Informed trading before positive vs. negative earnings surprises

This paper investigates whether institutional investors trade profitably around the announcements of positive or negative earnings surprises. Using Korean data over the period of 2001–2010, we find that information asymmetry is larger before negative earnings surprises (earnings shock) among investors and that the trading volume decreases only before earnings shock announcements due to the severe information asymmetry. We also find that institutions sell their stocks prior to earnings shock announcements whereas individual and foreign investors do not anticipate bad news. Finally, we find that institutional trade imbalance is positively related to the post-announcement abnormal returns of negative events. This study complements and extends prior literature on informed trading around earnings announcements by documenting evidence that domestic institutions exploit their superior information around particularly earnings shock announcements.     

Institutional stakeholdings and better-informed traders at earnings announcements

Utama and Cready [Utama, S., Cready, W.M., 1997. Institutional ownership, differential predisclosure precision and trading volume at announcement dates. Journal of Accounting and Economics 24, 129–150] use total institutional ownership to proxy for the proportion of better-informed traders, an important determinant of trading around earnings announcements. We argue that institutions holding small stakes cannot justify the fixed cost of developing private predisclosure information. Also, institutions with large stakes generally do not trade around earnings announcements since they are dedicated investors or face regulations that make informed trading difficult. However, institutions holding medium stakes have incentives to develop private predisclosure information and trade on it; we show that their ownership is a finer proxy for the proportion of better-informed traders at earnings announcements.     

Who Trades Around Earnings Announcements? Evidence from TORQ Data

Abstract:  Using TORQ database we investigate the intra-day trading volume reactions to earnings announcements of five trader groups, individuals, institutions, exchange members, program traders, and specialists. The results of this study indicate that institutions are most active in the immediate aftermath of an announcement. Individual investors are slow at the beginning but accumulate heavy volume afterwards and exceed institutional trading volume. We find support for Harris and Raviv (1993) and Admati and Pfleiderer (1988) , who respectively argue that divergence of opinion about a public information and portfolio rebalancing cause surges in pre- and post-announcement trading volume. Further we find evidence of swift and aggressive trading by informed and sophisticated institutions in the immediate aftermath of the announcement, and delayed, aggressive trading volume 'overreaction' by 'slow' and 'overconfident' individual investors as documented by Barber and Odean (2000 and 2002) and Daniel et al. (1998) . NYSE specialists provide the bulk of the liquidity needs around earnings announcements.     

Local institutional investors,information asymmetries,and equity returns

We examine the informational role of geographically proximate institutions in stock markets. We find that both the level of and change in local institutional ownership predict future stock returns, particularly for firms with high information asymmetry; in contrast, such predictive abilities are relatively weak for nonlocal institutional ownership. The local advantage is especially evident for local investment advisors, high local ownership institutions, and high local turnover institutions. We also find that the stocks that local institutional investors hold (trade) earn higher excess returns around future earnings announcements than those that nonlocal institutional investors hold (trade).     

Does Shareholder Composition Matter? Evidence from the Market Reaction to Corporate Earnings Announcements

We examine whether institutional ownership composition is related to parameters of the market reaction to negative earnings announcements. When firms report earnings below analysts' expectations, the stock price response is more negative for firms with higher levels of ownership by momentum or aggressive growth investors. There is no evidence, however, that these institutions cause an “overreaction” to earnings news. Ownership structure is also related to trading volume and to stock price volatility on days around earnings announcements. Our findings are consistent with the idea that the composition of institutional shareholders effects stock price behavior around the release of corporate information.     

Institutional Investors and Shareholder Litigation

We examine whether institutional investors are able to avoid future litigation. Our results show that institutions provide a fiduciary role by decreasing or eliminating their positions in sued firms well before litigation begins. We also find that institutional groups with high monitoring ability (independent investment advisors and mutual funds) are more proactive in their trading behavior than are institutions with low monitoring ability (banks, insurance companies, and unclassified institutions such as endowments, foundations, and self-managed pension funds). We find that percentage changes in institutional ownership are correlated with public information available more than two quarters before litigation.     

Management Earnings Forecasts,Earnings Announcements,and Institutional Trading in China

Abstract:

In this study, we investigate the trading behavior of institutional investors in China according to management earnings forecasts (MEFs) and earnings announcements (EAs). MEFs are mandatory under the stringent regulatory framework in China. We find evidence that both MEFs and EAs have an effect on the market. However, MEFs have a bigger effect on the market than do EAs. According to a sample of semiannual observations of firms from 2003 to 2008, we find that changes in the stock ownership of institutions are positively associated with EAs but not significantly associated with MEFs. When we further examine the relations between institutional characteristics and trading strategies, we find that growth funds exploit the arbitrage opportunity of MEFs.     

