Introduction
When it comes to trading shares, there are three main champions in the game; institutional investors, insiders and the firm. (Hoberg, 2018) Each has their own way of trading shares based on the information at hand. Firms sell their shares to the public at a decided price. The employees in the firm or even the firm can buy the shares beforehand. Institutions on the other hand wait for the firm to sell so as to buy and trade. The question is, do the insiders and the firm have an upper hand at profit making by buying earlier at a low price and reselling at a higher price despite the fact that all information should be public. The method used to determine if insiders have an advantage over institutions is to use a four step timeline that will breakdown the process from repurchase announcement to the implementation of repurchase.
This strategy will point out, if any, the advantage insiders might have and are using for insider trading against institutions and retail traders in the market. A fair trading platform will be indicated when all three main players have a range of equal profit. The institution and the insider have almost the same profit margins per share. The insider, a person who owns at least 10% shares and the firm are the ones that release information on shares. For the field to be equal, during the release of repurchase announcement, both the insiders and institutions will buy at around the same rate. If there is an unfair advantage, the insiders will buy slightly more than the institutional traders at the preannouncement stage because they know something the institutional traders do not.
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Other types of assessments or tools used to try and see if there is an unfair advantage between insiders and institutions include; 13F by Thomson Reuters, this includes exchanges, stocks, shares of closed investment companies and equities exceeding 100 million dollars. TAQ to provide details as time stamp and finally Abel Noser for viewing price and amount traded. The result showed that despite rule 10b-5 that restricts insider trading based on information the public does not have and prohibits leaking of the information; there is always a way to go around it. This will always give the firm and insiders an edge over the rest of the public, this includes institutional traders. In the end, the paper will show that institutional traders though good at what they do, cannot be equal or compared to the firm and its traders once they all start trading on the company’s shares.
Analysis
Institutional investors still benefit and profit despite the slight advantage of firms and their investors. They do this via various methods; Thomson Reuters 13F. This is a report that is necessary for institutional investment managers for amounts worth over $100 dollars. Institutional investors use this information to predict the next quarter of the repurchase. By studying this data, institutional investors are able to know if institutions are able to benefit when the firm and the insiders are involved. This enables institutional investors to earn a considerable amount of profit. (Bunshee, 2001) The other alternative institutional investors have is to use a low portfolio turnover. This will reduce transaction costs while still investing in a high average portfolio investment on items as government bonds, mutual bonds, corporate bonds and treasury bills among other portfolio investment options . To top up the two methods, Institutional Investors use a program that automatically executes once a certain target has been achieved. The program is known as ISOs, it generally performs selling and buying automatically under set conditions (Chakravart, 2012). The program has other added benefits as speed that enables the trader to capitalize on just released sensitive information.
Compustat is another beneficial tool for the institutional investor. Compustat is a program that contains all the financial market information of companies around the world, both active and inactive. They use this program to analyze trading activities that might be beneficial to them especially when dealing with short seller trading, watching and waiting for the price to decline so they can capitalize on the difference. Compustat is biweekly and provides short interest information. This is used by comparing trading prices between actual price and CRSP price at the end of the trade.
Institutional investors are considered the best in their field. While we acknowledge that prior research explains that institutional investors are informed and so far nobody in the market can refute that. The puzzle comes in their challenge to capitalize on profit generation while trading. Some believe the institutional traders have hit their target from a long term investment initiative, assuming that the shares were bought long before the announcement hence after the announcement they will have made their profit.
The other and most common reason is lack or delay of information. This works against the investors in that they do not have enough time to act on the information and capitalize on gains. The withholding information may be done deliberately by the firm in order to capitalize on itself or avoid unwanted competition. The other probable reason institutional investors might not have an advantage or equal footing is the lack of regulation or time limit in purchasing the shares. Since the firm is not necessarily obliged to buy back shares or follow up on the implementation this makes it a challenge to trade the shares.
. As brilliant as the institutional investors might be, it would still be a challenge to compete against the firm itself and the employees also known as insiders. The reason for this is, people inside the firm know everything or almost everything there is to know about the company, this makes it easier to predict or know the firms next financial move thus giving them an edge over the rest or in this case, institutional investors. Wall Street highlighted a trick used by insiders to give their members earn high returns. This is done by net insider buying shares and thus setting artificial prices. (Waggoner, 2015) These are just some of the reasons institutional investors, despite their knowledge and skill, are not earning the same level of profit as the firm.
When firms announce selling of their shares, different groups take different actions. The institutional investor takes the most unlikely action of them all. He does not buy. Different experiments were carried out to try and come up with a reason or explanation as to why institutional investors do not buy shares during the best and most likely time to earn a profit. The first experiment was done using ISO intra-day data, a system that takes note of investor reaction towards the news. As the rest bought shares before the price could rise, the institutional investor actually sold as witnessed by a negative record despite the fact that they would still profit even if they bought the shares.
The other experiment used was the Abel Noser data, using the data, a daily trading session was observed, it was observed that institutional investors did not make any profits in the entire period. The traders were selling their shares and not making any expected profit. When institutional profitability was calculated, the institutional traders did not record any profit in the entire duration. Despite the system used to calculate the data, none recorded any profit; this is despite other traders buying and making profits. After the experiment, further research was done to look into why the institutional investor was not buying shares at the most opportune time. The reason this was the case is because there was a hidden twist that could only be noticed when using CRSP. It was discovered that the cost of closing the short position was actually higher than the revenue that was gained during opening trade. What this means is the traders who bought would experience a loss after closing the short position. Without a keen eye and knowledge of the market and all its techniques, an investor can incur huge loses while rushing to gain profits from a trend.
