||Insider Trading in Stock Substitutes
||Department of Accountancy
U.S. securities laws prohibit insiders from exploiting material non-public information to trade own firms’ stocks. However, it is not illegal for insiders to trade correlated stocks, such as the stocks of own firms’ supply chain partners. Thus, there may be incentives for insiders to use private information and transact instead in the stocks of own firms’ suppliers and customers. I refer to this form of trading as trading in stock substitutes.
This study examines whether insider’s trading in stock substitutes occurs before and after the own firm’s M&A announcement. As expected, I find that a individual registered as insider at both M&A firm and its supply chain partner trades the stocks of M&A firm’s supply chain partner based on private information about the M&A deal. Specifically, I find that interlocked insider’s pre-announcement (post-announcement) net purchases of the M&A firm’s supply chain partners are positively (negatively) associated with supply chain partners’ five-day cumulated abnormal returns around the M&A announcements. Such trading is more evident in the presence of higher information asymmetry and lower perceived litigation risk of stock substitutes. Overall, this study provides the first systematic evidence for insider’s trading in stock substitutes.
1 Introduction 1
2 Literature Review and Hypothesis Development 7
3 Data and Research Design 15
4 Empirical Results 22
4.1 Descriptive Statistics 22
4.2 Regression results for Main Tests 25
4.3 The Impact of Litigation Risk on Substitute Trading 26
4.4 The Impact of Information Asymmetry on Substitute Trading 29
4.5 Additional Tests 30
5 Conclusion 34
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