REIT Institutional Ownership Dynamics and the Financial Crisis

Collectively, institutional investors hold large ownership stakes in REITs. The traditional view is that institutions are both long-term and passive investors. The financial crisis beginning in 2007 provides an opportunity to analyze the investment choices of institutional investors before, during, and after the crisis. Our results indicate that institutional ownership increased prior to the financial crisis, declined significantly during the period of market stress, but rebounded after. These results hold for four institutional investor subtypes: mutual funds/investment advisors, bank trusts, insurance companies, and other institutions, with mutual funds/investment advisors and bank trusts most clearly exhibiting this pattern. We also find evidence that institutions actively manage their REIT portfolios, displaying a “flight to quality” after the market downturn by reducing beta and individual risk exposure, and by increasing ownership in larger REITs.     

Do institutional investors destabilize stock prices? evidence from an emerging market

In this paper, we provide empirical evidence on the impact of institutional investors on stock market returns dynamics in Poland. The Polish pension system reform in 1999 and the associated increase in institutional ownership due to the investment activities of pension funds are used as a unique institutional characteristic. We find robust empirical evidence that the increase of institutional ownership has changed the autocorrelation and volatility structure of aggregate stock returns. However, the findings do not support the hypothesis that institutional investors have destabilized stock prices. The results are interpretable in favor of a stabilizing effect on index stock returns induced by institutional trading.     

Voting with their feet: institutional ownership changes around forced CEO turnover

We investigate whether institutional investors “vote with their feet” when dissatisfied with a firm's management by examining changes in equity ownership around forced CEO turnover. We find that aggregate institutional ownership and the number of institutional investors decline in the year prior to forced CEO turnover. However, selling by institutions is far from universal. Overall, there is an increase in shareholdings of individual investors and a decrease in holdings of institutional investors who are more concerned with holding prudent securities, are better informed, or are engaged in momentum trading. Measures of institutional ownership changes are negatively related to the likelihoods of forced CEO turnover and that an executive from outside the firm is appointed CEO.     

Which Institutional Investors Trade Based on Private Information About Earnings and Returns?

Recent work suggests that institutional investors execute profitable trades based on private information about earnings and returns. We provide new evidence on the prevalence and sources of such informed trading by (1) testing for the creation and liquidation of positions based on private information, (2) introducing private information proxies that reflect the size and nature of an institution's position in each portfolio firm, and (3) using a methodology that examines multiple investor characteristics simultaneously at the institution‐firm level. We find that changes in ownership by institutions with large positions in a firm are consistent with informed trading. However, other previously documented proxies for private information produce results more consistent with risk‐based trading (e.g., investment style) or insignificant in the presence of other proxies (e.g., fiduciary type). We also find that informed trading is more prevalent in small firms and when the large positions are taken by investment advisers and large institutions.     

Does governance travel around the world? Evidence from institutional investors

We examine whether institutional investors affect corporate governance by analyzing portfolio holdings of institutions in companies from 23 countries during the period 2003–2008. We find that firm-level governance is positively associated with international institutional investment. Changes in institutional ownership over time positively affect subsequent changes in firm-level governance, but the opposite is not true. Foreign institutions and institutions from countries with strong shareholder protection play a role in promoting governance improvements outside of the U.S. Institutional investors affect not only which corporate governance mechanisms are in place, but also outcomes. Firms with higher institutional ownership are more likely to terminate poorly performing Chief Executive Officers (CEOs) and exhibit improvements in valuation over time. Our results suggest that international portfolio investment by institutional investors promotes good corporate governance practices around the world.     

Heterogeneous institutional investors and CEO compensation

This paper examines the relationship between institutional ownership and executive compensation by taking into account the heterogeneity of institutional investors. The paper finds that ownership by transient institutional investors, who have short investment horizons and active trading, is positively related to the performance sensitivity of option grants for CEOs. However, no significant relationship holds for other types of institutions, including those dedicated institutional investors, who have longer horizon and concentrated holdings. Further tests suggest that the positive relationship between transient institutional ownership and the CEO pay-for-performance sensitivity is not driven by the trading behavior of transient institutional investors when stock performance is good. Instead, the paper documents preference of transient institutional investors for greater performance sensitivity of option grants for CEOs. After using an instrument approach to control for preference and endogeneity, transient institutional ownership is no longer significantly related to the CEO pay-for-performance sensitivity. Additionally, the paper does not find dedicated institutional investors serve a monitoring role in correcting overcompensation paid to CEOs. After controlling for preference and endogeneity, neither the level of salary nor the level of total direct compensation for CEOs is significantly related to dedicated institutional ownership. The findings suggest that on average the influence of institutional investors on CEO compensation occurs indirectly through their preference in line with their different investment types.     

Decomposing the persistence of international equity flows

The portfolio flows of institutional investors are widely known to be persistent. What is less well-known, however, is the source of this persistence. One possibility is the ‘informed trading hypothesis:’ that persistence arises from autocorrelated trades of individual investors who believe they have information about value and who face an imperfectly liquid market. Another possibility is that there are asynchroneities with respect to investment decisions across funds, across investments, or both. These asynchroneities could be due to wealth effects (across investments for a single fund), investor herding (across funds for a single investment), or generalized contagion (across funds and across investments). We use daily data on institutional flows into 21 developed countries by 471 funds to measure and decompose aggregate flow persistence. We find that the informed trading hypothesis explains about 75% of total persistence, and that the remaining amount is attributable entirely to cross-fund own-country persistence. While asynchroneities across funds investing in the same country are important, asynchroneities across countries, either within a given fund, or across funds, are not important. The cross-fund flow lags we identify might result from different fund investment processes, or from some funds mimicking others' decisions. We reject the hypothesis that wealth effects explain persistence.     

