Private information arrival, trading activity, and price formation: Evidence from nonpublic merger negotiations

Abstract: We provide evidence on how stock prices and trading activity respond to the arrival of private information about firm value using the dates of material nonpublic merger negotiations to proxy for private information arrival. Target firm returns are 0.41% higher over two days following each nonpublic negotiation event. Trading volume, order imbalance, and trade size also spike in this window. Larger price reactions following negotiation events preempt deal announcement returns. The price response following negotiation events is explained by proxies for the expected profits and price impact of informed trading, prior press speculation, institutional ownership, and contemporaneous trading activity signals. We thank Linda Bamber, Diane Del Guercio, Ro Gutierrez, Kathy Kahle, Ron Kaniel, Eric Kelley, Chris Lamoureux, Jochen Lawrenz, Lubo Litov, Wayne Mikkelson, Bill Schwert, Rick Sias, Jerry Warner, and workshop participants at MIT, and the Universities of Arizona, Georgia, Innsbruck, Oregon, Rochester, and Utah for helpful comments. We are also grateful to Denis Sosyura (discussant) and participants at the 2012 University of Washington Summer Finance Conference. We recognize the excellent research assistance provided by Tyler Brough, Michael Dambra, Douglas Fairhurst, Jordan Neyland, and Matthew Serfling. * Rochester, NY 14627; phone: 585.273.4818; email: [email protected] ** Tucson, AZ 85721; phone: 520.621.8761; email: [email protected] 1 Understanding the degree to which investors rapidly acquire and trade on new private information about firm value and how their trades affect price formation is central to the design of securities regulation and inferences about the efficiency of financial markets. The evidence in a number of recent studies shows that informed investors obtain private information in a variety of ways, such as through connections to insiders, and that they use this information to make profitable trades. For instance, To infer private information-based trades, the aforementioned studies often begin with a firm's disclosure of earnings or the announcement of a merger agreement and examine trading behavior and price movements over a brief window before the disclosure. But, ascertaining whether connected investors trade on private information is challenging in part due to the difficulty of tying stock returns and trading decisions to the underlying arrival of private information. Because securities regulation does not generally compel managers to disclose material nonpublic information immediately, traders can acquire and exploit private information weeks or months before the firm is required to disclose it. In this paper we study underlying events that produce and distribute private information about the value of a firm. Specifically, we use the dates of merger negotiations that occur privately, but are disclosed weeks or months after the deal is announced, to more precisely identify when private information is actually generated. These data allow us to examine whether informed investors promptly trade on private information that arrives during the course of merger 2 negotiations and if their trading has an economically important effect on target firms' stock prices. 1 For a sample of 545 completed acquisitions announced between 1995 and 2006, we use Securities and Exchange Commission (SEC)-mandated background disclosures to identify the dates and types of various material "events" that occur during negotiations between the target and potential acquirers before an acquisition deal is announced. These nonpublic negotiation events include, for example, the initiation of merger talks, a bidder making a private offer for the target, the retention of a financial advisor, or a meeting of the target's board to evaluate a proposed deal. On average, over the three months prior to the merging parties' disclosure of a preliminary merger agreement (hereafter, referred to as the deal announcement), there are about seven unique trading days during which at least one material negotiation event occurs. After controlling for the impact of press speculation about a potential acquisition deal (which affects 18% of the deals in our sample) we find that for each nonpublic negotiation event, target firm excess abnormal returns average 0.18% the same day and 0.23% the day after the event, resulting in a two-day estimated excess return of 0.41%. These returns are incremental to the average positive abnormal returns during the negotiation period and thus provide a lower-bound estimate of the price impact of trading on private information about merger negotiations. To more fully understand the source of these returns, we examine whether non-price measures of informed trading are also related to the arrival of private information during merger negotiations. We document significant spikes in abnormal trading volume, buyer-initiated transactions measured by order imbalance, and medium-size trades over the two-day window following a nonpublic negotiation event. Moreover, we also find that increases in contemporaneous 1 Informed trading before a merger announcement includes both illegal insider trading on material nonpublic information and legitimate trading based on superior information acquisition and processing. Moreover, the term "insider" in insider trading as used in this paper refers to any individual that knowingly trades on material nonpublic information. This could include, but is not limited to, corporate insiders as defined under Section 16 requirements for reporting trades (e.g., officers, directors, and some blockholders). See Agrawal and Jaffe (1995) and Agrawal and Nasser (2012) for evidence on trading by corporate insiders prior to merger announcements. 