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Affiliated Insiders, and Legislative and Enforcement Efforts

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Affiliated Insiders, and Legislative and Enforcement Efforts BARTHOLOW, Janet L. H., Ph.D. December, 2017 FINANCE AN EMPIRICAL STUDY OF INSIDER BEHAVIORS: AFFILIATED INSIDERS, AND LEGISLATIVE AND ENFORCEMENT EFFORTS Dissertation Co-Directors: John Thornton and Jayaram Muthuswamy Affiliated Insiders are not corporate officers or directors; but they do have access to material information. Affiliated Insiders include investment advisors and general counsels, as well as persons who have a relationship with other insiders. The first part of my study divides insiders into Routine insiders and Opportunistic insiders consistent with Cohen, Malloy and Pomorski (2012). CMP find inconsistent trading to be “Opportunistic” and informative because they predict market returns and attain abnormal returns. I find Affiliated Insiders, both Routine and Opportunistic, do not inform the market when testing the predictive ability of their trades on one-month future buy and sell returns. In a follow-up study, I create long-short portfolios for Routine and Opportunistic Affiliates on one-month and six-month future returns. Both CMP and Jeng, Metrick and Zeckhauser (2003) test corporate insiders’ ability to achieve abnormal returns using the Capital Asset Pricing Model of Sharpe (1964) and Lintner (1965), the Fama and French Three-Factor Model (1993), and the Carhart Four-Factor Model (1997). I do not find abnormal returns for one-month portfolios. The short-swing rule disallows insiders to profit in any six-month time period so by testing on rolling six-month portfolios I find Affiliates and the General Counsel subgroup trades produce abnormal annualized returns ranging from 15.2 to 21.2 percent. In 2002, legislators passed the Sarbanes-Oxley Act to increase criminal fines and penalties for illegal insider trading. Since 2007, regulators at the SEC prioritized enforcement for illegal insider trading practices. The second part of my study focuses on the behavior of insiders following enhanced legislative and enforcement actions. Testing monthly aggregated trades for all insiders from 1992 to 2014, I find insiders change their behavior post legislative and enforcement actions. In the period following Sarbanes Oxley’s enactment, insiders increase the value of their buy trade values relative to the firm’s total monthly traded value by 5.3 percent and reduce their sell trade values proportionate to the firm’s total monthly traded value by more than 37 percent. Similarly for post-SEC time periods and for both the number of shares traded and trade value, insiders increase buys and reduce sells following enforcement efforts. Dissertation written by Janet L. H. Bartholow B.B.A., Ohio University, 1996 M.B.A., Malone Collage, 2002 Ph.D., Kent State University, 2017 Approved by: _____________________________________ Co-chair Doctoral Dissertation Committee John Thornton, Ph.D. ______________________________________ Co-chair Doctoral Dissertation Committee Jayaram Muthuswamy, PhD. ______________________________________ Committee Member Xiaoling Pu, Ph.D. ______________________________________ Committee Member Michael Ellis, Ph.D. ______________________________________ Graduate Faculty Representative Emmanuel Dechenaux, Ph.D. Accepted by: ______________________________________ Ph.D. Director, Graduate School of Management Pratim Datta, Ph.D. ______________________________________ Dean, College of Business Administration Deborah Spake, Ph.D. iii Table of Contents LIST OF TABLES ..................................................................................................................................................... VI TABLE OF FIGURES ............................................................................................................................................... VII ACKNOWLEDGMENTS ......................................................................................................................................... VIII INTRODUCTION ..................................................................................................................................................... 1 PART 1 – AFFILIATED INSIDERS PREDICTIVE ABILITY .............................................................................................. 4 LITERATURE REVIEW ....................................................................................................................................................... 4 Legal Definition of an Insider ................................................................................................................................ 4 Affiliated Insiders .................................................................................................................................................. 4 Opportunistic versus Routine ................................................................................................................................ 5 Informativeness and Abnormal Returns ............................................................................................................... 7 International Informativeness ............................................................................................................................... 9 Abnormal Returns ............................................................................................................................................... 10 HYPOTHESIS 1.1 SUMMARY ........................................................................................................................................... 11 DATA ......................................................................................................................................................................... 12 Thomson Reuters Insider Database .................................................................................................................... 12 CMP Identification Process and Bartholow Adjustments for Affiliates ............................................................... 14 Type and Frequency of Trades ............................................................................................................................ 17 Insider Variables .................................................................................................................................................. 18 Firm-Level Data ................................................................................................................................................... 18 Additional Data Information for Hypothesis 1.2 ................................................................................................. 18 Preliminary Note on Statistics ............................................................................................................................. 20 Summary Statistics .............................................................................................................................................. 21 HYPOTHESIS 1.1 DO AFFILIATED INSIDERS’ TRADES INFORM THE MARKET? ............................................................................. 23 Interpreting and Testing the Betas for Market Predictability ............................................................................. 26 RESULTS ..................................................................................................................................................................... 28 Robustness .......................................................................................................................................................... 31 CONCLUSIONS ............................................................................................................................................................. 32 HYPOTHESIS 1.2 DO AFFILIATED INSIDER PORTFOLIOS ACHIEVE ABNORMAL RETURNS? ............................................................. 33 RESULTS ..................................................................................................................................................................... 38 CONCLUSIONS ............................................................................................................................................................. 44 PART 2 – IMPACT OF LEGISLATIVE AND ENFORCEMENT EFFORTS ON INSIDER TRADING ..................................... 45 LITERATURE REVIEW ..................................................................................................................................................... 47 Fair Trade ............................................................................................................................................................ 47 Purposes of Regulation ....................................................................................................................................... 48 Legislation ........................................................................................................................................................... 48 Empirical Research on Legislation ....................................................................................................................... 51 Enforcement ........................................................................................................................................................ 52 Increased SEC Prosecution and other Enforcement Measures Change Insider Trading ...................................... 55 iv Empirical Research on Enforcement ..................................................................................................................
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