 4 monhs), an ousider mimicking he rading behavior of an insider could be able o profi abnormally from rading. An innovaion in he volume of shares sold negaively affecs sock reurns during a shor period. [INSERT FIGURES 3 AND 4 HERE] [INSERT TABLE 3 HERE] Finally, from he daa in Table 3 i can be concluded ha bank insider sales have greaer informaional conen han purchases, a siuaion ha is he opposie of ha found for US and UK non-financial firms (Seyhun, 1986; Fidrmuc, Goergen and Renneboog, 2006), bu which is consisen wih he evidence found for Spain (Del Brio, Miguel and Peroe, 2002). Given all hese resuls, we can conclude ha having privae informaion is universally undersood as an advanage for bank direcors. I allows hem o anicipae movemens in heir bank sock prices and ime heir operaions. 3 We should consider he imporance ha his relaionship may have o anoher line of sudies by Karpoff and Lee (1991) and Bezer and Theissen (2008), among ohers, who deec ha insiders use iming and are capable of rading a an advanage around specific corporae announcemens. 5. FIRM-SPECIFIC FACTORS AND INSIDER TRANSACTIONS. According o he causaliy analysis performed in Secion 4, bank insiders in Spain seem o be able o idenify he mispricing of shares of heir own firms only when i is due o firm-specific facors, raher han macroeconomic ones. Therefore, we nex examine which firm characerisics may be riggering insider ransacions, applying Generalized Leas 12

14 Squares panel daa esimaion for a complee unbalanced panel composed of 18 banks and a 10-year ime series running from 1993 o For our analysis of he facors riggering insider rading, we apply he agency heory of insider rading, which holds ha he manager shareholder conflic is he lens hrough which o analyze insider rading. Insider rading is hus as a manifesaion of he lack of conrol shareholders have over managers and a source of agency coss due o he need o monior opporunisic managers. As a resul, a negaive relaionship is commonly expeced beween insider rading aciviy and he convergence of propery and conrol ineress. Under his assumpion, we nex examine he effecs on insider rading aciviy of several facors ha are crucial o undersanding manager behavior in he banking secor: he level of manager enrenchmen, he level of manager discreion, he level of managers riskaking incenives and he effecs of self-regulaion and exernal regulaion. Jensen and Meckling (1976) define ownership by direcors as an efficien mechanism o more closely align managers ineress wih hose of shareholders. The higher he direcor ownership, he higher he alignmen of ineress among conrol and propery groups. Jordan (1999) shows ha bank direcors who own a high percenage of he firm s shares end o rade less opporunisically on privae informaion, hus assuming ha he alignmen of ineress is a prelude for less insider rading aciviy. Neverheless, he enrenchmen lieraure has brough o ligh he fac ha, when insider ownership surpasses an opimal hreshold, an increase in insider ownership makes managers enrenched and allows hem o saisfy heir non value-maximizing objecives wihou endangering heir employmen and saus. However, alhough he relaionship beween enrenchmen and firm value is well documened, no evidence has ye been found regarding he level of direcor enrenchmen and bank insider rading. 4 Since enrenchmen usually exacerbaes boh informaion asymmery and non value-maximizing behaviors, we 13

