Informed Trading in Regulated Industries David M. Reeb, Yuzhao Zhang and Wanli Zhao Discussion by Ko-Chia Yu Shanghai University of Finance and Economics 2012 NTU ICF

The bigger picture  Why do governments regulate?  To gain control over a certain strategically important sector.  Shareholder protection  Monitoring of wrong doing of corporate insiders  Limit the information leakage of the insiders

The bigger picture  Summary of the results:  The very act of governmental intervention might lead to more passages for informational leakage.  Additional “insiders” are generated in the monitoring process. Regulators

Summary of Findings  A very long list of evidence that includes:  Potential avenues for informed trading  Short-sales  Equity sales and/or purchases  Option market  Potential informational leakage events  Abnormal short-sales before earning shocks  Natural Experiments  1978 Airline deregulation  1980 Trucking deregulation  1999 Gramm-Leach-Bliley Act (again a deregulation, banking industry)

Summary of Findings  Identification of the channels (Bank industry)  Timing of informational flows  Call report to the regulators by the end of every calendar quarter  Gone public 40 days later  Reaction in the first 20 days of the reports  Federal vs. State supervision  Duplicity increases informed trading.  Political integrity  Interaction between corruption index and supervision

Overall Impression  Very comprehensive and well structured  Convincing and very interesting natural experiments results  Many different takeaways and possible interpretations of the results  Highly unlikely for me to pick up any significant flaw to the contents of the arguments

Potential Avenues for Informed Trading  Alternative interpretations of the results  Regulation provides another channel of information leakage thus generate more “pseudo-insiders.”  Do they mitigate the extent of trading from the true insiders?  “Opportunistic trade” variable from Cohen et. al (2010) is included  It is still interesting to see how insider trading interacts with the regulator-insider trading

Potential Avenues for Informed Trading  Steele (1989) model: information leakage as the square of the number of people who have access to the information  Would the results (the mass data sample on short-sales, equity and the option markets)be driven by the fact that these industries (finance, utilities, and pharmaceuticals) consist of more people with valuable insider information about the industry?  E.g. A pharmaceutical researcher will likely have the same information (possibly better information) than an analyst studying on the firm.  Suggestion: average employee salary (NBER data)

Potential Avenues for Informed Trading  Short-sale market  Predictability is significantly better for regulated industries than non-regulated industries  However it is not clear that this predictability can be attributed to informed traders or liquidity providers (opportunistic or not).  Diether et al (2007): reversal  Short-sale constraints  Non-transient institutional ownership, index fund ownership (Bushee 1998, among others)

Potential Avenues for Informed Trading  Equity market  Adjusted-PIN  Liquidity-PS is controlled.  The asymmetric information part of PIN as in Duarte and Young (2009)

Other comments  What about other regulatory changes?  Other supervised firms?  Telecomm?  Supervision and regulation (more supervision than regulation, but it is the regulator who conducts the regulatory supervision)  Cost of getting caught seems to be low. (?)

Minor Issues  Table 6 “Regulatory duplicity” got truncated  Punctuation: “Although, …” in several places  Table 9  Citation update: Adams, R. B., & Ferreira, D. (2012). Regulatory pressure and bank directors’ incentives to attend board meetings. International Review of Finance, 12(2),

Conclusion  The research has a different takeaway for different people.  I really do enjoy reading the paper.  Good luck to the authors!