Recommendations
The main discussion here was insider trading having an upper hand to Institutional Investors and retail investors. The most burning question is; how do you even the playing field, create equal opportunity for everyone in the market? As seen before, insider trading is sharing information on the company to selected members that are not part of the company so as to give them an upper hand. (Investopedia, 2018) Insider trading has been witnessed in places as Wall Street. The reason insider trading succeeded and might succeed again is not only due to lack of air tight policies by firms and governments but also due to individual characteristics. Once a person disregards trust as a virtue in business they are more likely to seek inside information so as to gain that extra footing.
The presence of pressure to outperform one another, reach a certain target or give good returns encourages insider trading. It would be extremely hard not to consider a solution that would make you a killing in a single day. Imagine working as a manager in a farm and a person approaches you offering a bribe, twice your monthly pay for single seemingly unimportant information. My point is, a person who values money more than his position and responsibility to a company will gladly accept the amount, after all his position does give him access to such information. Taking the job position, roles and responsibilities for granted encourages such criminal activities. (Reichman, 1989)
Insider trading is profitable, if you are not caught in the process, but, while as an individual benefits, many more will lose. This is because insider information is meant to benefit a selected few while the rest lose their investments.
Firms deploy several methods to discourage and stop insider trading before it gets to state level. Some of the techniques include; preventing the firm’s managers and any other staff that has access to sensitive information from trading right before shares are announced. Employing a Chief Legal Officer who will approve or disapprove the buying of company shares by those with sensitive information can be instrumental in discouraging insider. Training the employees on how to avoid inside trading and avoiding participation in divulging company secrets is another method of reducing organizational insider trading.
Other methods a firm can deploy to prevent insider trading include; an employ interested in trading should first confirm if they are using material that is not publicly accessible, prevent access to company sensitive data from being accessed by unqualified staff or the public, this will require the company to have inaccessible areas where the information will be stored. Not discussing sensitive company data in public areas like parks or clubs. Having a trading window for the employees, once the window is closed, they should not be allowed to trade as this will raise suspicion on insider trading.
The government is also playing a part in regulating insider trading by setting up laws and regulations as seen above. By breaking the set laws, the firm is liable to imprisonment or fines. The prison sentence can be up to twenty years and a fine of $5 million dollars for the person who committed the crime. The company itself can be fined an amount of $1 million dollars or an amount thrice the profit or loss avoided if it was discovered the company knew and did nothing about it. (Insider Trading Policy, 2013) Basically the government is taking all the necessary steps to ensure equality and fairness when it comes to the stock market trading.
As for the institutional investor, they too have techniques to try and counter the advantage insiders and the firm might have when it comes to market trading. They are known as the brightest in the field; this attracts clients to them and ends up pooling a large amount of resources for trading. Their vast knowledge also enables them to detect and avoid traps as in an example above; when everybody was buying, they were selling the shares; in the end the buyers experienced a greater loss than the sellers. Their knowledge also comes in handy when deciding which shares to buy and which to sale making them a safe and more reliable option. They have a wide range of investment options at their disposal; this gives them a variety of choices hence further reducing the risk of huge loses. They control a large part of corporate governance hence have a say and mostly their opinion will be in favor to them and eventually to their investors. (Economy Watch, 2010)
Insider trading still poses a threat to the free and fair stocks market; this is regardless of the tight measures put in place to curb and stop the practice. Institutional investors still have a distance to cover before they are on the same level as insider traders. Despite the knowledge and vast amounts of resources, without the needed information, institutional investors will lag behind. The solution to this so far is tighter laws that discourage unfair trading, moral encouragement against aiding in illegal trading and educating the public on fair trading in the stocks market. The only solution recommendable at the time is moral uprightness even in the face of a tempting offer. Laws and the fear of consequences does not seem to have such a huge impact as it should.
Works Cited
Bunshee, B. Do Institutional Investors Prefer Near-Term Earnings Over Long-Run Value? Contemporary Accounting Research. 2001. 18, 207-246. Nov. 24, 2018
Chakravarty, S., Jain, P., Upson, J., Wood, R. Clean Sweep: Informed Trading Through Intermarket Sweep Orders. Journal Of Financial And Quantitative Analysis 2012. 47, 415-435. Nov. 24, 2018 Economy Watch. Institutional Investors. 2010. Web. Nov. 24, 2018. http://www.economywatch.com/investment/institutional-investors.html
Economy watch (insider trading). Institutional investors. 2010. Web. November 24, 2018. http://www.economywatch.com/investment/institutional-investors.html
Hoberg, G., Kumar, N., & Prabhala, N., 2018. Mutual Fund Competition, Managerial Skill, And Alpha Persistence. The Review Of Financial Studies, 1896-1929. Nov. 24, 2018
Investopedia. Investopedia. 2018. Web. Nov. 24, 2018. https://www.investopedia.com/terms/i/insidertrading.asp
Reichman, Nancy. Breaking Confidence: Organizational Influences On Insider Trading. 1989. Web. Nov. 24, 2018. https://www.jstor.org/stable/4120688?seq=1#metadata_info_tab_contents
Waggoner, J. Beware The Stock-Buyback Craze. The Wall Street Journal, Dow Jones & Company.2015. Web. Nov.24, 2018 www.wsj.com/articles/beware-the-stock-buyback-craze-1434727038 .
