INFORMATION ASYMMETRY AND INSIDER TRADING IN INDIAN EQUITY MARKET

Mohammed Iqbal M & Dr. Shijin Santhakumar

Department of Commerce

School of Management

Pondicherry University

INTRODUCTION

• Insider trading convictions in developed and developing economies.Reliance Industries 2008 – 11 crore fine

Raj Rajaretnam in 2011– 600 crore

Rajat Gupta (2011) -130 crore

Mathew Marthoma in 2014 -2000 crore

• Powered by undisclosed price sensitive insider information.

• Raise question about the trustworthiness and effectiveness of legal framework and the market as a whole

INFORMATION ASYMMETRY

• A state of disparity between Insiders and Outsiders in possession of information. He et. al (2011)

• It can’t be eliminated! It can only be reduced and check illegal usage. Aboody and Lev (2000)

• Insider trading backed by undisclosed price sensitive information is a by product of information asymmetry. Frankel and Li (2004)

• It is difficult to identify an illegal insider trade. Frankel and Li (2004)

REVIEW OF LITERATURE

• Information asymmetry affects the trustworthiness of market. Akerlof (1970)

• Informational superiority of insiders for market gains. Seyhun (1986), Seyhun (1992), Ke et, al,

(2003), Frankel and Li (2004) and Cohen et, al, (2012

• Core insider trades are excessively profitable. Frankel and Li(2004)

• Analyst follow up, media coverage and R&D investment are contributing to high

information asymmetry. Frankel and Li (2004)

REVIEW OF LITERATURE

• Insider trading profits are reaped around six months after the trade with highest profitability for core insiders. Seyhun (1998)

• Legal frameworks are a failure in checking the abnormal profitability of insider trade in US. Seyhun (1992)

• 7% of total insider trades are excessively rewarded in the US market. Seyhun (1992)

DATA AND VARIABLES

• Insider’s trading dates, No of insider trades.

• Dividend adjusted buy and hold return.

• Book value, market cap, market return and 3M T-bill rate for calculation of Fama

& French factors.

• Analysis ranges from January 2005 to December 2013

• Data collected from Bloomberg.

METHODOLOGY

• Profitability of insider trading – proxy for information asymmetry. Frankel and Li (2004)

• Six month trade window. Seyhun (1998)

• Comparison of time-specific common expected return with actual insider return. Frankel and Li (2004)

• Dividend adjusted buy & hold return = [(P1 – P0) + D]/P0

• Fama and French(1993) model to calculate expected return.

[R = Rf + β(Rm – Rf) + βHML + βSMB]

METHODOLOGY

• Portfolios created – SL/SM/SH/BL/BM/BH Fama and French (1993)

• All insiders were included. Based on SEBI definition

• Profitable insider trades. Frankel and Li (2004)

For Purchase:- Actual insider return is higher than common expected return.For Sales:- Common expected return is higher than actual insider return.

• Insider trading trend of a month was decided based on Net purchase. Frankel and Li (2004)

Net purchase = Total number of insider purchase - Total number of insider sales.