15 expec a posiive relaionship beween insider rading aciviy and he level of enrenchmen. Therefore, a cubic relaionship is expeced beween bank insider ownership and bank insider rading inensiy, i.e., we expec a negaive relaionship for low and very high levels of insider ownership and a posiive relaionship for moderae and high sakes, due o he enrenchmen effecs. To properly examine his relaionship, we consruc he variable insider ownership (IO), is square (IO 2 ) and is cubic (IO 3 ). IO is measured as he number of shares held by bank direcors a he end of he previous period divided by he oal number of ousanding shares, as developed in Jordan (1999) and Lee (2002), among ohers. We use hese o es he following hypohesis: Hypohesis 1: The more enrenched he bank direcor, he higher he inensiy of bank insider rading. Despie he crucial influence of charer value on bank risk and performance, no evidence has ye been found regarding he relaionship beween charer value and insider rading. Charer value (undersood as he value of he righ o coninue o operae) has radiionally been used as an indicaor of risk-aking incenives for bank direcors. In fac, we employ i in his sudy as a proxy for risk-aking incenives 5 in order o undersand how he level of risk ha managers are willing o ake on enhances insider rading. According o González (2005), lower charer values are radiionally associaed wih greaer risk-aking incenives. However, Goron and Rosen (1995) and Cebenoyan, Cooperman and Regiser (1999) acknowledge ha, as long as insiders increase heir proporion of he firm s wealh, hey increase heir exposure o undiversifiable risk in such a way ha, when propery and conrol ineress are aligned, insiders will aemp o ake on only profiable risks, hus modifying he expeced relaionship beween charer value and riskaking incenives. Therefore, according o hese auhors, o deermine he effecs of managers 14

16 risk aversion, we firs should deermine how he level of alignmen of ineress is affecing risk-aking incenives. For ha reason, we follow Cebenoyan, Cooperman and Regiser (1999) and creae he slope ineracion variable beween charer value (proxying risk-aking incenives) and inside ownership, which indicaes how he impac of risk incenives on insider rading is correlaed o insider ownership. 6 However, as an increase in insider ownership beyond an opimal level may produce enrenchmen problems, we go furher and examine he relaionship beween risk-aking incenives and insider rading by conrolling he effecs of enrenchmen. In his case, lower charer values should sill lead o greaer risk-aking incenives and higher insider rading aciviy he reason why a negaive relaionship is hus expeced beween he variables. For his purpose, we consruc he slope ineracion variable beween charer value and he square of inside ownership. To proxy charer value, we used Tobin s Q, previously used by González (2008), which modifies he radiional marke-o-book value of equiy by proxying he marke value of asses by he book value of asses minus he book value of equiy plus he marke value of common socks. Hypohesis 2: The lower he charer value a enrenchmen levels, he higher he inensiy of bank insider rading. As noed by Furfine (2001) and Lindquis (2004), in he presence of a supervisory discipline effec, excess capial increases, since banks aemp o avoid coss relaed o marke discipline and supervisory inervenion if hey approach or fall below he regulaory minimum capial raio. Since supervisors and marke discipline help o reduce informaion asymmery, he increase in excess capial may lead o less conrol and hus more severe insider rading aciviy. Therefore, a posiive relaionship could be expeced beween hese variables. In he lieraure, however, lower capializaion has been shown o be relaed o more opporunisic 15

17 behavior from managers, probably because, under he bad managemen hypohesis, managers have over-invesed in non-valuable invesmen projecs, hus reducing bank capial (Williams, 2004). According o his reasoning, a negaive relaionship should be expeced beween insider rading aciviy and excess capial. In fac, when excess capial is considered a proxy of exernal regulaion, a posiive relaionship is expeced. However, when i is considered as a proxy of he level of manager discreionaliy, a negaive relaionship is expeced. Since no evidence has ye been found regarding his relaionship and differen heories suppor conradicory expecaions, we consider i an open empirical quesion. To proxy excess bank capial, we follow Furfine (2001) and use he excess capial-oasse raio, measured as he difference beween he raio of he book value of equiy o he book value of risky asses minus he regulaory minimum capial raio (8%). Hypohesis 3: The lower he excess capial, he higher he inensiy of bank insider rading. Repuaion, ogeher wih size, media aenion and analys ineres, is usually considered a proxy for he firms ransparency or visibiliy, as in Dyck, Volchkova and Zingales (2002). Bad managemen, opporunisic behavior and ren-expropriaion by managers erode bank repuaion, which is one of he firm s main asses. Therefore, much effor should be devoed o proecing he firm from being he subjec of bad news, misleading rumors and financial scandals, among hem insider rading. When repuaion maers, firms usually dissuade heir managers from severely rading on heir own bank shares so as no o arac he aenion of he media and o avoid he negaive impac ha profiable rading by insiders migh have on fuure share prices. Ramirez and Young (2001) analyze he influence of repuaion on insider rading behavior for a sample of invesmen banks and conclude ha he insider rading aciviies of 16