Trading patterns of big versus small players in an emerging market: An empirical analysis

This study uses a Vector Autoregressive (VAR) model to examine interdependencies among institutional investors, big individual investors, and small individual investors, and the effects of their trading on stock returns on the Taiwan Stock Exchange (TSE). The results imply that, during the sample period, big individual investors are the most well informed players; their trading affects not only stock returns but also small individual investors. Small individual investors are not well informed and are slow learners. Their orders to trade tend to provide liquidity to institutional and big individual investors, but there is no compensation for their liquidity services. We find that institutional investors follow neither positive-feedback nor negative-feedback trading strategies. Overall, the responses to shocks, except for those of small individual investors, decay quickly, indicating that the TSE can absorb shocks quickly and efficiently. Our analysis implies that small individual investors would be better off institutionalizing their investment decisions (e.g., by investing in mutual funds).     

Institutional investor stability and crash risk: Monitoring versus short-termism?

This study tests two opposing views of institutional investors—monitoring versus short-termism. We present evidence that institutional investor stability is negatively associated with 1-year-ahead stock price crash risk, consistent with the monitoring theory of institutional investors but not the short-termism theory. Our findings are shown to be robust to alternative empirical specifications, estimation methods and endogeneity concerns. In addition, we find that institutional ownership by public pension funds (bank trusts, investment companies, and independent investment advisors) is significantly negatively (positively) associated with future crash risk, consistent with findings that pension funds more actively monitor management than other types of institutions.     

Institutional Investors and Firm Efficiency of Real Estate Investment Trusts

This study investigates the effect of institutional ownership on improving firm efficiency of equity Real Estate Investment Trusts (REITs), using a stochastic frontier approach. Firm inefficiency is estimated by comparing a benchmark Tobin??s Q of a hypothetical value-maximizing firm to the firm??s actual Q. We find that the average inefficiency of equity REITs is around 45.5%, and that institutional ownership can improve the firm??s corporate governance, and hence reduce firm inefficiency. Moreover, we highlight the importance of heterogeneity in institutional investors??certain types of institutional investors such as long-term, active, and top-five institutional investors, and investment advisors are more effective institutional investors in reducing firm inefficiency; whereas hedge funds and pension funds seem to aggravate the problem. In sub-sample analysis, we find that these effective institutional investors can reduce inefficiency more effectively for distressed REITs, and for REITs with high information asymmetry, and with longer term lease contracts. Lastly, we find that the negative impact of institutional ownership (except for long-term institutional investors) on firm inefficiency reduces over time, possibly due to strengthened corporate governance and regulatory environment in the REIT industry.     

Did institutions herd during the internet bubble?

We examine the trading behavior of institutional investors during the internet bubble and crash of 1998–2001, and its impact on stock prices. Similar to some recent findings concerning the trading behavior of hedge funds and NASDAQ 100 stocks, we find that during the bubble all types of institutions herded with great intensity into internet stocks for a comprehensive sample of institutional investors and internet stocks. In addition to this, we present three entirely new results. First, institutional herding was much greater than what can be explained by momentum trading. Second, institutions as a group continued to increase their holdings of internet stocks for two quarters past the market peak during the first quarter of 2000, and three quarters past the peak for individual stock prices, suggesting that institutions were unable to time the price peaks. Finally and most importantly, we find positive abnormal returns contemporaneous with institutional herding and negative abnormal returns (reversals) at the point that herding ceased. This finding suggests that institutions’ trading created temporary price pressures, and may have contributed to the bubble.     

The Impact of Regulation Fair Disclosure on Information Asymmetry and Trading: An Intraday Analysis

This study examines the impact of Regulation Fair Disclosure (FD) on liquidity, information asymmetry, and institutional and retail investors trading behavior. Our main findings suggest three conclusions. First, Regulation FD has been effective in improving liquidity and in decreasing the level of information asymmetry. Second, retail trading activity increases dramatically after earnings announcements but there is a significant decline in institutional trading surrounding earnings announcements, particularly in the pre‐announcement period. Last, the decline in information asymmetry around earnings announcements is closely associated with a lower participation rate in the pre‐announcement period and more active trading of retail investors after earnings releases.     

The impact of public information on investors

This study investigates the trading behavior of institutional and individual investors around both firm-specific news releases in the Wall Street Journal and macro-economic announcements. For the firm-specific news releases we find that investors conduct a high degree of trading around news releases, especially earnings and dividend news. Institutions buy and sell on both good and bad news, while individual investors only trade on good news. The length of the news article (visibility) is also an important attribute to motivate individual investor trading. Lastly, both institutions and individuals buy large firms after good economic news and sell large firms after bad economic news. The trading of small firms does not appear to be motivated by macro-news.