Insider Trading as a Menace: An Indian Perspective

By Arora, Shallu; Sharma, Meena et al. | IUP Journal of Applied Economics, October 2017 | Go to article overview

Insider Trading as a Menace: An Indian Perspective


Arora, Shallu, Sharma, Meena, Vashisth, A. K., IUP Journal of Applied Economics


(ProQuest: ... denotes formulae omitted.)

Introduction

Insider trading relates to the investment behavior of corporate employees in the securities of their own companies. When the stock prices move up or plunge in a stock market without any apparent reason, investors and analysts generally believe that shares are reacting to non-public information. To promote safe and fair trading in the securities market, SEBI discouraged this type of trading. The present study tries to analyze the impact of insider trading on stock market returns and how the stock market reactions differ with respect to insider purchases and insider sales. This study also examines whether delayed reporting of insider trades to respective stock exchanges and industrial differences have any impact on the magnitude of insider's abnormal returns.

Literature Review

Insider's Stock Returns

The concept of insider trading is controversial in academia and financial market research. One school of thought believed that it is a source of compensation to insiders for their entrepreneurial activities to the corporation (Manne, 1966; and Carlton and Fischel, 1983). Another school believed that to maintain parity of information between insiders and outsiders, insider trading should be regulated and penalized. Studies like Pratt and Devere (1970), Jaffe (1974), Finnerty (1976), Baesel and Stein (1979), Carlton and Fischel (1983), Seyhum (1986), Pope et al. (1990), Fishman and Hagerty (1992), Gregory et al. (1997), Hebner and Kato (1997), Brio et al. (2002), Merikas and Vozikis (2003), Bajo and Petracci (2006), Fidrmuc et al. (2006), Gupta and Sangray (2007), Aktas et al. (2008), Aussenegg and Ranzi (2009) and Cohen et al. (2012) found positive and significant returns on insider trades. The magnitude of abnormal return was significantly different and mixed.

Seyhum (1988) found insiders' increased stock purchases prior to increase in stock market and decreased stock purchases following increase in stock market. Bajo and Petracci (2006) reported CAR of 14.05% and 16.95% on insider purchases and sales, respectively, for six months. Finnerty (1976) reported CAR of 0.834% and 0.078% for insider purchases and insider sales over a 11-month period.

Reporting Delays

The country-wise regulations for reporting insider trades to respective stock exchanges substantially differ. In US, before the Sarbanes-Oxley Act, the insiders were required to report their trades within 10 days of the month following the trade. Whereas, after the Sarbanes-Oxley Act, reporting is within two days of the month following the trade. In UK and Germany, reporting is within 6 and 5 days respectively after the trade. Canada and Malaysia regulations allow for 10 and 14 days delay respectively. In India, listed companies under Regulation 13(4) have to report their trading information to stock exchange within two business days. Leland (1992) suggested that whether insider trading hurts or helps the market depends upon the characteristics of that market.

These international differences raise a question whether the allowed time for reporting of insider trades really matters. Fidrmuc et al. (2006) found that CAR of UK companies was high on reporting date because of speedier reporting of trades. Betzer and Theissen (2008) analyzed 4,272 transactions by German companies for the period from July 2002 to June 2004 and supported strong reporting requirements and their immediate disclosure.

Impact of Firm-Specific Variables on Insider's Stock Returns

Aboody and Lev (2000) studied whether the officers of research and development companies positively exploit the opportunities of insider trading. The notable finding of the study was that insiders in R&D-intensive companies buy ahead of good news and sell ahead of bad news. Coff and Lee (2003) found that R&D intensity is positively related to abnormal returns for stock purchases and negatively related to CAR for stock sales. …

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