RESULTS: SMALL CAP - INSIDER TRADE PROFITABILITY

CompanyPurchase Sales

Aggregate trade - month

Profitable trade -month

Un profitable trade - month Total trade - month

Un profitable trade - month

Profitable trade - month

Total trade - month

Aarti Drugs 29 13 42 0 0 0 42

Astra Microvave 12 11 23 8 6 14 37

India Infoline 12 3 15 24 4 28 43

Khandwala Sec 7 32 39 5 8 13 52

Mindtree 2 7 9 24 22 46 55

Navbharat Vent 16 14 30 6 10 16 46

NCC Ltd 12 0 12 11 2 13 25

Raymond 8 3 11 6 5 11 22

Sughjith Starch 16 16 32 0 0 0 32

Usha Martin 19 8 27 2 1 3 30

TOTAL 133 107 240 86 58 144 384

MID CAP - INSIDER TRADE PROFITABILITY

Company Purchase SalesAggregate

trade - month

Profitable trade - month

Un profitable trade - month

Total trade - month

Un profitable trade - month

Profitable trade - month

Total trade - month

Adani Power 3 4 7 0 0 0 7Bajaj Holdings 3 13 16 2 1 3 19Corromondal Intl 3 3 6 8 9 17 23Dabar India 3 5 8 10 50 60 68DLF India 14 1 15 10 5 15 30Glenmark Pharma 11 12 23 5 9 14 37GMR Infra 13 15 28 0 0 0 28IndusInd Bank 2 0 2 27 0 27 29JP Associates 19 5 24 1 4 5 29Jindal Steel 9 5 14 15 2 17 31JSW Steel 9 1 10 0 0 0 10Jubilant foods 0 0 0 4 14 18 18Marico ltd 4 3 7 4 7 11 18Mphasis 4 14 18 4 5 9 27Oracle Fin Serv 1 4 5 14 33 47 52Piramal Ent 2 5 7 11 26 37 44Power Finance 2 2 4 5 0 5 9Shriram Transport 5 9 14 4 3 7 21TATA Steel 9 0 9 4 0 4 13YES Bank 10 2 12 7 2 9 21TOTAL 126 103 229 135 170 305 534

LARGE CAP - INSIDER TRADE PROFITABILITY

Company Purchase SalesAggregate

trade - month

Profitable trade – month

Un profitable trade - month

Total trade - month

Un profitable trade - month

Profitable trade - month

Total trade - month

Asian Paints 17 2 19 10 8 18 37

Axis Bank 8 2 10 20 6 26 36

Bharti Airtel 2 9 11 1 14 15 26

Cipla 0 9 9 1 3 4 13

HDFC Bank 2 1 3 21 26 47 50

Hero Moto Corp 2 4 6 1 1 2 8

Idea Cellular 2 3 5 9 3 12 17

Infosys 0 2 2 4 10 14 16

ITC LTD 1 2 3 6 59 65 68

Kotak Mahindra 14 2 16 55 8 63 79

L&T 6 1 7 21 6 27 34

Lupin 9 13 22 16 42 58 80

M&M 16 22 38 4 1 5 43

Reliance Ind 2 9 11 5 5 10 21

TATA Motors 9 1 10 10 0 10 20

TOTAL 90 82 172 184 192 376 548

THE STATE OF INFORMATION ASYMMETRY IN INDIA

• The level of information asymmetry in India proxied by profitability of insider trade is alarmingly vulnerable.

• Mid cap companies followed by large cap and small cap companies are mostly affected by the problem of information asymmetry.

Size of Companies Excess profit firm-months for Purchase

Excess profit firm-months for Sale

Excess profit firm-months in Aggregate

Small Cap 55.42% 40.28% 49.74%

Mid Cap 55.02% 55.74% 55.43%

Large Cap 52.33% 51.06% 51.46%

Total Companies 54.25% 49.02% 52.46%

SUMMARY RESULT

SC MC LC0

100

200

300

400

500

600

PROFITABLE TRADE TOTAL TRADE

CONCLUSION

• Evidence shows that level of information asymmetry in Indian equity market is very high.

• About 52.46% of insider trade firm-months are excessively profitable.

• Purchase insider transactions are more profitable than sales insider transactions.

• Mid cap companies followed by large cap and small cap companies are very vulnerable to this market imperfection.

• It also points to the deficiency of the existing legal frame work and need for strong and effective laws.

Bibliography• Aboody, D., & Lev, B. (2000), Information Asymmetry, R&D, and Insider Gains, The Journal of Finance, LV(6): 2747–2766.

• Cohen, L., Malloy, C., & Pomorski, L. (2012), Decoding Inside Information, The Journal of Finance, LXVII(3): 1009–1043.

• Fama, E. F., & French, K. R. (1993), Common Risk Factors in the Returns on Stocks and Bonds, Journal of Financial Economics, 33(1): 3–56.

• Frankel, R., & Li, X. (2004), Characteristics of a Firm’s Information Environment and the Information Asymmetry between Insiders and Outsiders, Journal of Accounting and Economics, 37(2): 229–259.

• He, Y., Wang, J., & Wei, K. (2011), Do Bond Rating Changes Affect the Information Asymmetry of Stock Trading, Journal of Empirical Finance, 18(1): 103–116.

• Knill, A., Minnick, K., & Nejadmalayeri, A. (2012), Experience, Information Asymmetry, and Rational Forecast Bias, Review of Quantitative Finance and Accounting, 39(2): 241–272.

• Seyhun, H. N. (1986), Insiders’ Profits, Costs of Trading, And Market Efficiency, Journal of Financial Economics, 16(2): 189–212.

• Seyhun, H. N. (1992), The Effectiveness of the Insider-Trading Sanctions, Journal of Law and Economics, 35(1): 149–182.

• Tetlock, P. (2007), Giving Content to Investor Sentiment: The Role of Media in the Stock Market, The Journal of Finance, LXII(3): 1139–1168..

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