3 volume, buy-sell order imbalance, and medium-size trades predict stock returns following negotiation events. For example, a ten percentage point increase in abnormal trading volume is associated with a 12 basis point larger stock price reaction to each negotiation event. These effects are incremental to the typical effect of trading activity on stock returns and suggest that the arrival of private information about merger negotiations has substantive implications for understanding the trading decisions of informed investors and the informational efficiency of stock prices. Next, we investigate whether firm and deal-specific factors explain how quickly target stock prices respond to the arrival of private information. We show that stock returns following negotiation events are increasing in both the expected profits from trading on private information, as measured by the offer premium, and the likelihood of deal completion, captured by a tender offer or target termination fee clause. We further document that the magnitude of the stock price response is increasing in the adverse selection costs of trading in the target firm's shares, proxied by PIN (probability of informed trading) and low analyst coverage. In other words, stock returns are more sensitive to negotiation events for firms whose stock price is generally more sensitive to informed trades. We also find that higher institutional ownership is associated with a decrease in the sensitivity of stock returns to negotiation events. This evidence suggests that institutions may be less willing than individuals to trade on private information from negotiation events or that if they do trade on this information, they do not do so immediately after a negotiation event. We also examine whether media speculation about a deal is related to the sensitivity of target firm stock returns to nonpublic negotiation events. Controlling for the market's reaction to a rumor, we show that for the 18% of the deals in our sample with at least one published rumor prior to the deal announcement, the target firm's stock returns respond significantly more to negotiation events. Further, we document that this effect is most pronounced for nonpublic negotiation events that occur after the rumor is published. These findings are consistent with the conventional wisdom that 4 the litigation risk from trading on private information is decreasing in the amount of existing public information about a potential deal and with the notion that because press speculation increases target firms' stock return volatility, news rumors make it easier for informed investors to trade without detection from other traders. We investigate the factors that determine the timing and occurrence of press speculation. Indicating that private information from merger negotiations is in some instances quickly leaked to the media, we show that although press rumors tend to follow observable abnormal stock returns and trading volume, they are incrementally more likely to take place over the two days following a nonpublic negotiation event. Further, implying that informed investors are potentially responsible for at least some of this leakage, we find that a deal is more likely to be rumored when the set of investors with private information about deal negotiations is larger, proxied for with measures for the number of deal insiders (Acharya and Johnson One interpretation of this finding is that, at times, informed investors intentionally leak some of their private information to the press so they can more easily trade on the remainder of their information. To further assess the economic importance of informed trading following the arrival of private information, we examine the extent to which the price impact of this trading affects the target's acquisition price and the market's reaction to the announcement of a merger agreement. Schwert's (1996) evidence suggests that for every 1 increase in the target's stock price prior to the deal announcement, the target negotiates more than a 1 increase in the final acquisition price from the acquirer. However, acquirers and targets know the dates they negotiated, and thus, acquirers should be able to discount stock price movements occurring just after negotiation events. Our results suggest that a $1 increase in stock price attributable to informed trading following nonpublic negotiation events leads to a$0.81 increase in the final transaction price, a significant 29% discount from the $1.14 increase in the final transaction price for each$1 of non-event price increase. In 5 other words, deal negotiators place a lower weight on stock returns linked to nonpublic negotiation event days than stock returns on other days. We also find that a one percent increase in the target's stock price attributable to informed trading following nonpublic negotiation events reduces the market's reaction to the deal announcement by 26 basis points. However, a similar one percent increase in stock price during the period prior to the deal announcement that is not attributable to negotiation events reduces the market's reaction by only 13 basis points. These findings imply that private information-based trading following merger negotiations is economically important in preempting the information in the deal announcement. Our study contributes to the literature that considers how public and private information impacts trading decisions and price formation. We use a novel but intuitive approach to provide insights on private information-based trading and its impact on price formation by focusing on the dates when private information is created. Our evidence indicates that well-informed traders rapidly exploit their information advantage. Their trades are reflected in volume, order flow, and trade size, and have an economically important effect on a firm's stock price. Further, we identify several factors that determine the magnitude of the stock price reaction to the arrival of private information during merger negotiations. The stock price reaction depends on contemporaneous volume and order flow, expected profits from trading on private information, the expected price impact of informed trading, institutional ownership, and whether a private negotiation event is preceded by press speculation. Implying that informed trading following merger negotiations preempts information in the deal announcement, we also show that stock returns linked to days with private information events are associated with significantly smaller deal announcement returns. This study also contributes to the emerging literature on how traders' characteristics and connections to insiders impact the timing and profitability of their trades and