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Ownership Structure and Insider Trading: Evidence from China

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Abstract

In this paper, we examine the information content of insider transactions in China and analyze how ownership structures shape market reaction to these transactions. We find that the cumulative abnormal return (CAR) to insider purchases is a convex function of the percentage of shares owned by the largest shareholder. Further, the CAR to insider purchases is lower when the largest shareholder is government-related, or when the control rights of the largest shareholder exceed its cash flow rights. We also find that the market reaction to insider purchases is more positive for firms audited by Big4 auditors. However, we do not find a significant relationship between an ownership structure and the market reaction to insider sales. Our results are remarkably robust to alternative model specifications, corporate insider identities, and recent corporate news releases on price-sensitive events. Finally, we show that market reaction to insider purchases is larger for firms with less severe expropriations, as captured by the use of other receivables.

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Notes

  1. Following developed countries, most emerging market economies have introduced insider trading laws to regulate corporate insider transactions, including their timely reporting.

  2. For example, the Sarbanes–Oxley Act (SOX) of 2002 in the U.S. and the Market Abuse Directive of 2003 in the European Union.

  3. Although many emerging market countries have introduced regulations and laws on insider trading, their law enforcement is less effective than that of developed countries. Bhattacharya and Daouk (2002) show that 100 % of developed countries had insider trading laws and that 82 % prosecuted insider trading as of 2002. For emerging market countries, the respective amounts were 80 and 25 %.

  4. However, this law is not well enforced. Insider dealing, which relies on private material information to trade in the stock market for profit, is prevalent throughout the Chinese listed corporations (Howson 2012). A noticeable example is the enforcement action taken by the CSRC against Zhejiang Hang Xiao Steel Co. (stock market code 600477). Its stock price rose 150 % in 5 weeks following its announcement of a large infrastructure contract with Angola in March 2007. The insiders who purchased the company’s stocks before the announcement and sold them afterward received a profit of US$5 million.

  5. The reasons include a lack of regulatory resources, the difficulties involved in detecting inside trading, insufficient investigation, and deficient technical tools (Howson 2012).

  6. Replaced by the Administration of the Takeover of Listed Companies Procedures on September 1, 2006.

  7. In the United States, a principal shareholder who holds 10 % or more of a firm’s shares must report any changes in their beneficial ownership to the Securities Exchange Commission.

  8. Any shares owned by spouses, parents, children, siblings, legal entities, or other organizations are also considered to be the interests of directors, supervisors, or senior officers.

  9. However, the relatives of directors, supervisors, and senior management officers are allowed to trade during the trading ban periods.

  10. In the United States, insider trading is regulated by the Securities and Exchange Act of 1934. According to Section 16 of this Act, corporate insiders must report their shareholdings within 10 days of the close of the calendar month during which the trade was made. Section 403 of SOX amended this provision on August 29, 2002. The new provision requires insiders to report their holdings within 2 business days of an insider’s transaction.

  11. A very small number of reported insider transactions were made before the implementation of the Rules on the Management of Shares Held by the Directors, Supervisors, and Senior Management Officers of Listed Companies. According to the Shenzhen Stock Exchange, directors, supervisors, senior management officers, and their relatives reported only eight transactions from November 29, 2004 to April 9, 2007.

  12. Of these, the Shanghai Stock Exchange circulated critical notices of 26 cases with the others subject to supervisory attention.

  13. For example, Director of LU XIANG Co. (stock code: 002192) Guohua Zheng sold 296,400 shares on October 20, 2010. As the announcement day of the third quarter report was October 27, 2010, this transaction violated the regulation banning trading during the 30 days preceding periodic reports. Zheng was fined RMB110 million.

  14. As large shareholders or their appointed managers play active roles in running their corporations, they share similar interests. Managerial entrenchment effects can worsen the PP conflicts.

  15. As Chhaochharia and Grinstein (2007) suggest, the event-study methodology can decrease the potential endogeneity problems inherent in traditional cross-sectional regressions.

  16. As the market reaction can only be observed fully once the trade is publicly disclosed to the market, we define an event window (0, 20) to cover the announcement day. We examine the delay between the trading day and the announcement on the Shanghai Stock Exchange. The median delay is 2 days, and the 75th delay is 14 days. To assess the robustness, we add a discussion and use CAR (0, 4) as dependent variable in Table 6. We also calculate CARs over longer event windows as dependent variables, and our primary results remain qualitatively unchanged. For the sake of brevity, the results are not reported, but are available upon request.

  17. We follow a similar data selection process to that of Lakonishok and Lee (2001). To focus on more meaningful events, they exclude firms whose share prices are less than $2 and transactions with fewer than 100 shares. We also use 2,000, 5,000, and 10,000 as alternative thresholds to check the sensitivity of our results. We find that the results are essentially the same for all of these values.

  18. Seyhun (1986) reports that the insider purchase-to-sale ratio is about 0.7 in the U.S. market.

  19. We use the average exchange rate (¥6.9/USD) during our sample period. Brochet (2010) reports that the mean dollar value of insider purchases and sales is USD$0.152 million and USD$1.56 million, respectively, after SOX.

  20. Brochet (2010) investigates the profits of insider trading after SOX and finds that the mean abnormal returns for purchases and sales are 1.89 and −0.11 %, respectively, over a 3-day window after the insider transactions are made.

  21. For the sake of brevity, the regression estimates for control variables (SIZE, TURNOVER, No. of Purchases/No. of Sales, No. of Analysts, BOARDSIZE, BOARDMEETING, MHOLDING, INDEPENDENT, M/B, Loss and Lnasset) are not reported here, but available upon request.

  22. We are grateful to one referee for suggesting further analysis in this direction.

  23. We also use CAR (0, 5) as dependent variable. Our results remain qualitatively unchanged.

  24. The interests of managers and large shareholders may differ. To examine whether investor protection from manager entrenchment and large shareholder expropriation can influence the effects of ownership structures on market reactions to insider trades, we partition our sample into two groups: managers and large shareholders. The results show that most of the coefficients of ownership structure remain qualitatively unchanged. The results are not reported here but available upon request.

  25. For example, in China, insider trades are restricted in the 10 days prior to periodic reports and earnings announcements.

  26. Jiang et al. (2010) show that a large amount of financial resources have been siphoned off by the largest shareholders through intercorporate loans. These loans are typically reported as other receivables.

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Acknowledgments

We are grateful to Douglas Cumming, Joseph Fan, Wenxuan Hou, Kenneth Kim, Edward Lee, Haim Levy, Luc Renneboog, and the seminar participants at the Journal of Business Ethics Special Issue Conference, the third annual Chinese Finance Association (TCFA) Best Paper Symposium and Utrecht University for their very helpful comments and suggestions. This paper is supported by the Program for New Century Excellent Talents in University (NCET-11-0495), National Natural Science Foundation of China (No.71402181) and the National Social Science Foundation of China (10CGL011).

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Authors and Affiliations

  1. School of Finance and China Financial Policy Research Center, Renmin University of China, Beijing, China

    Qing He

  2. China Europe International Business School, Shanghai, China

    Oliver M. Rui

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  1. Qing He
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Correspondence to Qing He.

Appendix

Appendix

See Table 11.

Table 11 Variable definitions
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He, Q., Rui, O.M. Ownership Structure and Insider Trading: Evidence from China. J Bus Ethics 134, 553–574 (2016). https://doi.org/10.1007/s10551-014-2384-4

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