Insider Trading Returns: Does Country-level Governance Matter?

Transcription

1 Svenska handelshögskolan / Hanken School of Economics, Insider Trading Returns: Does Country-level Governance Matter? Jyri KINNUNEN Juha-Pekka KALLUNKI Minna MARTIKAINEN Svenska handelshögskolan / Hanken School of Economics, Copyright Hanken 1

2 Introduction 1. Do corporate insiders in European countries with a different level of governance and shareholder protection earn different abnormal returns on their stock trading? 2. How insiders trading behavior has changed after the financial crisis in ? Has the financial crisis highlighted differences in insiders opportunistic trading behavior between countries? 3. Did the recent financial crisis and its volatile aftermath increase or decrease the value of insider information? Introduction» Insider trading regulation restricts the gains that corporate insiders can earn when using their private information to trade insider stocks.» A representative investor assumes that stronger country-level governance prevents insiders to misuse their informational advantage» Bhattacharya and Daouk (2002; 2009): The initial enforcement of an insider trading law decreases the cost of equity in a country» Beny (2005): Countries with more prohibitive insider trading laws have more liquid stock markets with more informative stock pricing and dispersed equity ownership» Christensen et al. (2011): The adoption and enforcement of directives that tightened insider trading regulation in the member states of the EU increased stock market liquidity and decreased the cost of equity» A relation between insider returns and country-level governance?» Fidrmuc et al. (2013): A positive relation between country-level shareholder protection and abnormal insider returns in (15 European countries + US). Copyright Hanken 2

3 Introduction» The financial crisis in offered an excellent opportunity for insiders to exploit their informational advantage» Due to turbulent market conditions, access to private information about future cash flows and discount rates not incorporated in stock prices became extremely valuable.» On the other hand, investors have become more concerned about the failures in governance and unethical behavior of corporate executives, potentially limiting opportunistic trading.» The financial crisis revealed asymmetries in country-level governance between European countries» The financial crisis evolved into the public debt crisis, which has been argued to result from weak governance in certain European countries => Lax governance a major topic» A cross-section of European countries ideal to investigate whether abnormal insider returns vary with country-level governance» The 1989 Insider Dealing Directive (89/592/EEC), the Market Abuse Directive (2003/6/EC) and Directive 2004/72/EC Introduction» We expand the limited evidence on the relation between insider returns and country-level governance and shareholder protection by investigating cross-country differences in abnormal insider returns in Europe» Governance measured by the control of corruption index and the rule of law index from the Worldwide Governance Indicators (see Kaufman et al., 2009).» Following Fidrmuc et al. (2013), we proxy shareholder protection by the anti-self-dealing (ASD) index of Djankov et al. (2008).» The ASD index is constructed on the basis of legal rules governing a hypothetical relatedparty transaction. Our measures capture a country s actual tendency to obey laws and perceptions of the extent of corruption.» Spearman s rank correlation between the country rankings implied by the ASD index and our governance classification is only Copyright Hanken 3

4 Introduction» Second, we contribute by investigating whether the effect of the countrylevel governance and shareholder protection on abnormal insider returns has changed after the global financial crisis in » During the post-crisis period, investors have become more concerned of failures in governance and unethical behavior of corporate executives (see e.g. Kirkpatrick, 2009)» Consequently, political and legal costs of informed insider trading (see e.g. Huddart and Ke, 2007; Kallunki et al., 2009) may have increased due to the crisis.» If these costs have increased asymmetrically across European countries, the relations between insider returns and country-level governance may differ between the pre- and postcrisis periods.» Third, we compare insider profits in high- and low-governance countries before and after the recent financial crisis» Previous studies address the issue only in a single-country setting. Van Geyt et al. (2013) find that the Belgian insiders earned higher profits during the peak of the financial crisis. Data» Data on insider transactions for the period from 1999 to 2011 from 2iQ Research. Stock price data and accounting data from Thomson Datastream.» The data set consists of 146,886 insider transactions in 20 European countries (44,317 sales and 102,569 purchases)» Insider trading profitability measured as the profit following a purchase transaction and the loss avoided following a sales transaction.» The market-adjusted return measured as the difference between the raw log-return over the six months (125 trading days) after the day on which the insider trades and the log-return on the respective stock market index.» We measure country-level governance by the control of corruption index and the rule of law index from the Worldwide Governance Indicators (WGI).» 20 European countries sorted in two groups (High/low governance) based on the WGI cross-country indicators of governance.» The 10 countries with the highest levels of governance are from Northern Europe. The 10 countries ranked as having the lowest levels of governance are from the Mediterranean, and Middle and Eastern Europe. Copyright Hanken 4

5 Table 1 Cross-country indicators of governance This table shows a cross-country comparison of governance indicators. Twenty countries are ranked based on two dimensions of the Worldwide Governance Indicators (WGI): Control of Corruption and Rule of Law. The countries are sorted in an ascending order according to their average rank (Governance). Panel A (B) lists the 10 top (bottom) countries that were ranked as having the highest (lowest) levels of governance. Shareholder protection ranks the countries based on the anti-self-dealing index of Djankov et al. (2008); Legal Origin classifies the legal origin of the country s commercial law. The last column shows the period for which we have insider trading data for a country. Country Control of Corruption Rule of Law Governance Shareholder Legal origin protection Time coverage Panel A: High level of governance Denmark Scandinavian Civil Law 04/ /2011 Finland Scandinavian Civil Law 09/ /2011 Sweden Scandinavian Civil Law 02/ /2011 Norway Scandinavian Civil Law 12/ /2011 Switzerland German Civil Law 08/ /2011 Netherlands French Civil Law 12/ /2011 Austria German Civil Law 11/ /2011 Luxembourg German Civil Law 08/ /2011 United Kingdom Common Law 04/ /2011 Germany German Civil Law 12/ /2011 Panel B: Low level of governance Ireland Common Law 01/ /2011 Belgium French Civil Law 06/ /2011 France French Civil Law 07/ /2011 Spain French Civil Law 06/ /2011 Portugal French Civil Law 11/ /2011 Hungary German Civil Law 10/ /2011 Czech Republic German Civil Law 05/ /2011 Italy French Civil Law 08/ /2011 Poland German Civil Law 03/ /2011 Greece French Civil Law 01/ /2011 Empirical framework» Matched-pair insider sale and purchase samples» Linear regressions with country- and firm-specific control variables» Country-specific fixed effects and year dummies control for differences in abnormal returns across countries and over time» Standard errors adjusted for clustering at the firm level» To control for outliers and potential data errors, continuous variables winsorized to the 1st and 99th percentiles of their distribution Copyright Hanken 5

6 Conclusions» Insiders avoid about 2.0 percent points (4.0 per annum) more negative abnormal returns after their sales, if compared to outsiders» Insiders earn about 3.0 percent points (6.0 per annum) more positive abnormal returns after their purchases, if compared to outsiders Conclusions» No support for the view that stronger governance or shareholder protection prevents insiders to exploit their information advantage.» Results rather point to opposite: 1. Insiders in countries with strong governance and shareholder protection avoid significantly more abnormal negative results after selling their insider stocks than their peer group 2. Differences in abnormal returns between the groups are mostly insignificant for insider purchases. Copyright Hanken 6

7 Conclusions» The financial crisis and its volatile aftermath increased the informational advantage of corporate insiders over outside investors but also dampened differences in insiders opportunistic trading behavior between countries.» Suggests that insiders across Europe have recognized that investors have become more concerned of failures in governance and unethical behavior of corporate executives after the start of the recent financial crisis. Svenska handelshögskolan / Hanken School of Economics, hanken.fi Copyright Hanken 7