Insider Trading Rules Research Articles

Relationship Banking and Firms’ Earnings Quality – Does it Matter Whether Banks are Creditors or Owners?

There is mixed empirical evidence on whether close banking relationships are associated with lower or higher earnings quality of borrowing firms. This paper analyzes how this evidence can be explained by the role of the bank, whether the bank is a creditor or equity-holder of the firm. We use a sample of Japanese public firms. In Japan, (1) banks historically have both close financial and personal ties to borrowing firms, (2) banks are not only lenders, but are also permitted to have an equity stake in the firm, and (3) detailed data on bank relationship characteristics are publicly available.One key result is that relationship banking is associated with lower earnings quality if the bank only provides debt. This effect is more pronounced in years of economic expansion. The results are in line with the theoretical literature, which argues that borrowing firms that want to conceal good performance from competitors benefit from relationship banking because banks’ access to private information lowers the demand for high earnings quality. However, if banks have an equity stake, they are more concerned about complying with insider-trading rules and governing agency problems of equity by efficient executive compensation contracts. Consistently, the second main finding is that the firm's earnings quality improves significantly with a bank's equity stake, regardless of the state of the economy. These results are robust according to various specifications of relationship banking or earnings quality.

حظر استغلال التعامل بالمعلومات الداخلية في قطر: دراسة نقدية مقارنة مع القانون الأمريكي

The purpose of this research is to examine existing loopholes in Qatar’s insider trading laws as impediments to a functional stock market. Weak insider trading rules diminish investor trust in local markets, which may encourage investors on the Qatar Stock Exchange to seek other markets, inhibiting Qatar’s intent to serve as a regional financial hub. This research revolves around proposing new rules to the current insider trading regulations. This critical analytical study gives a breakdown of the Qatari law on insider trading, studying its deterrence, investigation, and punitive components. Comparing these components with US regulations on insider trading, which are globally recognized as effective, this work identifies a key issue in each component of the Qatari law. Based on the US model, this study found that Qatari regulations need: a disclosure system to prevent immediate trading after information publication, a corporate whistleblower system to curb illicit transactions, and a treble damages provision to prevent violators from profiting or avoiding losses. This research offers substantial value to academics, corporations, governments, and investors looking to strengthen corporations and market development in Qatar or similar economies, emphasizing the importance of effective laws on disclosure, whistleblowers, and damages.

Capitalism and Distributive Justice: Musings of a Mormon Economist

Capitalism and Distributive Justice: Musings of a Mormon Economist

Disclosing and Cooling-Off: An Analysis of Insider Trading Rules

Disclosing and Cooling-Off: An Analysis of Insider Trading Rules

European Insider Trading Theory Revisited: The Limits of the Parity-of-Information Theory and the Application of the Property Rights in Information Theory to Activist Investment Strategies

AbstractParity-of-information is purported to be the single overarching policy rationale for the European Union (EU) regulation on insider trading. This is because securities trading on the basis of informational advantages is generally prohibited under EU rules, as is tipping (and issuers’ selective disclosure) of material, non-public information. Yet, EU regulations allow market actors, including investment professionals and analysts, that have discovered valuable information -and thereby, have an informational advantage vis-à-vis their trading counterparties- to trade on this information. Relatedly, issuers of financial instruments, takeover bidders and merging parties can share information with a selected group of investors prior to public announcement of the transaction (market sounding), whereas firms can delay public disclosure of inside information and prevent all other market participants from trading on this information. I argue that these exceptions from the parity-of-information theory are -from a doctrinal standpoint- best explained as property rights in information of market actors that have developed new proprietary information with respect to European listed securities. This article, therefore, aims at providing a property rights account of the exceptions to the parity-of-information theory and it illustrates the trade-offs between the parity-of-information and the property rights in information theories underlying European insider trading rules. By extension, I analyze the specific case of activist campaigns as inside information and argue that it would be consistent with the property rights approach to allow activist investors to share their investment and trading strategies with other market participants that further their activist agenda.

