Rob Swystun, Pristine Advisers
The media plays many different roles and among them, one can be a disciplinary role, helping to expose wrongdoing and swaying public opinion one way or the other about events. In the realm of corporate governance, this disciplinary role can counteract potential wrongdoing from company insiders.
A new research paper has shed light on the disciplinary role of the media in regard to corporate governance. It says when the media reports regulatory information about Form 4 filings for the US Securities and Exchange Commission (which detail a company’s officers and directors, and any beneficial owners of more than 10% of a class of the company’s equity securities), that media coverage acts to restrict potential future profits from insider information.
The researchers, Lili Dai, with the ANU College of Business and Economics at Australian National University; and Jerry T. Parwada, and Bohui Zhang with the School of Banking and Finance, UNSW Australia, found that media plays this disciplinary role in three ways:
- helping to eliminate information asymmetry between insiders and investors,
- shining a spotlight on insiders with litigation risks, and
- making insiders who have personal wealth and reputations tied to their firms more cognizant of their activities.
The three investigated corporate and insider news coverage from 2001-2012 for their research. They used more than 1.375 million trades by U.S. corporate insiders from the Thomson Financial Insiders Data Feed, plus corporate news coverage data from RavenPack, which provided them with Dow Jones news releases associated with the insiders’ firms. They then computed insiders’ profits earned during the 180-day window after an insider’s buy or sell transaction. (All done with a bunch of sciency equations and stuff that go way over my head.)
They wanted to see if insiders earned abnormal profits when they were subjected to news coverage about their prior trades and found that there was a negative association between insiders’ future trading profits and news coverage of regulatory releases of insiders’ prior trading activities.
The researchers define information asymmetry as one side (managers and business insiders) having more information than another side (investors), which gives them a leg up on potentially profitable trades.
News coverage of potential insider information advantages, they found, served to have a significantly higher impact on firms where insiders had a lot more information than investors (higher information asymmetry). It reduces this asymmetry by turning public attention to the firm and increasing investor scrutiny of insider activities.
Executives in firms that have a higher risk of litigation are more cautious when it comes to potentially profiting from non-public material information, particularly after the media has turned the public’s attention toward the company via news coverage.
Those who work for companies with a higher risk of litigation, the researchers found, are less likely to try and be opportunistic with the information they have, particularly when it comes to the sale of shares and especially in officers (as opposed to board members).
However, deals that involved purchase of stocks, seemed unaffected.
“As a by-product, our results suggest that the media, through the litigation risk channel, is at least partially responsible for the common empirical finding that, on average, insiders profit from purchases (which we find are apparently immune to the news coverage effect) but not from sales,” the researchers wrote.
Capital at Risk
Whether it’s equity capital or so-called reputational capital, Dai, Parwada and Zhang found that the more an executive has to lose, the less likely they are to try and profit from insider information when their name is out in the media.
Although the media can add editorial opinion to their coverage, the researchers found that it was mainly just the dissemination role it plays in spreading the word about SEC Form 4 filings that has the main disciplining effect. The more the media covers these filings, the less likely executives from the firms they come from will try to profit.
“… We conclude that news coverage reduces insiders’ trading profits through the media’s news dissemination role rather than through its information creation role, adding value by broadening the dissemination of insider trading regulatory filings through replication,” the report says.
Those juicy insider tidbits of information seem to be a little less juicy when subjected to news coverage. The media, through its dissemination role, can help investors and the general public play watchdog to help ensure good corporate governance is being followed.