Author: Tong, Chak Wai Wilson
Title: Can insider trading activities and board independence affect company performance? : a study of Hong Kong market
Advisors: Cheng, Louis (AF)
Degree: D.B.A.
Year: 2013
Subject: Insider trading in securities -- China -- Hong Kong
Stocks -- Prices -- China -- Hong Kong.
Hong Kong Polytechnic University -- Dissertations
Department: Faculty of Business
Pages: 113 leaves ; 30 cm
Language: English
Abstract: Over the past few decades, there has been strong demand from governments, regulators, investors, scholars and the general public to impose stricter rules and regulations on stock markets. Such impositions work to a certain extent, but they also impose huge monitoring costs on markets. The opponents of regulation then criticize the adverse impact of the heavy-handed governance system. Recent global financial crises have highlighted the importance of corporate governance. The general public usually believes that better monitoring can prevent actions that lead to the crisis. Therefore, regulators are commonly blamed for failing to effectively monitor companies that hurt people's interests. In the past two decades, many significant measures and reforms have been applied to tighten controls on companies. One of these reform areas has concerned the independence of boards.The general understanding is that increased board independence leads to more effective board monitoring. However, even with the stricter rules there is still misconduct by the boards of collapsed companies. Such failures to prevent misconduct suggest that imposing stricter rules is not efficient enough to improve corporate governance. By linking agency theory and the efficient market hypothesis, this study investigates the relationship between insider trading activities (ITAs) and company performance as well as the monitoring effect of INEDs on ITAs, which further reveal the impact of INEDs' effect upon company performance based on the findings of the former relationship between ITAs and company performance. The study aims to test whether insider trading activities and good corporate governance can co-exist, and whether insider trading is actually a win-win solution for all parties.Insider trading is a popular research area in business with most studies focus on ethical measures. In the common sense, ITAs are interpreted as culpable behaviors. Nevertheless, there is not a clear way to quantify the negative effects or damage caused by such insider trading activities.While in the finance literature, most researchers draw a different conclusion. They find that even though insiders exploit abnormal returns through ITAs, such profits won't necessarily become a negative signal in the market. To the certain extent, ITAs serve as a positive signal to minority shareholders who can take a free ride and make some profits as well by following insiders' trading strategy. In this regard, ITAs can reduce transaction costs and make the market more efficient. My first research question concerns the effect of ITAs on company performance. Market performance is usually measured in terms of annual returns, abnormal returns, and market-to-book ratio ("MB"). Financial performance is generally measured in terms of earnings per share ("EPS"), dividends per share ("DPS"), return on assets ("ROA"), and return on equity ("ROE"). If companies involved in insider trading perform better and bring higher returns to shareholders, then shareholders may not overly oppose to ITAs. Shareholders can benefit from better performance due to ITAs, even though they cannot make the same abnormal returns as made by insiders. In other words, if ITAs improve profitability, shareholders are rewarded with additional dividends, share price returns and liquidity. Under such circumstances, ITAs may provide a win-win situation in the capital market.
My findings indicate that insider trading does help companies to perform better. In the subsequent investigation, I separate ITAs into buying and selling trades and find that company performance is improved by selling ITAs, but not by buying ITAs. This result strongly suggests that those insiders do not trade on superior information which is not revealed to all shareholders. If the information asymmetry problems were serious, the company performance should go in the opposite direction. Companies would perform worse when insiders sell, and perform better when they buy. The results, however, show that companies do perform better when insiders sell. One possible explanation for this finding is that insiders cannot sell all of their shares at once. Companies may grant free shares and stock options to insiders periodically (usually once or twice a year). The awarded shares and stock options are always provided with lock-up periods and vesting periods. Thus, insiders need to continuously perform in order to maximize their benefits from the awarded shares and stock options. They have to ensure that the company performance is improving for the sake of their future share sales. Another possible explanation is that insiders need to be better rewarded during years of good company performance. When insiders buy shares, however, their companies may not perform better. Again, this result is an indication of non-asymmetry in trader information. One possible reason for this low performance is that insiders buy shares for their own investments, but not as an abnormal profit-taking activity.My second research question is whether company performance can improve for companies that have both ITAs and a higher percentage of independent non-executive directors (INEDs). Building on test results of the first research question, which show that companies can perform better with ITAs, I further investigate how an increased percentage of INEDs affects company performance, and what the combined effect of these factors may be. The results of second investigation indicate that companies perform better when their ITAs are sales, and when their percentage of INEDs is high.These results are consistent with those concerning the first research question,i.e.,selling ITAs tends to improve company performance.In order to investigate the correlation between board independence and ITAs, I examine the effect of a higher percentage of INEDs on the likelihood of ITAs. Although the board independence is usually measured as the number of INEDs, I consider the percentage of INEDs to be a more accurate measure. The general conclusion from the finance literature is that a higher percentage of INEDs can reduce the likelihood of ITAs.My findings, however, do not support the findings of finance literature that an increased percentage of INEDs decrease the likelihood of ITAs. The result shows no significant correlation between the percentage of INEDs and the likelihood of ITAs. Assuming the presence of ITAs, when further differentiate ITAs with buying and selling trades, this study finds that the probability of buying ITAs is higher than that of selling ITAs when the percentage of INEDs increases. One possible explanation for this result is that it is more difficult to get approval from a board of directors for selling ITAs. Other directors (especially INEDs) may question why insiders want to sell their shares. The directors show an opposite tendency when insiders want to buy the company's shares.
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Access: restricted access

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