Academic journal article Quarterly Journal of Business and Economics

The Effectiveness of Legal Sanctions in Curtailing Insider Trading: Evidence from Exchange Listings *

Academic journal article Quarterly Journal of Business and Economics

The Effectiveness of Legal Sanctions in Curtailing Insider Trading: Evidence from Exchange Listings *

Article excerpt


Over the past several years there has been a lot of research interest in NASDAQ firms listing their stock on the American Stock Exchange (AMEX) or New York Stock Exchange (NYSE). Previous studies have found that the market reacts positively to announcements of an impending listing on the AMEX or NYSE. (1) The positive market reaction begins even before the first announcement of an application for exchange-listed status and persists until the actual listing date.

There have been several widely cited reasons for NASDAQ firms listing on an organized exchange: improved liquidity on the exchange, managers signaling to the market their positive perception of the firm's future prospects, and the enhanced visibility that an exchange listing brings to the firm. Sanger and McConnell (1986) and Grammatikos and Papaioannou (1986a), among others, find evidence consistent with the improved liquidity explanation of the listing announcement behavior of firms. More recently, Kadlec and McConnell (1994) find that NYSE listings are associated with an increase in the number of shareholders and a reduction in bid-ask spreads, providing support for both investor recognition and improved liquidity as sources of value from exchange listings.

Previous studies also have found that after listing on the NYSE, NASDAQ firms generally experience significant negative abnormal returns (McConnell and Sanger, 1987; Dharan and Ikenberry, 1995). Dharan and Ikenberry (1995) find that the poor post-listing performance appears to be related to managers timing their application for listing. Managers of small firms, for whom the initial listing requirements may be more binding, tend to apply for listing before a decline in performance.

Previous researchers attribute the positive abnormal returns before the listing announcement to the activities of insiders who buy the stock in anticipation of the gains from improved liquidity and investor recognition. Recently, Lamba and Khan (1999) provide evidence that corporate insiders act upon their private information of an impending exchange listing on the AMEX or NYSE by purchasing, or postponing the sale of stock on private account during the 1977-1993 period.

One of the objectives of insider trading regulations is to prevent insiders from exploiting their private information for personal gain. In recent years, there has been a significant increase in the scope of insider trading regulations, particularly since the implementation in 1984 of the Insider Trading Sanctions Act (ITSA). ITSA allows the Securities and Exchange Commission (SEC) to impose triple damages on anyone convicted of trading on nonpublic information, instead of just requiring the return of illegally obtained profits. In addition to these penalties, the burden of proof required for conviction became the same as that in a civil case, rather than the burden of proof applied to criminal cases, i.e., the proof of guilt beyond a reasonable doubt. (2) The expected effect of the passage of ITSA is to significantly increase the marginal costs associated with trading on insider information, presumably resulting in a change in the trading behavior of insiders. For example, evidence obtained by Arshadi and Ey ssell (1991) and Eyssell and Reburn (1993) shows that there has been a significant decline in the level of insider trading preceding events such as tender offers and seasoned equity offerings following the passage of ITSA.

It is likely that more stringent insider trading regulations may not have the same effect on insider trading around all events that affect firm value (Eyssell and Reburn, 1993). Also, changes in the trading behavior of insiders may not be uniform across different types of insiders. There is also the question of whether ITSA has had the desired effect of increasing the costs of trading on insider information. In this context, Meulbroek (1992, p. 1668) provides evidence why ITSA may not have affected insider trading behavior. …

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