18 he more presigious invesmen banks are less likely o show sysemaic paerns of abnormal profis since heir repuaion will exer a consrain on improper insider rades. Alhough no evidence has been documened regarding he relaionship beween insider rading and commercial bank repuaion, a negaive relaionship would be expeced. Repuaion for US invesmen banks is usually proxied by way of he Carer and Manaser (1990) underwrier presige ranking; however, i is difficul o measure repuaion for commercial banks ouside he US. Furhermore, our sudy focuses on Spanish commercial banks, for which no presige ranking mechanism exiss. However, invesors usually reac posiively o any Spanish bank belonging o he Forbes Global 2000, a lis of he world s wo housand larges companies based on a composie ranking of sales, profis, asses and marke value. Therefore, we consruc a dummy variable ha akes he value of 1 for Spanish banks ranking among he firs 2000 firms wihin he Forbes Global 2000 (which we consider presigious), and akes he value of zero, oherwise. Abou 40% of he banks in he sample ranked among he firs 2000 firms in a leas one year wihin he sample period. Hypohesis 4: The worse a bank s repuaion, he higher he inensiy of bank insider rading. Finally, bank size is used as a conrol variable since i is ofen correlaed wih oher unobserved variables (such as managerial abiliies and asse diversificaion). Thus, he esimaed model is expressed according o equaion 7: (7) LSNVI i BC 5 i IOi 2IOi 3IOi 4CV * REPU 6 i SIZE 7 i u i IO 2 i, where ui i i i, i correcs for bank-specific effecs and i for ime-effecs, and i is he disurbance of he model. The dependen variable in our sudy is he absolue value of he logarihm conversion of he SNVI index, measured as he ne euro volume of insider 17

19 purchases sandardized by he earnings-per-share raio. This index is chosen as he dependen variable in our model because i is found o be he mos significan measure of insider rading among he four indexes esed in his paper. We use he absolue value of he index since i is used as an index of severeness of insider rading regardless of he sign of he ransacion. Conrolling for ime-specific effecs in our sudy is of grea imporance due o possible changes in he macroeconomic environmen or regulaion affecing Spanish banks, as well as changes in echnology, as noed by Williams (2004), among ohers. We use GLS esimaion and included T-1 lags as insrumenal variables for he explanaory variables in order o conrol for endogeneiy. Table 4 shows he descripive saisics and Pearson s correlaion for he explanaory variables. [INSERT TABLE 4 HERE] 6. RESULTS OF THE ESTIMATION Resuls of he esimaion are shown in Table 5. The variables IO, IO 2 and IO 3, which capure he non-linear expeced relaionship beween insider rading and insider ownership, are all significan and he signs are as expeced. IO is negaively relaed o insider rading, which means ha, as insider ownership increases, direcors are more aligned wih shareholder ineress and hey rade less severely on privae informaion. A he same ime, IO 2 is posiively relaed o insider rading a he 1% significance level, which means ha, above a cerain hreshold, he higher he inside ownership, he higher he insider rading aciviy. Finally, IO 3 is negaively relaed o insider rading aciviy. This confirms ha, a moderae-o-high levels of insider ownership, he convergence of ineress is no guaraneed and insiders behave opporunisically by increasing heir insider rading aciviy. We are unaware of any previous paper analyzing he combined effecs of insider rading and enrenchmen for he banking secor, bu his firs insigh seems o indicae 18

