In recent years, the number of firms undertaking stock repurchases has increased dramatically, while the proportion of firms distributing value through cash dividends has declined. The popularity of share repurchases has not been mitigated even after the passage of the Jobs and Growth Tax Relief Act of 2003. In our paper, The Role of Institutional Investors in Open-Market Share Repurchase Programs, which was recently made publicly available on SSRN, we empirically analyze whether institutions have the ability to produce information about firms announcing open-market repurchase (OMR) programs, and how their information interacts with the private information held by firm insiders (which they may attempt to convey to the equity market through a repurchase program).
Posts Tagged ‘Information asymmetries’
Illegal insider trading has become front-page news in recent years. High profile court cases have brought to light the extensive networks of insiders surrounding well-known hedge funds, such as the Galleon Group and SAC Capital. Yet, we have little systematic knowledge about these networks. Who are inside traders? How do they know each other? What type of information do they share, and how much money do they make? Answering these questions is important. Augustin, Brenner, and Subrahmanyam (2014) suggest that 25% of M&A announcements are preceded by illegal insider trading. Similarly, the U.S. Attorney for the Southern District of New York believes that insider trading is “rampant.”
In my paper, Information Network: Evidence from Illegal Insider Trading Tips, which was recently made publicly available on SSRN, I analyze 183 insider trading networks to provide answers to these basic questions. I identify networks using hand-collected data from all of the insider trading cases filed by the Securities and Exchange Commission (SEC) and the Department of Justice (DOJ) between 2009 and 2013. The case documents include biographical information on the insiders, descriptions of their social relationships, data on the information that is shared, and the amount and timing of insider trades. The data cover 1,139 insider tips shared by 622 insiders who made an aggregated $928 million in illegal profits. In sum, the data assembled for this paper provide an unprecedented view of how investors share material, nonpublic information through word-of-mouth communication.
Understanding the mechanics of public dissemination of firm information has become especially critical in a world where trading advantages are now measured in fractions of a second. In our study, Run EDGAR Run: SEC Dissemination in a High-Frequency World, which was recently made publicly available on SSRN, we examine the SEC’s process for disseminating insider trading filings. We find that, in the majority of cases, filings are available to private paying subscribers of the SEC feeds before they are posted to the SEC website, with an average private advantage of 10.5 seconds.
In our paper, Financial Disclosure and Market Transparency with Costly Information Processing, which was recently made publicly available on SSRN, we provide new insights about the effects of financial disclosure and market transparency. Specifically, we address the following question: can the disclosure of financial information and the transparency of security markets be detrimental to issuers? On the one hand, there is an increasing concern that, in John Kay’s words, “there is such a thing as too much transparency. The imposition of quarterly reporting of listed European companies five years ago has done little but confuse and distract management and investors.” On the other, insofar as disclosure reduces adverse selection and thus increases assets’ issue prices, it should be in the best interest of asset issuers: these should spontaneously commit to high disclosure and list their securities in transparent markets. This is hard to reconcile with the need for regulation aimed at augmenting issuers’ disclosure and improving transparency in off-exchange markets. Yet, this is the purpose of much financial regulation such as the 1964 Securities Acts Amendments, the 2002 Sarbanes-Oxley Act, and the 2010 Dodd-Frank Act.
If the institutions of a country (e.g., property rights and contracting institutions) jeopardize the quality of its financial market, can the market by itself put in force corrective mechanisms that counterbalance and offset such negative impact? This question is at the core of modern financial economics because it essentially asks whether the market plays a more fundamental role than institutions in shaping modern financial activities, or the other way around. While the role of institutions has many facets and is subtle in nature, in our paper, Mutual Funds and Information Diffusion: The Role of Country-Level Governance, forthcoming in the November issue of the Review of Financial Studies, we focus on one unique element of the market—the global mutual fund industry—to provide some new insights.
In my paper, Opacity in Financial Markets, forthcoming in the Review of Financial Studies, I study the implications of opacity in financial markets for investor behavior, asset prices, and welfare. In the model, transparent funds (e.g., mutual funds) and opaque funds (e.g., hedge funds) trade transparent assets (e.g., plain-vanilla products) and opaque assets (e.g., structured products). Investors observe neither opaque funds’ portfolios nor opaque assets’ payoffs. Consistent with empirical observations, the model predicts an “opacity price premium”: opaque assets trade at a premium over transparent ones despite identical payoffs. This premium arises because fund managers bid up opaque assets’ prices, as opacity potentially allows them to collect higher fees by manipulating investor assessments of their funds’ future prospects. The premium accompanies endogenous market segmentation: transparent funds trade only transparent assets, and opaque funds trade only opaque assets. A novel insight is that opacity is self-feeding in financial markets: given the opacity price premium, financial engineers exploit it by supplying opaque assets (that is, they render transparent assets opaque deliberately), which in turn are a source of agency problems in portfolio delegation, resulting in the opacity price premium.
In our paper, Window Dressing in Mutual Funds, forthcoming in the Review of Financial Studies, we investigate an alleged agency problem in the mutual fund industry. This problem involves fund managers attempting to mislead investors about their true ability by trading in such a manner that they disclose at quarter ends disproportionately higher (lower) holdings in stocks that have recently done well (poorly). The portfolio churning associated with this practice of window dressing has potentially damaging effects on both fund value and performance.
In its recent decision in Halliburton Co., et al. v Erica P. John Fund, Inc., the U.S. Supreme Court upheld the legal standard for reliance in Rule 10b-5 securities fraud class actions that it had established some 25 years ago in Basic, Inc. v. Levinson. This standard, known as the fraud-on-the market doctrine, created a rebuttable presumption that plaintiffs relied on the integrity of the market price if they can establish that the market for that security was efficient. Defendants can rebut this presumption in several ways, including showing that the market for the security was not efficient or that the security’s price was not affected by the misrepresentations at issue. In delivering its ruling, the Halliburton Court noted that market efficiency is not a binary, yes-or-no proposition but is instead a matter of degree, pointing out that “a public, material misrepresentation might not affect a stock’s price even in a generally efficient market.” (Halliburton, 573 U.S. ___ at 10.)
Even as rabble rousers rail against financiers, the powers that be prize the breadth and liquidity of financial markets. Flash traders are investigated for unsettling stock markets and violators of securities laws receive jail sentences on par with violent criminals. The Federal Reserve has spent trillions with the avowed aim of pumping up the prices of traded securities, while expressing little more than the pious hope that this largesse might spill over into old-fashioned, illiquid loans.
In mergers and acquisitions transactions with privately-held (or closely-held) target companies, transacting parties will often agree to make payments to the target shareholders contingent upon some post-closing measures. Two often used arrangements are purchase price adjustments (PPAs) and earnouts. With a purchase price adjustment mechanism, payment to the target shareholders will be adjusted based on an accounting metric (such as the net working capital or shareholders’ equity) calculated shortly after the deal is closed. For instance, with a purchase price adjustment based on the target’s net working capital, as the target’s post-closing net working capital goes up or down compared to a pre-closing estimate, consideration to the target shareholders increases or decreases in accordance. Similarly, with an earnout, the transacting parties will agree upon post-closing performance targets, using measures such as earnings, net income, or gross revenue, and the amount of consideration that the target shareholders are entitled to receive will depend on whether such targets are met over the earnout period.