{"id":852,"date":"2021-09-28T13:16:04","date_gmt":"2021-09-28T12:16:04","guid":{"rendered":"https:\/\/blogs.bath.ac.uk\/business-and-society\/?p=852"},"modified":"2021-09-28T13:16:04","modified_gmt":"2021-09-28T12:16:04","slug":"cgris-stories-the-impact-of-strategic-insider-trading","status":"publish","type":"post","link":"https:\/\/blogs.bath.ac.uk\/business-and-society\/2021\/09\/28\/cgris-stories-the-impact-of-strategic-insider-trading\/","title":{"rendered":"CGRIS Stories: The impact of strategic insider trading"},"content":{"rendered":"

Throughout the month of\u00a0September\u00a0we will hear about the work being done by the members of the\u00a0<\/em>Centre for Governance, Regulation and Industrial Strategy<\/em><\/a>.\u00a0Here\u00a0<\/em>Hanwen\u00a0Sun<\/em><\/a> presents the findings of her recent research, which explores how corporate insiders strategically trade their shares in response to the presence of short sellers<\/em>.<\/p>\n

My recent paper set out to explore how corporate insiders alter their trading strategies when seeing short sellers actively\u00a0exploit\u00a0trading opportunities from insider sales.<\/p>\n

By corporate insiders, we generally refer to the officers, directors or substantial shareholders of a company. Corporate insiders are legally permitted to buy and sell shares of the firm and any subsidiaries that employ them once their transactions are not utilizing non-public material information. However, a class of information events that is especially difficult to decipher is the trading activity of corporate insiders. It is widely recognized that these people have superior \u2018information advantage\u2019 compared to other stakeholders and their trades generally incur abnormal returns and profits. However, they now face unprecedented challenges in their monopoly of private information, given the fierce competition from the surge of sophisticated investors like short sellers.<\/p>\n

One reason for this is that the trades placed by insiders generate \u2018order flows\u2019 into the financial market. In simple terms an order flow is the number of orders (or trades) that are waiting to be executed at a certain price level. This affects the price of the stock because if there are more buyers than sellers the price goes up, and if there are more sellers than buyers the price goes down. If you are watching the order flow, you can predict future price movements. Sophisticated investors who employ an \u2018order flow trading strategy\u2019<\/a> serve as competition for the insiders, as it piggybacks on the insiders\u2019 information advantage. Short selling is a key part of this trading strategy \u2013 if an investor bets that a stock is going to go down then they can borrow it and sell it on the open market, and then buy it back later for less money. Indeed, a\u00a0growing strand of literature documents that short sellers learn from insiders\u2019 order flows and trade accordingly for profit.<\/a>\u00a0These challenges force insiders to develop more strategic and dynamic trading approaches to stay profitable.<\/p>\n

Understanding the interactions between insiders and short sellers\u00a0<\/strong><\/p>\n

We developed a model looking at the relationship between the trading strategies of corporate insiders and short sellers, to understand how the former responds to the latter\u2019s activities.<\/p>\n

Our model predicts that insiders tend to adopt a cautious trading strategy (aka splitting their trades over time and reducing initial sales) when they see that short sellers are using order flows to predict trading patterns, in order to disguise their order flows and prevent these tactics.<\/p>\n

Empirically, we identified cautious trading by tracking consecutive transactions at the insider-strategy level. We find that, when anticipating intensive short selling potential:<\/p>\n