20 ha as direcors ge more enrenched and shareholder conrol is less efficien, managers rade more severely on privae informaion. [INSERT TABLE 5 HERE] The slope ineracion variable CV*IO 2, which capures he effecs of risk-aking incenives on insider rading when conrolling for is correlaion wih he level of enrenchmen, is significan and negaively relaed o insider rading aciviy, as expeced. This variable is esed for he firs ime in he insider rading lieraure, and i corroboraes he posiion in Klock (1994) ha, when managers are allowed o rade on privae corporae informaion, hey usually ake on oo much risk, alhough we should specify ha his happens only when managers are enrenched. The obained relaionship indicaes ha risk-aking incenives are higher for managers rading on heir own firms as long as he level of insider ownership depars from conrol levels. The evidence shown in his paper clearly suppors ha a lack of alignmen of ineress leads o managers behaving opporunisically and, more specifically, managers rading on privae informaion. This fac is also corroboraed by he coefficien obained for excess capializaion (CB), which is negaive and significan, suggesing ha, for he Spanish banks, hin capializaion works as an indicaor of opporunisic behaviors from he side of managers. These managers are no only more likely o over-invesed in non-profiable projecs, bu hey are also more likely o increase heir insider rading aciviy. We may also conclude ha his resul suppors he philosophy behind he Basel I Capial Accord, which advocaes close surveillance of hin capialized banks under he presumpion ha hese banks are he mos likely o incur in opporunisic behavior. Finally, repuaion is also significan and negaively relaed wih insider rading aciviy, which confirms he expecaion ha, when firms care abou heir collecive repuaion, hey provide incenives o heir managers no o rade on he basis of privae 19

21 informaion as a way of proecing he firm from financial scandals. Size, considered as a conrol variable, is significan and posiive, in conradicion o previous lieraure. This suggess ha small firms are usually less moniored and insiders are more camouflaged when rading on heir own bank s shares. 7. DISCUSSION OF RESULTS AND CONCLUSIONS. This paper analyses he causaliy beween sock reurns and corporae insider rading, boh a he aggregae level and a he firm level for he Spanish banking secor. No evidence is obained o sugges causaliy a he aggregae level, indicaing ha any mispricing exploied by insiders in heir open marke ransacions wih shares of heir own bank is no due o macroeconomic facors. In conras, firm-specific feaures seem o enhance insider rading aciviy, as a srong posiive relaionship is deeced beween insider rading measures and sock reurns a he firm-level running mainly from curren insider rading o fuure sock reurns. These findings indicae ha insiders are able o predic fuure sock prices when he mispricing is due o firm-specific characerisics and ha insiders do no sysemaically base heir rading on pas reurns. In a second sage, we use panel daa esimaion under he assumpions of he agency heory o idenify he facors enhancing bank insider rading. We conclude ha he more enrenched he direcors, he less presigious he bank, he bigger he firm and he lower he charer values for high levels of ownership, he higher he inensiy of insider rading aciviy. Thus, he emerging picure is of a scenario where insider rading aciviy is riggered by he absence of efficien conrol mechanisms, eiher exernal (regulaors conrol he level of bank capializaion bu i is no easy for hem o also conrol oher opporunisic behaviors) or inernal (shareholders fail o conrol managers when managers sakes are very low or very high). 20

22 Enrenchmen is clearly relaed o insider rading, hus indicaing ha managers may exrac privae benefis hrough differen manifesaions of opporunisic behavior. Furhermore, enrenchmen modifies managers risk-aking incenives, which in urn has a direc effec on financial coss, bank performance and firm value (Lee, 2002), an associaion ha will be much ineresed o analyze in fuure research. We hus agree wih Sánchez- Ballesa and García-Meca s (2007) assessmen ha i is sill an open quesion wheher insider ownership helps o address agency problems. Our resuls also provide evidence agains he lower monioring of small caps small size banks are no associaed wih higher insider rading, as hypohesized by Madura and Wian (1995), Jordan (1999) and Madison, Roh and Saporoschenko (2004). Thus, he posiive relaionship beween insider rading aciviy and size could be undersood as he achievemen of enrenched managers who no only inves based on privae informaion, bu are also able o achieve one of heir main perquisies firm growh. Finally, his invesigaion has implicaions for bank regulaion, insider rading regulaion and he design of corporae governance mechanisms wihin he firm. I is worhwhile noing ha one facor ha dissuades insiders from rading on privae informaion is bank repuaion, which resuls from he managemen s effor o preserve he firm s public image from any kind of financial scandal. I brings o ligh he relevance and efficacy of inernal ehical codes of conduc, which could be more suiable for enforcing insider rading han exernal or governmenal rules an idea also proposed by Bris (2005), who believes ha harsher laws are no usually good for reducing he profiabiliy of insider rading. Alhough our resuls are mainly aribuable o counries characerized by low shareholder proecion, such as Spain, hey are easy o exend o mos counries where he subprime crisis has demanded higher harmonizaion beween he regulaory insiuions of differen counries. 21