Asymmetric information consolidation and price discovery: Inferring bad news from insider sales

AbstractDue to the paucity of sources of negative firm‐specific information, US capital markets have more difficulty identifying and incorporating bad news into stock prices than they do good news. Even though insider selling is a potentially important proxy for undisclosed bad news, researchers have difficulty ex ante identifying information‐based sales due to an inability to separate liquidity‐motivated from information‐based insider trades. We hypothesize that when insiders in multiple firms sell shares of one firm in which they are insiders and at the same time buy shares of other insider portfolio firms, the sale is more likely to be information‐based, since the proceeds are reinvested. Conversely, when an insider sells one firm without purchasing others or sells multiple insider firms the sale is likely liquidity‐motivated. We find that insider sales identified as information‐based using this algorithm are followed by significant negative abnormal returns. Information‐based sales are also more likely to be associated with delistings, earnings declines and earnings restatements. Analysts are also more likely to revise their earnings forecasts downwards for these firms. It is thus possible to ex ante identify insider sales with information content. Our results will be of interest to investors and also to regulators designing insider trading rules.

The Efficiency of Stock Exchange Self-Regulation: Evidence from Stock Market Liquidity and Transparency

This study examines whether and how stock exchange self-regulation affects stock market liquidity and corporate transparency. Using a large sample of firms from 46 stock exchanges from 2001 to 2015, we find significant and robust evidence that firms listed in self-regulated stock exchange are associated with fewer zero-return days, lower daily stock price variation, higher stock trading volume, smaller analyst forecast errors, lower discretionary accruals and less earnings management. These findings are more pronounced when the stock exchange has a strong self-regulation model rather than a limited self-regulation model. Also, our results are robust in different-in-difference tests based on the Australian Securities Exchange’s change from strong self-regulation model to a government regulation model. Further, when a firm from a country with a government-regulated stock exchange is cross-listed in a self-regulated stock exchange, the firm has higher liquidity and transparency than the matched firms. In addition, we find that self-regulated exchanges set more detailed insider trading and disclosure rules and are more transparent with their rules and rule enforcement. Overall, our study suggests that stock exchange self-regulation improves the efficiency of stock market regulation.

Regulating information flows: Is it just? Insider trading and mandatory-disclosure rules from a free-market perspective

Much of Henry Manne’s work on insider trading emphasised that this practice enhances quick dissemination of information and ultimately efficiency. In this paper, we draw attention to the fact that regulating insider trading encroaches upon the foundations of a free-market economy, and boils down to a question of envy, rather than justice. In particular, there is nothing undesirable, fraudulent or shameful in a process through which selected agents (the insiders) transform dispersed information into specialised knowledge, and make use of it. One may be envious that insiders make a profit or avoid a loss thanks to their privileged position. Yet, insiders do not steal any information and do not violate any property right. Their only constraint is an explicit contractual agreement with their employer. In that case, the government might be required to enforce the contract. Regulation would be illegitimate.

Knocking at the Boardroom Door: A Transatlantic Overview of Director-Institutional Investor Engagement in Law and Practice

Under the current context of (re)concentrated ownership, institutional shareholders are expected to play a more active role in corporate settings in making managers more accountable and urging them to favour a long-term view. Calls from institutional investors for engagement with the board have grown and private dialogue with directors is now an important instrument of institutional investor activism. In spite of this favourable trend, director-shareholder dialogue is still problematic. Public disclosure and insider trading rules set legal constraints on board-shareholder engagement. However, the reach of these constraints should not be overstated, as they do not appear to ban outright all private dialogue between directors and shareholders. In this regard, recommendations within corporate governance and stewardship codes, and from practitioners, have played a major role in developing a practical framework for director-shareholder dialogue that seeks to prevent the violation of insider trading and public disclosure rules, and to make dialogue more effective. Against this backdrop, this article will provide a comparative transatlantic overview of recent developments in the area of director-institutional shareholder dialogue in the US and in Europe with the aim of assessing the effective reach of legal constraints on board-shareholder dialogue under current legislation, and considering some practical solutions offered by corporate governance and stewardship codes that could facilitate board-shareholder engagement and enhance its effectiveness.

