Insider Trading around Bank Failures

Article excerpt

ABSTRACT

In this paper we examine insider trading around bank failures. We examine insider trading around four major bank failures that took place in the 1980's. The four failures that are examined are Continental Illinois National Bank and Trust Company, First City Bancorp., First Republic Bank and Mbank. We find that insiders in both the failed bank, as well as non-failed banks, change their trading behavior in the time period surrounding large bank failures. Moreover, we find that insiders in failing banks exhibit different trading patterns than insiders in non-failed banks. We find insiders in the failed bank are larger sellers of their banks stock around the time of the failure than insiders in other banks.

INTRODUCTION

In this paper we examine insider trading around the failure of banks. Between 1980 and 1994, 1,617 banks failed in the United States. This number constitutes 9.14 percent of all U.S. chartered banks. On a total asset basis, the failed banks held 8.98 percent of the total banking system assets (FDIC, 1997). While no geographic area of the United States was immune from the failures, some were hit harder than others. Nearly 60 percent of the failures occurred in 5 states: Texas, Oklahoma, California, Kansas and Louisiana (FDIC, 1997). Despite the economic significance of these bank failures, to date no paper has examined insider trading behavior around bank failures. We examine insider trading around four largest commercial bank failures that took place in the 1980's. The four failures that are examined are Continental Illinois National Bank and Trust Company, First City Bancorp., First Republic Bank and Mbank.

Given the lack of evidence regarding insider trading for banks and other financial institutions, we will discuss the empirical literature on insider trading behavior in non-financial firms. These studies have attempted to answer three important questions: (1) Is insider trading beneficial to capital markets? (2) Do insiders earn excess returns?, and (3) What kind of trading patterns do insiders exhibit relative to significant corporate news announcements? While all of these issues are interesting, our focus is on answering the third question for the banking industry.

Elliott, Morse and Richardson (1984) found evidence that insiders with private information purchased stock in their firms before value increasing announcements and sold stock before value decreasing information releases. Oppenheimer and Dielman (1988) examined insider trading patterns during the twelve months prior to announcements of dividend resumption (omission) and possible abnormal returns associated with such insider trading. They found evidence suggesting that insiders engaged in extensive net buying (selling) activity prior to dividend resumption announcements (omission). However, these pre-announcement insiders purchases failed to consistently earn excess returns, while pre-announcement insider sales enabled the insider to avoid negative abnormal returns. Furthermore, officers (high-information insiders) were found to earn larger profits than all insiders considered as a broad group.

The literature relating to non-financial firms indicates that the announcements of voluntary liquidations tend to benefit stockholders, whereas the announcement of filing for bankruptcy reduces equity prices. On that basis, Eysell (1991) hypothesized that the announcement of voluntary liquidations would be associated with an increase in insider purchases and that announcements concerning bankruptcy filings would lead to increased insider sales. As expected, when he empirically tested these hypotheses he found that corporate insiders were in fact heavy purchasers prior to liquidation announcements and during the period when the value of firms' stock kept rising. Furthermore, as expected, insiders of firms that eventually filed for bankruptcy were heavy net sellers. Additionally, those with the greatest access to information (high-information insiders) were found to be the heaviest purchasers before liquidation announcements and the heaviest sellers before bankruptcy announcements. …