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24 Fidrmuc, J., Goergen, M. and Renneboog, L. Insider Trading, News Releases and Ownership Concenraion. Journal of Finance, Vol. 61, no. 6, 2006, pp Furfine, C. Bank Porfolio Allocaion: The Impac of Capial Requiremens, Regulaory Monioring and Economic Condiions. Journal of Financial Services Research, Vol. 20, 2001, pp González, F. Bank Regulaion and Risk-Taking Incenives: An Inernaional Comparison of Bank Risk. Journal of Banking and Finance, Vol. 29, 2005, pp González, F. The Relaionship Beween Charer Value and Bank Marke Concenraion. The Influence of Regulaions and Insiuions. Applied Financial Economics, Vol. 18, no.2, 2008, pp Goron, G. and Rosen, R. Corporae Conrol, Porfolio Choice and he Decline of Banking. Journal of Finance, Vol. 50, 1995, pp Hillier, D. and Marshall, A.P. Are Trading Bans Effecive? Exchange Regulaion and Corporae Insider Trading. Journal of Corporae Finance, Vol. 8, 2002, pp Hirschey, M., Slovin, M. and Zaima, J. Bank Deb, Insider Trading, and he Reurn o Corporae Selloffs. Journal of Banking and Finance, Vol. 14, no. 1, 1990, pp Iqbal, Z. and Shey, S. An Invesigaion of Causaliy Beween Insider Trading Transacions and Sock Reurns. The Quarerly Review of Economics and Finance, Vol. 42, no. 1, 2002, pp Jensen, M. and Meckling, W. Theory of he Firm: Managerial Behavior, Agency Coss and Ownership Srucure. Journal of Financial Economics, Vol. 3, 1976, pp Jordan, J. Bank Managers Opporunisic Trading of he Firms Shares. Financial Managemen, Vol. 28, 1999, no. 4, pp Karpoff, J.M. and Lee, D. Insider Trading before New Issue Announcemens. Financial Managemen, Vol. 20, no. 1, 1991, pp

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27 NOTES 1 Alhough Iqbal and Shey (2002) sae ha he main secor in heir sample is he financial indusry, heir resuls are influenced by he effecs of oher indusries insider rading. 2 Anoher suiable proxy for insider rading can be found in Hillier and Marshall (2002). 3 Our resuls improve on hose obained by Iqbal and Shey (2002), who find ha i is he sock reurn ha affecs insider ransacions significanly and negaively, and no vice-versa, for a sample composed of boh financial and non-financial firms. 4 For non-financial firms, Fidrmuc, Goergen and Renneboog (2006) analyze he effecs of enrenchmen of he marke reacion o insider rading, raher han he relaionship beween enrenchmen and he profiabiliy or he inensiy of insider rading aciviy. 5 See Klock (1994) for a discussion of he effecs of insider rading on risk and of he need for legal regulaion of insider rading. Also, see Jordan (1999) for an analysis of insiders risk-exposure. 6 Cebenoyan, Cooperman and Regiser (1999) do no analyze he relaionship beween charer value and insider ownership on insider rading, bu raher he influence of charer value and insider ownership on risk. 26

