The Governance Effect of the Media's News Dissemination Role: Evidence from Insider Trading

Using a comprehensive data set of corporate and insider news coverage for the 2001–2012 period, the authors show that the media reduces insiders’ future trading profits by disseminating news on prior insiders’ trades available from regulatory filings.

They find support for three economic mechanisms underlying the disciplining effect of news dissemination:

• The reduction of information asymmetry
• Concerns regarding litigation risk
• The impact on insiders’ personal wealth and reputation

Their findings provide new insights into the real effect of news dissemination.

Evidence from Insider Trading - White Paper's Guideline

• Introduction
• Hypothesis Development
• Research Design
• Results
Abstract
We investigate whether the media plays a role in corporate governance by disseminating news. Using a comprehensive data set of corporate and insider news coverage for the 2001–2012 period, we show that the media reduces insiders’ future trading profits by disseminating news on prior insiders’ trades available from regulatory filings. We find support for three economic mechanisms underlying the disciplining effect of news dissemination: the reduction of information asymmetry, concerns regarding litigation risk, and the impact.

Introduction

That the media plays a role in corporate governance is well known.1 What is less clear is how the governance effect of the media works. Existing evidence supports the notion that the media disciplines managers by creating content that exposes governance problems (Miller [2006], Dyck, Volchkova, and Zingales [2008]). We use evidence from a large sample of insider trading filings to investigate whether the media’s news dissemination role directly affects governance.

The SEC requires insiders to report their trading activities on Form 4 filings, which are typically disseminated through the media.2 This setting provides us with a useful opportunity to examine the effect of the media’s dissemination role on corporate governance, and specifically in restricting insiders’ trading profits. Since news dissemination increases the breadth of coverage and the attention of investors through repetition (Fang and Peress [2009], Bushee et al. [2010], Blankespoor, Miller, and White [2014], Peress [2014]), we conjecture that the media reduces the profitability of insiders’ future transactions by disseminating regulatory releases of prior insider trading activities. We call this view, which forms our main hypothesis, disciplining via dissemination.

Our main hypothesis is based on three mechanisms. First, by disseminating news on prior insider trades, insiders’ information advantage is reduced and prices adjust more quickly to the news (Bushee et al. [2010], Tetlock [2010]), directly reducing the profitability of future insiders’ trades. We refer to this attenuation effect of the media on insiders’ profits as the information asymmetry channel. Second, recent studies show that litigation can restrict and punish insiders’ opportunistic behavior, especially their selling activities (Cheng, Huang, and Li [2013], Billings and Cedergren [2015]).

Therefore, because of concerns regarding litigation risk, insiders in firms in the media spotlight avoid opportunistic trading strategies and thereby earn reduced profits. We refer to this effect of news coverage as the litigation risk channel. Third, since the dissemination of insider trading news can adversely affect executives’ personal wealth and reputation (Dyck, Volchkova, and Zingales [2008]), we expect that the disciplining effect of news is more pronounced when executives have a greater amount of personal capital tied to firms. We refer to this mechanism as the capital-at-risk channel.

We examine our hypotheses using more than 1.375 million trades by U.S. corporate insiders from Thomson Reuters. Corporate news coverage data from RavenPack provide us with the number of Dow Jones news releases that are associated with the insiders’ firms. Following Jagolinzer, Larcker, and Taylor [2011], we compute insiders’ profits as the alpha earned during the 180-day window after an insider’s buy or sell transaction. We investigate whether insiders consistently earn future abnormal profits when they face news coverage on their prior trades. Our examination is similar to recent studies of corporate activities conditional on prior media coverage (e.g., Core, Guay, and Larcker [2008], Kuhnen and Niessen [2012] on executive compensation; Braggion and Giannetti [2013] on limited voting shares). Consistent with our disciplining via dissemination hypothesis, we find a negative association between insiders’ future trading profits and news coverage of regulatory releases of insiders’ prior trading activities.

Next, we find evidence suggesting that our disciplining via dissemination hypothesis operates through three economic channels, namely, information asymmetry, litigation risk, and capital-at-risk. First, we show that news coverage is more effective in attenuating insiders’ profits in firms with higher analyst forecast dispersion and in firms that are not audited by Big N auditors. Second, we adopt Kim and Skinner’s [2012] litigation risk measure and find that the effect of news coverage is more pronounced in firms that face higher litigation risk. Finally, we find that the relation between insiders’ trading profits and news coverage is magnified when insiders’ personal capital, proxied by executives’ equity-based compensation and the strength of firms’ corporate social responsibility (Gao, Lisic, and Zhang [2014]), is more closely tied to firms.

In additional tests, we provide evidence in support of our main findings. First, the negative effect of news coverage on insiders’ trading profits operates by reducing trading profits instead of increasing trading losses. Second, to rule out the possibility that the media engages in information creation rather than mere news dissemination, we show that initial news coverage alone does not have a significant influence on insiders’ trading profits. Third, news coverage significantly reduces the incidence of abnormal insider trading activities and transactions executed around earnings announcements. Finally, using both instrumental variable (IV) and natural experiment approaches, our endogeneity analysis suggests that news dissemination has a causal disciplining effect on insiders’ trading profits.

Our paper is among the first to link news coverage with insider trading. Frankel and Li [2004] examine the effect of financial statement informativeness, analyst following, and company news on insiders’ profits and frequency. The authors find a nonsignificant relation between a firm’s general news coverage (e.g., new product announcements), which is used as an alternative variable to proxy for a firm’s information environment, and its insiders’ profits. Instead of focusing on firms’ general news coverage, our study examines the dissemination effect of insider trading-related news and shows that such news coverage does play a governance role in restraining insiders’ trading profits.

More broadly, our paper contributes to the literature on the corporate governance role of the media. The literature recognizes the role of the news media in bringing governance issues to the attention of...

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