Insider trading, the use of material non-public information about a company’s performance to buy and sell shares in the stock market, is an illegal practice. Usually exchanged during private interactions between external investors and corporate executives, such information allows meeting participants to better anticipate changes of the value of company shares.
Even though investors are not allowed to obtain specific details about the company when privately meeting with corporate executives, such meetings are still quite popular. According to a Wall Street Journal article, investors spend a staggering $1.4 billion a year only in the United States to buy face time with corporate executives.
Without violating the law, investors can learn a lot by observing corporate executives’ body language and listening to tone of their voice and then use these bits and pieces of information to get ahead of the curve of other investors who didn’t attend these private meetings.
It turns out that investors are not the only ones using private meetings for their own benefit. A new study published in the prestigious Review of Accounting Studies by Telfer School of Management Professor Shantanu Dutta and his co-authors suggests that corporate executives are actually manipulating what’s exchanged in these meetings to have an advantage when trading their company shares.
Opening the black box of private meetings
“Everyone talks about all the benefits that investors can get from gaining material information about a company in private in-house meetings, but we often forget that corporate ‘insiders’—top executives, board members and their family—can also use these events to manipulate information and benefit from these interactions” explains Professor Dutta.
Proving that these “insiders” were involved in such questionable practices has always been challenging. However, Professor Dutta and his co-authors, University of San Diego Professors R. Bowen and P. Zhu, and East China University of Science and Technology Professor S. Tang were able to connect corporate executives’ trading activities with the meeting dates and content.
To do so, the researchers analyzed a unique hand-collected dataset of approximately 17,000 private meeting reports of Shenzhen Stock Exchange firms from 2012 to 2014. Only Shenzhen Stock Exchange requires listed firms to disclose private meeting details, including meeting dates, the names of external and corporate participants, and a summary of questions and answers exchanged during these interactions.
Impactful research findings
The results were telling: trading within the window of 20 days before and after private meeting dates, corporate insiders cashed $ 8.7 billion, just over 50% of the value of their company stock sales. Corporate insiders’ abnormal returns around meeting dates point to two questionable practices.
First, they may be controlling what is shared during private meetings to influence investors’ trading behavior. Second, corporate executives may be also timing their own trades according to the content of the meetings.
For example, during a meeting, a company CEO may intentionally bring up an indicator that investors may interpret as good news during the meeting. If the CEO decides to hold off trading company shares until the news affects the market, he or she is likely to benefit from such a decision.
“If this is happening in Shenzhen – the world’s 7th largest stock exchange – we can just imagine how corporate executives use those private interactions to benefit when trading at other major stock exchanges” explains Professor Dutta.
What happens in private meetings between investors and corporate executives stays private. Government agencies can only link unusual trading patterns to the content of these meetings after very long and costly investigations.
Clearly, investors are likely lose if corporate executives are controlling what and how much they want to share in their meetings. However, “the biggest danger is that corporate executives’ manipulation of meeting information and profiting stock trades can cause loss in confidence in the market in the long term,” adds Professor Shantanu.
How policymakers can discourage these questionable trades
If government agencies and policymakers decide in the future to ask companies to disclose what executives and investors share in private meetings with investors, they will better understand and monitor how insider trading happens. However, Professor Dutta and his colleagues are aware that companies already struggle with many regulations.
“We not advocating for tougher rules that can discourage corporate executives from privately meeting with investors. When done in good faith,” he adds, “these meetings make sure all relevant parties have access to non-material information.”
Professor Dutta believes that “a good solution could be to ask companies to simply disclose the dates of private meetings.” Knowing when investors and company executive meet can help government agencies more effectively spot insider trading before it leads to a serious financial crisis.
The result of an international research project funded by China’s National Science Foundation, Professor Dutta’s collaborative study has received several best paper awards, including the “Emerald Best Paper Award” from the China Finance Review International Conference. His research team is currently working on two follow-up studies on private meetings between investors and corporate executives.
Bowen, R. M., Dutta, S., Tang, S., & Zhu, P. (2018). Inside the “black box” of private in-house meetings. Review of Accounting Studies. doi:10.1007/s11142-017-9433-z