INFORMATION ASYMMETRY AND INSIDER TRADING IN INDIAN EQUITY MARKET Mohammed Iqbal M & Dr. Shijin Santhakumar Department of Commerce School of Management Pondicherry Universit y

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 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 = [(P 1 – P 0 ) + D]/P 0 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 Company PurchaseSales Aggregate trade - month Profitable trade - month Un profitable trade - monthTotal trade - month Un profitable trade - month Profitable trade - month Total trade - month Aarti Drugs Astra Microvave India Infoline Khandwala Sec Mindtree Navbharat Vent NCC Ltd Raymond Sughjith Starch Usha Martin TOTAL

MID CAP - INSIDER TRADE PROFITABILITY Company PurchaseSales Aggregate trade - month Profitable trade - month Un profitable trade - month Total trade - month Un profitable trade - month Profitable trade - month Total trade - month Adani Power Bajaj Holdings Corromondal Intl Dabar India DLF India Glenmark Pharma GMR Infra IndusInd Bank JP Associates Jindal Steel JSW Steel Jubilant foods Marico ltd Mphasis Oracle Fin Serv Piramal Ent Power Finance Shriram Transport TATA Steel YES Bank TOTAL

LARGE CAP - INSIDER TRADE PROFITABILITY Company PurchaseSales Aggregate trade - month Profitable trade – month Un profitable trade - month Total trade - month Un profitable trade - month Profitable trade - month Total trade - month Asian Paints Axis Bank Bharti Airtel Cipla HDFC Bank Hero Moto Corp Idea Cellular Infosys ITC LTD Kotak Mahindra L&T Lupin M&M Reliance Ind TATA Motors TOTAL

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

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–

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