28 Table 1: Descripive saisics. This able repors descripive saisics for he banks in he sample each year from 1994 o Panel A displays he mean, median, sandard deviaion, minimum and maximum values for he variables oal asses, ne income, ne resuls and reurn on asses over he sudy period. Panel B displays he yearly average number of insider ransacions, oal number of shares raded by insider and values for he four indexes of insider rading. SNVI and NVI. SNVI represens he EPS Sandardized Ne Euro Volume Index for period, and is defined as SNVI NVI / EPS P S / EPS, where NVI is he ne volume index for period and is measured as NVI NV /( P S ) ( P S ) /( P S ), and EPS is he earnings-per-share raio for period. P is he volume of purchases for monh and S is he volume of sales in monh. Panel A: Financial daa Thousands of Euros Mean Median Sandard Deviaion Minimum Maximum Toal Asses 32,572,691 6,413,236 63,881, , ,032,798 Ne Income 2,694, ,618 5,698,630 33,164 20,499,721 Ne Resul 231,341 52, ,886-6,186 1,408,294 Reurn-on-asses (%) Panel B: Mean values of sock reurns and indexes of insider rading for he banks in he sample Average Number of Average Number of Transacions by Insider Shares Traded Insider Trading Indexes Year Reurn Purchases Sales Purchases Sales SNVI NVI PI SI ,817, ,812 5,182, ,860,639 1,798,237 4,380, ,776,971 1,812,055 2,062, ,858, ,307 4,357, ,106 2,547, , ,060, ,973 19,140, ,183,494 5,527,863 2,969, ,272,089 4,730, , ,303,462 50,386, , ,326,734 10,079,396 17,207,

29 Table 2: Granger causaliy ess for sock reurns, SNVI and NVI. This able repors esimaed coefficiens (-raios in parenheses) and Granger causaliy ess (F saisics and p- values in parenheses) for he VAR model: R X k 1 2 j j1 j 2 j 1 j R X j j 1 2, using 1, 3 and 6 lag horizons for wo insider rading indexes SNVI and NVI. SNVI represens he EPS Sandardized Ne Euro Volume Index for period, and is defined as SNVI NVI / EPS P S / EPS, where NVI is he ne volume index for period and is measured as NVI NV /( P S ) ( P S ) /( P S ), and EPS is he earnings-per-share raio for period. P is he volume of purchases for monh and S is he volume of sales in monh. *, **, *** denoe significance a he 10%, 5% and 1% levels, respecively. For he sake of breviy, resuls of he coefficiens of he lagged dependen variables do no appear in he ables, bu are available upon reques o he auhors. SNVI NVI No. of Lags Dependen Variable Explanaory Variable Lag Coefficien (-Saisic) Granger Causaliy Tes (p-value) Coefficien (-Saisic) Granger Causaliy Tes (p-value) 1 Reurn Index E-10 (2.22)** Index Reurn E+06 (-0.21) 3 Reurn Index E-10 (2.19)** E-10 (-0.99) E-10 (-0.78) Index Reurn E+07 (-0.35) E+07 (0.42) E+07 (-2.10)** 6 Reurn Index E-10 (2.11)** E-10 (-1.28) E-10 (-1.01) E-11 (-0.12) E-10 (-3.32)*** E-11 (-0.25) Index Reurn E+06 (-0.30) E+06 (0.25) 3-5,08E+07 (-1.57) E+07 (-1.91) E+07 (-0.84) E+06 (0.30) 4.93 (0.03)** 4.460E-02 (0.833) 2.21 (0.09)* 1.48 (0.22) 3.05 (0.01)*** 1.76 (0.11) -2.56E-03 (-0.58) (0.007) -3.84E-03 (-0.88) 9.25 E-03 (2.14)** 4.47E-3 (0.95) (0.29) (-0.33) (0.30) -1.60E-03 (-0.35) 7.760E-03 (1.71)* 2.32E-03 (0.51) (2.37)** 8.94E-04 (0.189) -3.25E-03 (-0.69) (0.40) (0.49) (0.25) (0.48) (0.70) (-1.23) (0.56) 5.37E-05 (0.99) 2.12 (0.10)* (0.97) (0.07)* (0.81) 28