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To Trade or not to TradeThe Strategic Trading Around News

Announcements

Meziane LasferProfessor of Financem.a.lasfer@city.ac.uk

Web page: http://www.cass.city.ac.uk/faculty/m.a.lasfer/

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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

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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/

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Definitions

• Insider trading is the trading activity before “price sensitive” (material in US) information is announced.

Time

TRADING? News announcement

Issues:

Who could be an insider?

What type of news?

How long is the period before news announcements?

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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

Meetings with financiers/advisers to negotiate funding of deal

To seek support for the deal

TargetPreliminary talks possibility of takeover; Board meeting CEO, CFO and advisers

First meeting

Financing

Lawyers/advisor to discuss

Large investor meeting

Meeting pension trustees

Others

Responsibilities under takeover code

To explain proposals for pension deficit

PR firms, IT, printers, cleaning staff may have access to (discover) confidential information as the deal nears conclusion.

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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, 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 and Blackberrys containing key data• Sensitive information left out on untidy desks

Source: FSA November 2006

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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 one-third 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!)

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UK insider trading regulations (1)

• 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

periodSee FSA Market Watch June 2008

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Insider trading laws around the world• Battacharyan and Daoud, JF, 2003, find that even

though the 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.

• New legislation in 2009.

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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 • Reputation damage

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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 countries

• Such evidence is related to trading on private information– Superior knowledge about the firm’s prospects

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Insider trading before corporate events (1)

• Long run – Yes– Corporate sell-offs (Hirschey and Zaima 1989)– Takeover 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)

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Insider trading before corporate events (2)

• Short run – No/Little– Earnings downturns (Ke et al. 2003)– Earnings announcements (Huddart et al. 2006) – Management earnings forecasts (Noe 1999)– Non-earnings announcements (Givoly and

Palmon 1985)– The impact of regulations?

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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)

Empirical Findings

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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

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Hypothesis – illustration

Abs value of the market reaction (CAR)

Probabilityof trading

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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

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Methodology (1)

• Good/bad news– 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

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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 Insider Trading• Otherwise

• Total 10.31% of good news, 16.09% of bad news preceded by insider trading

2020

Good news

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

6.0%

7.0%

All

Earnin

gs

Other

Res

ults &

Div

Capita

l Stru

cture

Restru

ctur

ing

Owners

hip

Board

Cha

nges

Gener

al B

usine

ss In

fo

Misc

ellan

eous

Mea

n C

AR

0.0%

3.0%

6.0%

9.0%

12.0%

15.0%

18.0%

% P

rece

ded

by

Insi

der

Tra

din

g

Mean CAR % Preceded by Insider Trading

2121

Good news

0.0%1.0%2.0%3.0%4.0%5.0%6.0%7.0%

Mea

n C

AR

Preceded by Insider Trading Without Insider Trading

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Logit results – Good news

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) |CAR| News 0.206 (0.642) CAR2 News -1.045 (1.106) |CAR| Banned -25.525*** (3.418) CAR2 Banned 28.280*** (5.437) |CAR| Not Banned 1.070 (0.556) CAR2 Not Banned -2.218 (1.483) N 36,617 36,617 Pseudo R2 0.021 0.038

Prob(Trading=1) = logit(α1 + β1Size + β2Market-to-Book + β3Buy-and-Hold 120

pre + β4Multiple News + β5 |CAR| + β6 CAR2 + ε)

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Logit results – Bad news

Coeff Std error Coeff Std error Constant -4.509*** (0.215) -4.482*** (0.217) Size 0.190*** (0.034) 0.188*** (0.034) Market-to-Book 0.008* (0.003) 0.008*** (0.003) Past Return 0.245*** (0.053) 0.239*** (0.054) |CAR| News -5.277*** (1.302) CAR2 News 2.001*** (0.544) |CAR| Banned -155.381*** (54.228) CAR2 Banned 91.515*** (33.268) |CAR| Not Banned -4.366*** (1.274) CAR2 Not Banned 1.597*** (0.592) N 38,634 38,634 Pseudo R2 0.031 0.037

Prob(Trading=1) = logit(α1 + β1Size + β2Market-to-Book + β3Buy-and-Hold 120

pre + β4Multiple News + β5 |CAR| + β6 CAR2 + ε)

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Logit results – Specific news categories

Significant coefficients (p-value < 0.10)

Good news Bad news |CAR| CAR2 |CAR| CAR2 Earnings - + - + Other Results & Div - + - Capital Structure + - Restructuring - + Ownership + - Board Changes + - General Business Info - + Miscellaneous - +

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Summary

• 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 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.

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