Stock Market Law and the Accuracy of Public Companies’ Stock Prices

The social benefits of more accurate stock prices—that is, stock-market prices that more accurately reflect the future cash flows that companies are likely to produce—are well established. But it is also thought that market forces alone will lead to only a sub-optimal level of stock-price accuracy—a level that fails to obtain the maximum net social benefits, or wealth, that would result from a higher level. One of the principal aims of federal securities law has therefore been to increase the extent to which the stock prices of the most important companies in our economy (public companies) contain information about firms’ prospects so that society generates more wealth. Indeed, enhancing the accuracy of these prices in this way is perhaps the primary justification for the corporate disclosure, fraud, and insider-trading rules that make up the traditional core of federal securities law. Yet, important price-accuracy effects of a distinct area of the field (the law governing the market in which stocks are traded) have been overlooked. This Article theorizes that a set of central, yet little-noticed, stock-market rules is resulting in society producing a lower level of stock-price accuracy than it otherwise might. The Article therefore provides examples of ways in which the laws governing stock trading can be altered to increase stock-price accuracy. And it urges regulators to consider whether such alternations might be socially desirable in one of two ways: by enhancing the current level of stock-price accuracy in a manner that results in net social benefits, or by providing society with a lower-cost means than those associated with existing disclosure, fraud, and insider-trading laws for obtaining that current level. Accordingly, the Article theorizes that regulators have a fourth main securities-law tool (stock-market law) for increasing the accuracy of public companies’ stock prices, and sets forth a cost-benefit framework to help them determine whether it can be used to achieve one of the chief goals of securities law: obtaining a socially optimal level of stock-price accuracy.

Insider Trading in Uganda: An Analysis of the Capital Markets Regulatory Framework

In a bid to promote economic growth in Uganda, the Government of Uganda breathed life into the Capital markets industry in Uganda through the enactment of the Capital Markets Authority Act Chapter 84, and the subsequent establishment of the Uganda Securities Exchange in 1997. In order to protect the integrity of the Market, the Capital Markets Authority Act, and the Uganda Securities Exchange Insider Trading Rules, 2008 prohibit the dealing of securities of a listed company by an insider of that company. This is a conceptual study of the provisions of the Act prohibiting insider trading, and the Uganda Securities Exchange Insider Trading Rules, 2008 evaluating their adequacy to achieve the goal of preventing insider trading. It was found that there are gaps in these laws, and recommendations are proposed to bridge those gaps for a more comprehensive approach on insider trading, to further increase investor confidence in Uganda’s stock exchange.

Insider Trading and IRC Section 6103(e)(1)(D)(iii)

ABSTRACT Tax returns, including corporate returns, are generally confidential and not disclosed to the public. However, in certain circumstances, Internal Revenue Code (IRC) Section 6103(e)(1)(D)(iii) provides that corporate shareholders who meet a 1 percent ownership criterion can request from the Internal Revenue Service (IRS) a copy of the corporate tax return. In this paper, we discuss the legislative history of IRC Section 6103 as it relates to tax return disclosure in general (for individual and corporate returns) and its precursors that provide for disclosure of corporate tax returns to shareholders who own more than 1 percent of the capital stock. We then provide examples of the valuable proprietary information that is included in corporate tax returns. Next, we provide a history and discussion of the insider trading laws and argue that the information content of a corporate tax return is such that it provides material nonpublic information that is not readily available in annual reports or other public documents filed with the Securities and Exchange Commission (SEC). While 1 percent shareholders do not meet the classical definition of an “insider,” we argue that they are similar to other “outsiders” who have been found liable for violating insider trading rules. We conclude by arguing that the actions of a 1 percent shareholder who requests and receives the corporate return and who subsequently makes purchases and/or sales of corporate stock should constitute illegal insider trading.

