PDF Ebook Does Cross-Listing Mitigate Insider Trading?
We compare the information content of insider trading in UK companies cross-listed in the US (cross-listed) to that in UK companies without a US-listing (domestically listed). We argue that insiders of cross-listed companies are less likely to trade on private information because they are subject to their domestic as well as foreign regulations. While the abnormal returns on the announcement and trading dates of insider trading in domestic companies are consistent with previous evidence, we find low or no abnormal returns for cross-listed companies and the news preceding insider trading in cross-listed companies is, in general, immaterial while that of domestically listed companies is price-sensitive. These results hold even after controlling for endogeneity and other differences across the two samples. Overall, the results suggest that the bonding contract mitigates the propensity of insiders in cross-listed firms to trade on insider information.
Previous studies report that insiders trade around news announcements, earn abnormal profits, and outsiders can also earn abnormal profits by mimicking these trades.1 The legality of such trading is widely debated in the literature. Some studies argue that insider trading is beneficial as it increases market efficiency because any private information, related to the news released after the trade or to the insiders’ assessment of the true value of their miss-valued firms, becomes compounded quickly into share prices (e.g., Cornell and Sirri, 1992, and Hu and Noe, 1997, Manne, 1966, Meulbroek, 1992). Demsetz (1986) argues that restrictions on insider trading can also have motivational problems that interfere with efficient contracting between managers and shareholders. In contrast, other studies argue that insider trading should be regulated because such trades are based on private information, leading to an expropriation of uninformed investors. (See Bainbridge, 2002, and Bhattacharya and Daouk, 2002, for a review). Maug (1999) also argues that if insider trading is not prohibited, then both insiders and controlling shareholders will benefit but at the expense of the minority shareholders. Moreover, restricting insider trading will lower perceptions of unfair practices and level the playing field for investors, thus attracts more capital and lowers the cost of capital (e.g., Kyle, 1985). Although these arguments provide support for the current insider trading regulations in the vast majority of countries, this activity is difficult to regulate because of the complications in defining the trader and the ‘price-sensitive’ information, separating insider trading on private information from trading for portfolio changes and liquidity, and the controversies as to whether insider trading is profitable after transaction costs are accounted for. As a result, while in many countries a set of laws prohibit insider trading based on private information, they are inefficient as only few cases emerged from these rules (Bhattacharya and Douk, 2002).
The purpose of this paper is to extend this research and assess the extent to which insider trading is constrained by the regulation by testing the hypothesis that insiders of cross-listed companies are less likely to trade on private information because they face stricter enforcement regimes as they are subject to two countries’ legal requirements. We focus on UK cross-listed firms in the US for a number of reasons. First, although the UK and the US markets have relatively similar insider trading legal environments and corporate governance characteristics,3 the exposure into the two legal systems is expected to decrease the trading profits of insiders and result in the insider trading activity to be undertaken for liquidity rather than information purposes. This exposure also presents an attractive research environment to test whether managers of UK cross-listed companies are subject to the ‘bonding contract’ (Cofee, 1999, 2002; Stulz, 1999) as they become subject to increased disclosure requirements, and a more thorough investor monitoring than UK companies without a US-listing (referred thereafter as domestically-listed companies). In addition, previous studies report that cross-listing in the US decreases the level of information asymmetry and improves firm’s visibility through greater analyst coverage, better accuracy and increased media attention (e.g., Baker, Nofsinger and Weaver, 2002; Lang, Lins and Miller, 2003, 2004). These arguments suggest that the information content of insider trading is likely to be lower in the UK cross-listed compared to domestically-listed companies. Finally, since the UK has the largest number of firms listed in the US market,4 our sample is sufficiently large to undertake such analysis.
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PDF Ebook Does Cross-Listing Mitigate Insider Trading?
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