informed trading in regulated industries david m. reeb, yuzhao zhang and wanli zhao discussion by...

Informed Trading in Regulated Industries

David M. Reeb, Yuzhao Zhang and Wanli Zhao

Discussion by Ko-Chia Yu

Shanghai University of Finance and Economics

2012 NTU ICF

The bigger picture

Why do governments regulate? To gain control over a certain strategically important

sector.

Shareholder protection Monitoring of wrong doing of corporate insiders

Limit the information leakage of the insiders

The bigger picture

Summary of the results: The very act of governmental intervention might

lead to more passages for informational leakage.

Additional “insiders” are generated in the monitoring process. Regulator

s

Summary of Findings

A very long list of evidence that includes: Potential avenues for informed trading

Short-sales Equity sales and/or purchases Option market

Potential informational leakage events Abnormal short-sales before earning shocks

Natural Experiments 1978 Airline deregulation 1980 Trucking deregulation 1999 Gramm-Leach-Bliley Act (again a deregulation,

banking industry)

Summary of Findings

Identification of the channels (Bank industry) Timing of informational flows

Call report to the regulators by the end of every calendar quarter

Gone public 40 days later Reaction in the first 20 days of the reports

Federal vs. State supervision Duplicity increases informed trading.

Political integrity Interaction between corruption index and supervision

Overall Impression

Very comprehensive and well structured

Convincing and very interesting natural experiments results

Many different takeaways and possible interpretations of the results

Highly unlikely for me to pick up any significant flaw to the contents of the arguments

Potential Avenues for Informed Trading

Alternative interpretations of the results Regulation provides another channel of information

leakage thus generate more “pseudo-insiders.” Do they mitigate the extent of trading from the true

insiders? “Opportunistic trade” variable from Cohen et. al

(2010) is included It is still interesting to see how insider trading

interacts with the regulator-insider trading

Potential Avenues for Informed Trading

Steele (1989) model: information leakage as the square of the number of people who have access to the information

Would the results (the mass data sample on short-sales, equity and the option markets)be driven by the fact that these industries (finance, utilities, and pharmaceuticals) consist of more people with valuable insider information about the industry? E.g. A pharmaceutical researcher will likely have the same

information (possibly better information) than an analyst studying on the firm.

Suggestion: average employee salary (NBER data)

Potential Avenues for Informed Trading

Short-sale market Predictability is significantly better for regulated industries

than non-regulated industries However it is not clear that this predictability can be

attributed to informed traders or liquidity providers (opportunistic or not). Diether et al (2007): reversal

Short-sale constraints Non-transient institutional ownership, index fund

ownership (Bushee 1998, among others)

Potential Avenues for Informed Trading

Equity market Adjusted-PIN Liquidity-PS is controlled. The asymmetric information part of PIN as in Duarte and

Young (2009)

Other comments

What about other regulatory changes?

Other supervised firms? Telecomm?

Supervision and regulation (more supervision than regulation, but it is the regulator who conducts the regulatory supervision)

Cost of getting caught seems to be low. (?)

Minor Issues

Table 6 “Regulatory duplicity” got truncated

Punctuation: “Although, …” in several places

Table 9

Citation update: Adams, R. B., & Ferreira, D. (2012). Regulatory pressure and bank directors incentives to attend �board meetings. International Review of Finance, 12(2), 227-248.

Conclusion

The research has a different takeaway for different people.

I really do enjoy reading the paper.

Good luck to the authors!