Common Roots, Divergent Evolution: Insider Trading Doctrine in the United States, Japan, and Germany

Many nations ostensibly use (or at least credit) U.S. insider trading doctrine under Rule 10b-5 as the model for their own regulation of insider trading. This phenomenon has occurred in part because of historical and political factors and in part because the United States is seen as (and has wielded regulatory power as) a market leader — an early adopter of regulation with both (a) a well established supervisory and policy-oriented regulatory and enforcement agency and (b) a well developed, disaggregated, public securities market. As a result, the laws of many countries now prohibit identified classes of persons from trading while in possession of material nonpublic information, the central focus of insider trading regulation under Rule 10b-5. Yet, despite seemingly convergent beginnings and a general agreement on the nature of the regulated conduct, operative insider trading principles in the United States (as a rule originator) have evolved to protect different interests and regulate different specific market activities than insider trading rules in other countries. With the foregoing in mind, this working paper describes the common roots and divergent developmental paths of insider trading rules in the United States, Japan, and Germany and endeavors to place them in a meaningful international legal, political, economic, and social context.

Stock-Market Law and the Accuracy of Public Companies' Stock Prices

The social benefits of more accurate stock prices — that is, stock-market prices that more accurately reflect the future cash flows that companies are likely to produce — are well established. But it is also thought that market forces alone will lead to only a sub-optimal level of stock-price accuracy — a level that fails to obtain the maximum net social benefits, or wealth, that would result from a higher level. One of the principal aims of federal securities law has therefore been to increase the extent to which the stock prices of the most important companies in our economy (public companies) contain information about firms’ prospects so that society generates more wealth. Indeed, enhancing the accuracy of these prices in this way is perhaps the primary justification for the corporate disclosure, fraud, and insider-trading rules that make up the traditional core of federal securities law. Yet, important price-accuracy effects of a distinct area of the field (the law governing the market in which stocks are traded) have been overlooked.This Article theorizes that a set of central, yet little-noticed, stock-market rules is resulting in society producing a lower level of stock-price accuracy than it otherwise might. The Article therefore provides examples of ways in which the laws governing stock trading can be altered to increase stock-price accuracy. And it urges regulators to consider whether such alternations might be socially desirable in one of two ways: by enhancing the current level of stock-price accuracy in a manner that results in net social benefits, or by providing society with a lower-cost means than those associated with existing disclosure, fraud, and insider-trading laws for obtaining that current level. Accordingly, the Article theorizes that regulators have a fourth main securities-law tool (stock-market law) for increasing the accuracy of public companies’ stock prices, and sets forth a cost-benefit framework to help them determine whether it can be used to achieve one of the chief goals of securities law: obtaining a socially optimal level of stock-price accuracy.

Asymmetric Information Consolidation and Price Discovery: Inferring Bad News from Insider Sales

Although insider selling is a potentially important proxy for undisclosed bad news, the literature has failed to document consistent evidence of insiders’ sales being informative. The lack of information in insider sales is attributed to researchers’ inability to separate liquidity-motivated from information-based insider trades. We present and evaluate a new algorithm for identifying information-based insider sales. We hypothesize that when individuals who have insider-status with respect to multiple firms sell shares of one firm in which they are insiders and at the same time buy shares of other affiliated firms, the sale is more likely to be information-based, since the proceeds are reinvested. Insider sales unaccompanied by insider purchases are more likely to be liquidity-motivated. We find that insider sales identified using this algorithm as information-based are followed by statistically and economically significant negative abnormal returns. In validation tests comparing the incidence of adverse events for firms with information-based versus liquidity-motivated sales in the year of and the two years following the sale, we find that information-based sales are significantly more likely to be associated with delistings, earnings declines, downward analyst forecast revisions, analysts dropping coverage, and earnings restatements. We conclude that it is possible to ex ante and directly identify insider sales with significant information content. Our results will be of interest to investors as well as to regulators designing insider trading rules.

