To Trade or not to Trade The Strategic Trading Around News Announcements Meziane Lasfer Professor of Finance m.a.lasfer@city.ac.uk Web page: http://www.cass.city.ac.uk/faculty/m.a.lasfer/ city ac a lasfer/ 1 Roadmap Introduction Definitions of insider trading Who has access to insider information Difficulties in identifying insider trading Reasons for trading by insiders Insider trading regulation Can insiders trade strategically? Empirical evidence of trading around news announcements Conclusions 2
Introduction Diploma (1982), MBA (1985) and PhD (1987) from London School of Economics and University of Bath Worked in investment bank and water company Started at Cass in1990 Research in corporate finance, asset management and corporate governance Empirical research, publications and consultancy for BP, FLA, NAPF, ICAEW, Trillium (Goldman Sachs/Land Securities), Donaldson and Morley Asset Management Teaching Cass: MBA, MSc, PhD Corporate Finance and Asset Management Executives: Goldman Sachs, KPMG, Thales, Deloitte, Lloyds-TSB, Bank of China, PT Commicacoes (Portugal), Global Aviation Underwriting Managers, Swedish CFOs Details are in http://www.cass.city.ac.uk/faculty/m.a.lasfer/ 3 Definitions Insider trading is the trading activity before price sensitive (material in US) information is announced. TRADING? News announcement Time Issues: Who could be an insider? id What type of news? How long is the period before news announcements? 4
First meeting Who has access to insider information? The case of Mergers and Acquisitions (by order of importance) Bidder CEO and CFO meet advisers to discuss strategy options Target Preliminary i talks possibility of takeover; Board meeting CEO, CFO and advisers Financing Lawyers/advisor to discuss Large investor meeting Meeting pension trustees Others Meetings with financiers/advisers to negotiate funding of fdeal Responsibilities under takeover code To seek support for the deal To explain proposals for pension deficit PR firms, IT, printers, cleaning staff may have access to (discover) 5 confidential information as the deal nears conclusion. How details of a deal can leak? Discussions overheard in city restaurants/ pubs/wine bars (tube?) Junior banker brags about big deal to friends CEO s PA leaves confidential information on photocopier (or at home on a dinning table!!) Fat finger errors on e-mails mails, letters and faxes Code names for bidder and target easily deciphered Staff may leave to another firm in the middle of a deal negotiations Insecure IT systems lead to information being vulnerable to outside hackers Loss of laptops p and Blackberrys containing key data Sensitive information left out on untidy desks Source: FSA November 2006 6
Why do Insiders Trade Private Information: Illegal, unethical, market inefficiency But difficulties in enforcing the legal system because Typically, several hundred individuals will be aware of a deal, rising to over a thousand in the case of large deals. Thus, many insiders may trade strategically to take advantage of the loopholes. We suggested that insider trading may have taken place before about onethird of takeover announcements in 2004. FSA Market Watch Dec 2006 Other reasons: Market miss-pricing/inefficiency Undervaluation: Buy Over-valuation: Sell Mimicry by non-informed investors Thus insider trading may lead to increase in efficiency Liquidity Cash needs Diversification (don t put all your eggs in one basket!) 7 UK insider id trading regulations (1) 8 Outlined in the Model Code of the LSE/FSA Trading bans 60 days before the preliminary annual results 60 days before the half-yearly results 30 days before quarterly results Any periods when there exists any matter which constitutes inside information in relation to the company Clearance to deal Granted by the chairman or designated director Possibility to get a permission to sell in the ban period See FSA Market Watch June 2008 8
Insider trading laws around the world Battacharyan and Daoud, JF, 2003, find that even though hthe laws across different countries in the world are strict, they are not enforced BUT Under Hong Kong s stock-exchange rules, listed companies need to report results twice a year but can disclose them three months after the end of the period for the half-year report, and four months for the year-end (Vs. US 40 days of a quarter-end and 60 days of a year-end). Directors and managers are permitted to trade shares until a month before results are announced, giving them months of proprietary access to information that could be invaluable in knowing whether to buy or sell shares. (Economist Jan 2009) SEC disclosed on 6 Feb 2008 that insider-trading charges had been settled by David Li, a man at the centre of almost everything that matters in Hong Kong. 9 New legislation in 2009. Costs and benefits of trading on information Benefits: Capitalize on foreknowledge of the information Financial Rewards Increase prestige Costs: Regulatory scrutiny Subsequent civil and criminal penalties under the insider trading laws, Potential loss of job, Reduction in future career prospects 10 Reputation damage
