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Insider trading—buying and selling shares based on non-public information—can threaten the equilibrium of the stock market by giving some traders an advantage over others. Although the term “insider trading” often carries the implication of illegal activity, top managers can legally trade company stock if they report their trades to the authorities in a timely manner. As they have access to valuable non-public information, their trades are, on average, informed. To decipher the trading activity of these special “corporate insiders,” HKUST’s Abhiroop Mukherjee and colleagues focus on the ripple effects of their trades in the U.S. stock market. Their findings may change how we understand and regulate future corporate insider trading.

As the researchers point out, inside information goes beyond internal memos and advance notice of important deals. Corporate insiders may also provide information indirectly, through their conversations with brokers when requesting trades. For example, an astute broker may notice vocal cues signaling bad news, or she might infer from an unexplained international call that a particular acquisition is moving forward.

Alternatively, an insider might indicate that a particular trade is not motivated by inside knowledge. He might mention plans to “purchase some asset, like a house or a yacht,” say the researchers, or remark that a particular trade will be the first in a sequence of regular trades. Again, the broker privy to this information knows something that other brokers do not: she knows that the trade is not relevant to the state of the company. Outside actors, in contrast, may assume that the trade is based on inside information and revise their opinion of the stock accordingly.

Prior to this study, it was assumed that any information advantage would evaporate quickly after the trade in question had been made public. It was also unclear what brokers did with the inside information they obtained. To examine these issues, the research team created a database that covered 591,715 legal trades made by insiders at 11,380 firms. They drew the information from Form 144, a document that inside traders use to declare their trades and render them legal. Using two publicly available databases, the researchers linked the trades to the brokers who had executed them and then linked the brokers to their analyst and mutual fund manager colleagues, seeking to determine whether insider information affected the decisions made downstream.

By applying advanced modeling techniques that allowed them to pinpoint specific effects and rule out alternative explanations, the researchers revealed that “brokers’ information advantage is more pervasive than previously believed: it is substantial and long-lived, lasting well beyond mandatory trade disclosure.” They also found that analysts and fund managers who are affiliated with inside brokers enjoy significant advantages. Following an insider trade, the forecasts of affiliated analysts were 10.5% more accurate than those of non-affiliated analysts. The researchers also found evidence that insider information is communicated in the context of long-term, currently active working relationships in which the broker and analyst or manager work in the same location.

Finally, the research team found that analysts and fund managers tend to draw on inside information when they are feeling less confident—for example, when they have less job experience or when the future of a company is hard to predict. This nuanced understanding of corporate insider trading may help us to craft more targeted regulatory measures that further level the playing field between insiders and the rest of the market.