Insider Trading Rules and Price Formation in Securities Markets - An Entropy Analysis of Strategic Trading

This paper addresses the issue of how insider trading rules affect price formation in securities markets and suggests the application of information theory to market microstructure theory. We analyze a variant of Kyle's (1985) setting by simply introducing a more general criterion for informational efficiency borrowed from information theory - namely maximum information transmission. The analysis shows that both the insider's optimal trading strategy and the market price of the risky security depend on the insider trading restriction. Insider trading restrictions are reported to be detrimental to the liquidity of the securities market. We find that a unique insider trading rule exists which implements semi-strong form informational efficiency of the securities market. Alternative restrictions on insider trading give rise to either underreaction or overreaction in securities prices. Too strict insider trading rules are shown to account for excess volatility in securities prices. Contrary to common notion, the uninformed investors are shown to be hurt by too restrictive insider trading rules. We conclude that loose insider trading rules are preferred by the group of investors as a whole.

Transgovernmental Networks and Domestic Policy Convergence: Evidence from Insider Trading Regulation

AbstractCross-border cooperation among domestic regulators and public officials has become a defining feature of global governance. While a number of studies have tracked the emergence and institutionalization of such transgovernmental networks, less is known about their effect on domestic policy. This study explores this link for the important case of insider-trading regulation in original data for 116 countries between 1977 and 2006. It offers quantitative evidence that transgovernmental cooperation is related to domestic policy convergence but that the relationship is more complex than often assumed. Direct ties to powerful regulators increases a jurisdiction's likelihood of adopting internationally promoted policies such as insider-trading rules. Separately, membership in the International Organization of Securities Commissions (IOSCO), a forum designed to diffuse best practices among regulators, increases a jurisdiction's likelihood of subsequently enforcing newly adopted policies. The findings in this study suggest that different network components are associated with distinct aspects of domestic policy convergence. The results are directly relevant for current public policy debates about the reregulation of global financial markets as transgovernmental networks among domestic regulators have assumed a critical role.

INSIDER TRADING, REGULATION, AND THE COMPONENTS OF THE BID–ASK SPREAD

AbstractIn this article we investigate the relation between insider trading regulations and the bid–ask spread. We decompose the spread into its components before and after the enactment of strict new insider trading rules in New Zealand. We find that the enactment led to a significant decrease in the information asymmetry component of the spread, which is observed mainly in illiquid and high prechange information asymmetry companies. These findings are robust to model specification. In addition, we find a decrease in the contribution of information asymmetry to price volatility.

Legal insider trading, CEO’s incentives, and quality of earnings

The recent accounting scandals brought into light the failure of corporate governance mechanisms to curbing earnings management. This study focuses on the insiders who design the managers’ compensation contracts. The contract designers are seen as lacking the financial expertise to correctly uncover the true outcome. However by virtue of their knowledge of the contract details, they can discern the likelihood that the firm’s public report is not truthful. Modeling the firm as a principalagent contract, we show that insiders induce earnings management and make trading gains by designing suboptimal incentives. Given that our results are driven largely by the lack of these directors’ financial expertise, our study has the policy implication that inclusion of financial experts in compensation committees can contribute to transparencies under the current insider trading rules in place

INSIDER TRADING RULES AND PRICE FORMATION IN SECURITIES MARKETS: AN ENTROPY ANALYSIS OF STRATEGIC TRADING

This paper addresses the issue of how insider trading rules affect price formation in securities markets and suggests the application of information theory to market microstructure theory. We analyze a variant of the setting in [20] by simply introducing a more general criterion for informational efficiency borrowed from information theory — namely maximum information transmission. The analysis shows that both the insider's optimal trading strategy and the market price of the risky security depend on the insider trading restriction. Insider trading restrictions are reported to be detrimental to the liquidity of the securities market. We find that a unique insider trading rule exists which implements semi-strong form informational efficiency of the securities market. Alternative restrictions on insider trading give rise to either underreaction or overreaction in securities prices. Too strict insider trading rules are shown to account for excess volatility in securities prices. Contrary to common notion, the uninformed investors are shown to be hurt by too restrictive insider trading rules. We conclude that loose insider trading rules are preferred by the group of investors as a whole.