Does Insider Trading Deter Private Information Trading International Evidence

1
Does Insider Trading Deter
Private Information Trading? International
Evidence

• Art A. Durnev
• Amrita S. Nain
• Desautels Faculty of Management
• McGill University

2
Decisive practitioners and indecisive academics

• In the past decade, most countries have
  introduced some form of insider trading (IT)
  restrictions.
• Bhattacharya and Daouk (2002) find that 87 out of
  103 countries that have stock markets have
  introduced IT rules.
• Principal objectives of the IT restrictions
  appear to be
• Fairness - restrict trading by insiders with
  material non-public information.
• Reduce adverse selection facing the uninformed
  investor.
• While governments have ploughed ahead with IT
  regulation, academics have continued to debate
  the need for them.
• Pro IT Restrictions
• Brudney (1979), Easterbrook (1985), Glosten
  (1989), Manove (1989), Ausubel (1990), Fischer
  (1992), Maug (1995 and 1999))
• Critics of IT Restrictions
• Carlton and Fischel (1983), Dye (1984)
• Empirical evidence on the effects of IT
  regulation is scarce.
• Bhattacharya and Daouk (2002), Beny (2002, 2003)

3
Research question

• Question Do IT restrictions reduce the aggregate
  incidence of private information trading?
• Based on 2,827 firms from 21 countries we find
• On average, IT restrictions reduce private
  information trading.
• However, IT restrictions are less effective in
  firm with high agency problems.

4
Two explanations

• The marginal positive impact of IT restrictions
  on trading by informed outsiders is highest for
  high control firms.
• Lang, Lins, Miller (2003) analysts avoid firms
  with concentrated control rights. Bushman,
  Piotroski, Smith (2004) analysts become more
  active in the presence of IT restrictions
• Alternative explanation of why IT restrictions
  are less effective for high-control firms
• information asymmetry encourages trading by
  informed outsiders.
• trading on non-public information is only one of
  many different ways in which insiders can
  expropriate wealth from shareholders
• controlling shareholders (who are also insiders)
  extract benefits in many other ways.
• IT restrictions may distort the incentives of
  controlling shareholders.

5
Two explanations

• In the presence of IT restrictions controlling
  shareholder may choose to extract benefits in
  other ways
• Diversion ? earnings opacity and poor disclosure
• ? Greater information asymmetry in the market.
• Consistent with our argument above we find that
  high-control firms in the presence of IT
  restrictions
• are valued lower
• have more opaque earnings
• disclose less
• score lower on corporate governance

6
Sample and variables

• Ownership for 8,212 firms from 22 countries
• Claessens, Djankov, Fan, Lang (2002)
• Faccio and Lang (2002)
• Takes into account pyramid structure,
  cross-holdings, dual class shares, etc.
• Private information trading
• Run for each firm i in each country c, with at
  least 30 days of data, Jan 2 1997 Dec 29,2000
• IT regulation, 1-5
• Beny (2002 and 2003)
• IT Laws Enforcement, 0-1
• Bhattacharya and Daouk (2000)

7

• If shareholders are not acting in the best
  interests of the firm we expect
• destruction in value (Tobins Q)
• diversion (CLSA governance scores)
• poor disclosure and greater earnings opacity (SP
  disclosure and transparency and earnings opacity
  measure)
• for high-control firms in countries with IT
  restrictions
• Split the sample into countries with high- and
  low- investor protection standards.
• For our argument to be consistent, the
  interaction term must be
• significantly positive in countries with poor
  investor protection and weak laws enforcement.
• insignificant in countries with strong investor
  protection and strong enforcement of laws.

Do IT restrictions appear to distort incentives
of controlling shareholders?
8
Summary

• On average, IT restrictions reduce the amount of
  private information trading.
• However, concentrated control rights make IT
  restrictions less effective in reducing private
  information trading.
• especially in low-investor protection countries
• Firms with concentrated control in countries with
  stricter IT regulation have lower valuation,
  disclose less, have more opaque earnings, and
  score lower on governance.
• Our cautious interpretation is that controlling
  shareholders may expropriate and hide more in the
  presence of strict IT laws, especially in poor
  investor protection countries.

9
Policy implications

• IT restrictions are costly to introduce and
  enforce.
• If the primary objective of imposing IT
  restrictions is to minimize losses of the
  uninformed investors and encourage their
  participation in the stock markets then
  regulators need to be cautious.
• In countries where control rights are
  concentrated, IT restrictions should be
  accompanied by a concomitant improvement in
  investor protection standards.
• Otherwise, the costs of IT restrictions may not
  be worthwhile.