Focus on Research
Penn State Intercom......May 23, 2002

Insider trading disclosures
could lower trading costs

By Steve Infanti
The Smeal College of Business RESEARCH_Huddart

Allegations of accounting irregularities and insider trading underlie the lion's share of federal securities law class-action litigation, and there is a growing chorus for a change in regulations governing insider trading and disclosure.

A University accounting professor co-authored some recent research that offers insights into the effects changing public disclosure regulations may have on insider trading and the market.

"Generally speaking, under the current Securities and Exchange Commission regulations, people don't find out a CEO or other insiders have traded until after the trade. We model what would happen if insiders were required to disclose that they were going to trade, not that they had traded," explained Steven J. Huddart, associate professor of accounting. University of California at Los Angeles' professors John Hughes and Michael Williams co-authored the research.

Huddart noted that shareholder class-action suits are commonly filed in the wake of insider selling ahead of a stock price drop. Typically, these lawsuits allege that top executives sold their over-valued stockholdings at the same time that they misled investors with overstated or opaque accounting reports.

The study models the effects of (1) a requirement that insiders disclose their intention to trade and (2) more stringent financial reporting standards. Both types of rule changes serve to remove insiders' information advantage and reduce trading costs, but the study also shows how these rule changes can interact in surprising ways.

"One consequence of more stringent financial reporting standards is the reduction of trading costs for all traders because price adjustments to the order flow become smaller. Another consequence is a reduction in insiders' information advantage and their ability to profit at the expense of other traders," Huddart said. "A further consequence is the additional risk that insiders and other traders must bear from the inability to trade before the price adjustment to information contained in those financial reports is complete."

The relative magnitude of these three effects depends on the liquidity of the market for the firm's stock. At one extreme, Huddart explained, for highly liquid stocks, trading costs will be low and the promise of gains from trading on private information is likely to override all else causing, as conventional wisdom suggests, insiders to favor less stringent financial reporting standards.

"At the other extreme, for thinly traded stocks, where insiders' trades are stripped of their disguise, insiders may favor greater public disclosure," Huddart said.

Mandating that insiders disclose the intention to trade ahead of their actual trades has the effect of making a stock appear thinly traded from the insider's perspective. Accordingly, changing rules that govern insider trading can affect executives' attitudes toward new financial reporting standards in potentially beneficial ways.

Huddart notes that insiders routinely trade stock in their firms for reasons other than the exploitation of their information advantage, such as to rebalance portfolios, manage taxes or undertake estate planning. If market makers were sure that an insider's motive for trading was unrelated to private information, then the stock price would be unaffected by the trade.

"However, in the more likely case that market makers cannot distinguish why insiders are trading, market makers adjust the stock price based on the order flow, thereby imposing trading costs on all traders, including insiders. In turn, these trading costs prompt insiders to distort their trades," Huddart explained.

Steve Infanti can be reached at smi3@psu.edu.

 

Dan Welch will head new cancer
partnership with several research groups

A group of national research institutions have announced the formation of a new partnership with the basic goal of finding out what causes cancer to metastasize or spread -- and how the spread of cancer to the bones of an individual can be prevented.

The College of Medicine, the University of Chicago and the National Foundation for Cancer Research (NFCR) have announced the creation of a new national cancer research center. Center researchers will work to identify the fundamental molecular changes in cancer cells that cause them to metastasize and translate those basic findings into strategies to prevent metastasis and better treat patients who have metastatic cancer.

The center will be linked with seven other centers around the world to share collaborative information to help cure cancer.

Dan Welch of the Jake Gittlen Cancer Research Institute at the Hershey Medical Center was named director of the NFCR Center for Metastatic Cancer Research at Milton S. Hershey Medical Center/College of Medicine. Welch is widely credited with identifying several genes that block metastasis in breast cancer and melanoma. One gene, called breast cancer metastasis suppressor, could be a key to preventing the growth of cancerous tumors when they escape from the original tumor.

The team of investigators will focus on the most difficult and challenging problems related to metastasis using state-of-the-art methodology and interactive collaboration.

Web site, course
help dairy farmers cow

Pennsylvania ranks in the top third of America's milk producers, but, according to Ken Bailey, associate professor of dairy markets and policy, new business education programs for dairy farmers could have a positive impact on the Commonwealth's dairy industry.

"We are in a new environment where it's either boom or bust for dairy farmers," Bailey said. "One year you're going to make a lot of money and, the next year, you're going to lose all the money you made the year before. Farmers need to know how milk is priced, and they need to understand how the futures market works."

Through the Cooperative Extension's Dairy Options Pilot Program, Bailey is teaching Pennsylvania's dairy farmers to take advantage of federal policies that allow farmers to buy into the futures market and lock into high milk prices.

Bailey developed and implemented a training program for Co operative Extension agents in 25 counties. The agents then deliver a four-hour course to local farmers, teaching them how to use futures trading to survive fluctuations in the milk market and keep their farms solvent. Bailey also maintains a weekly dairy market report online at http://dairyoutlook.aers.psu.edu/.

For more of this story, visit http://www.outreach.psu.edu/News.

Scholar awarded
$300,000 for study

Sean Reardon, assistant professor of education, was named a W.T. Grant Scholar and awarded $300,000 to pursue his research.

The funding from the William T. Grant Foundation will allow Reardon five years for his study, "Adolescence to Adulthood in Chicago Neighborhoods." The study will investigate the neighborhoods' effects on the timing and trajectories of adolescent behaviors, including substance use, crime, sexual activity and educational attainment.

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