Can insiders trade strategically? Many studies report abnormal returns earned by insiders on trades in their companies shares Early seminal contributions by Jaffe (1974), Finnerty (1976) and Seyhun (1986) Wide later evidence from different e countries Such evidence is related to trading on private information Superior knowledge about the firm s prospects 11 11 Insider trading before corporate events (1) Long run Yes Corporate sell-offs (Hirschey and Zaima 1989) Takeover er bids (Seyhun 1990b) Dividend initiations (John and Lang 1991) Seasoned equity offerings (Karpoff and Lee 1991) Stock repurchases (Lee et al. 1992) Bankruptcies (Seyhun and Bradley 1997) Earnings downturns (Ke et al. 2003) 12 12
Insider trading before corporate events (2) Short run No/Little Earnings downturns (Ke et al. 2003) Earnings announcements ncements (Huddart et al. 2006) Management earnings forecasts (Noe 1999) Non-earnings announcements (Givoly and Palmon 1985) The impact of regulations? 13 13 Empirical Findings Source: Korczak, A., Korczak, P. and Lasfer, M., 2009, To Trade or not to Trade: The Strategic Trading Around News Announcements, Journal of Business Finance and Accounting (forthcoming) 14
Research question When do insiders trade? A universe of corporate news announcements Trading vs. No trading Decision to trade before good vs. bad news Decision conditional on the information content of the disclosure (proxied by stock price reaction) Hypothesis: strategic decision to trade driven by a trade-off Incentive to capitalise on private information Disincentive regulatory scrutiny Hence non-linear relation 15 15 Probability of trading Hypothesis illustration ti Abs value of the market reaction (CAR) 16 16
Data All regulatory news releases by FTSE All Share firms published in the RNS between 01/1999 and 12/2002 (retrieved from Perfect Information) Hand-coded into 2 and 8 categories Banned Earnings announcements with bans Not Banned Other Results & Dividends,, Capital Structure, Restructuring, Ownership, Board Changes, General Business Info, Miscellaneous Total 119,179 announcements, 78,251 with a unique company-date Open-market directors trades in the sample period (obtained from Directors Deals Ltd) Total 8,086 trades Stock market data from Datastream 17 Good/bad d news Methodology (1) Non-negative/negative CAR(0,1) CARs market model adjusted Estimation window: 260 trading days ending 30 calendar days before the disclosure FTSE All Share index as proxy for market portfolio Total 39,617 good news, 38,634 bad news 18 18
Methodology (2) Net insider trading in the firm s shares before each news announcement Total no. of shares purchased less sold 30 calendar days News Preceded by Insider Trading If the direction of trading consistent with the content of the news News without t Insider Trading Otherwise Total 10.31% of good news, 16.09% of bad news preceded by insider trading 19 19 Good news Mean CAR % Preceded by Insider Trading Mea an CAR 7.0% 6.0% 50% 5.0% 4.0% 30% 3.0% 2.0% 1.0% 0.0% 20 All Earnings Other Results & Div Capital Structure Restructurin ring Ownership Board Changes General lbusiness Info Miscellaneou ous 18.0% 15.0% 12.0% 9.0% 6.0% 3.0% 0.0% 20 % Pr receded by Insider Trading
Good news Preceded by Insider Trading Without Insider Trading Mea an CAR 7.0% 6.0% 5.0% 4.0% 3.0% 2.0% 1.0% 00% 0.0% 21 All Earnings Other Results & Div Capital Structure Restructuring Ownership Board Changes General Businessss Info Miscellaneous 21 22
23 Logit results Good news Prob(Trading=1) = logit(α 1 + β 1 Size + β 2 Market-to-Book + β 3 Buy-and-Hold 120 pre + β 4 Multiple News + β 5 CAR + β 6 CAR 2 + ε) Coeff Std error Coeff Std error Constant -3.028 *** (0.149) -3.023 *** (0.054) Size 0.147 *** (0.024) 0.146 *** (0.008) Market-to-Book -0.006 (0.004) -0.006 (0.001) Past Return -0.628 *** (0.114) -0.622 *** (0.047) 047) CAR News 0.206 (0.642) CAR 2 News -1.045 (1.106) 106) CAR Banned -25.525 *** (3.418) CAR 2 Banned 28.280 *** (5.437) CAR Not Banned 1.070 (0.556) CAR 2 Not Banned -2.218 (1.483) N 36,617 36,617 Pseudo R 2 0.021 0.038 24
Logit results Bad news Prob(Trading=1) = logit(α 1 + β 1 Size + β 2 Market-to-Book + β 3 Buy-and-Hold 120 pre + β 4 Multiple News + β 5 CAR + β 6 CAR 2 + ε) Coeff Std error Coeff Std error Constant -4.509 *** (0.215) -4.482 *** (0.217) Size 0.190 *** (0.034) 034) 0.188 *** (0.034) 034) Market-to-Book 0.008 * (0.003) 0.008 *** (0.003) Past Return 0.245 *** (0.053) 053) 0.239 *** (0.054) 054) CAR News -5.277 *** (1.302) CAR 2 News 2.001 *** (0.544) CAR Banned -155.381 *** (54.228) CAR 2 Banned 91.515 *** (33.268) CAR Not Banned -4.366 *** (1.274) CAR 2 Not Banned 1.597 *** (0.592) N 38,634 38,634 Pseudo R 2 0.031 0.037 25 Logit results Specific news categories Significant coefficients (p-value < 0.10) Good news Bad news CAR CAR 2 CAR CAR 2 Earnings - + - + Other Results & Div - + - Capital Structure + - Restructuring - + Ownership + - Board Changes + - General Business Info - + Miscellaneous - + 26
Summary 27 More insider trading before good than before bad news Trading is concentrated before less price sensitive releases Probability of trading before bad news decreases with the information content t of news releases Other results: Amount of trading before good news increases with the information content of the news, but is reduced when the news is extreme Next work: Expand data to cover new rules by FSA Trading in options (data problem?) International evidence to assess effectiveness of legal settings. 27 28