the efficiency of stock 6 prices. Our focus on days when information is produced and distributed provides an avenue for future research to examine how the trades of specific investors correlate with the arrival of private information. Given that we document trading activity and stock returns respond quickly to the arrival of new private information about firm value, our evidence also speaks to the SEC's focus on hedge funds, brokerages, deal advisers, and exchange traders and their access to and use of confidential inside information. The remainder of the paper is organized as follows. Section 1 reviews prior work on private information-based trading and discusses the potential for such trading activity subsequent to merger negotiations. Section 2 presents our empirical results. Section 3 concludes. Informed Trading and the Timing of Nonpublic Merger Negotiations Asymmetric information is a pervasive trait of capital markets. The intent of disclosure regulation is to ensure that material information is disclosed to investors, but there are few mandatory obligations for real-time disclosure of new information. As a result, stock prices can diverge from their full information value. Public disclosure of material nonpublic information may be delayed for weeks or even months, thereby providing incentives for traders to uncover private information. Traders with more precise information about a firm's value are more likely to trade on their information. In the absence of public disclosure of new information, the speed at which price converges to its full information value depends on informed trading. Profit-maximizing informed traders have incentives to camouflage their trades by spreading them out over time As the number of privately-informed investors grows, competition between them can create incentives to trade more aggressively, leading to more efficient prices (Holden and Subrahmanyam 7 (1992)). In contrast, 2 We focus on the timing of nonpublic merger negotiations to identify informed trading activity and its effect on price formation. 3 An informed investor's trading incentives depend on how negotiations progress, the expected offer price relative to the current price (the premium), and the likelihood of a successful deal. The distribution of that private information during negotiations also matters. The initial contact between the merging parties is often between CEOs and a few close advisors and directors. As discussions progress, the target's (and often the acquirer's) entire board is informed, financial and legal advisors are retained, investment bankers are contacted to assist with financing, and lower-level managers and auditors are brought in to support the due diligence process and integration planning. While the negotiating managers, directors, advisors, and financing 2 Prior studies that attempt to link trading on private information prior to acquisitions with target stock price formation look at the magnitude of stock price runups in acquisition targets 5 4 Expert networks are one of the interesting targets of recent insider trading investigations. Expert networks retain current and past managers and other industry specialists as consultants to investors such as mutual funds and hedge funds. While expert network firms have policies that bar their consultants from passing along confidential information, it appears that many consultants have done so. A recent complaint filed by the SEC alleges that ten consultants and one investment advisor working for the expert network firm Primary Global Research (PGR) passed along material nonpublic information to hedge funds and other PGR clients in exchange for cash compensation. The SEC alleges that the clients of PGR earned about $30 million in illicit profits as a result (SEC vs. Longria et a

Adding 6 months of androgen deprivation therapy to postoperative radiotherapy for prostate cancer: a comparison of short-course versus no androgen deprivation therapy in the RADICALS-HD randomised controlled trial

Background Previous evidence indicates that adjuvant, short-course androgen deprivation therapy (ADT) improves metastasis-free survival when given with primary radiotherapy for intermediate-risk and high-risk localised prostate cancer. However, the value of ADT with postoperative radiotherapy after radical prostatectomy is unclear. Methods RADICALS-HD was an international randomised controlled trial to test the efficacy of ADT used in combination with postoperative radiotherapy for prostate cancer. Key eligibility criteria were indication for radiotherapy after radical prostatectomy for prostate cancer, prostate-specific antigen less than 5 ng/mL, absence of metastatic disease, and written consent. Participants were randomly assigned (1:1) to radiotherapy alone (no ADT) or radiotherapy with 6 months of ADT (short-course ADT), using monthly subcutaneous gonadotropin-releasing hormone analogue injections, daily oral bicalutamide monotherapy 150 mg, or monthly subcutaneous degarelix. Randomisation was done centrally through minimisation with a random element, stratified by Gleason score, positive margins, radiotherapy timing, planned radiotherapy schedule, and planned type of ADT, in a computerised system. The allocated treatment was not masked. The primary outcome measure was metastasis-free survival, defined as distant metastasis arising from prostate cancer or death from any cause. Standard survival analysis methods were used, accounting for randomisation stratification factors. The trial had 80% power with two-sided α of 5% to detect an absolute increase in 10-year metastasis-free survival from 80% to 86% (hazard ratio [HR] 0·67). Analyses followed the intention-to-treat principle. The trial is registered with the ISRCTN registry, ISRCTN40814031, and ClinicalTrials.gov, NCT00541047. Findings Between Nov 22, 2007, and June 29, 2015, 1480 patients (median age 66 years [IQR 61–69]) were randomly assigned to receive no ADT (n=737) or short-course ADT (n=743) in addition to postoperative radiotherapy at 121 centres in Canada, Denmark, Ireland, and the UK. With a median follow-up of 9·0 years (IQR 7·1–10·1), metastasis-free survival events were reported for 268 participants (142 in the no ADT group and 126 in the short-course ADT group; HR 0·886 [95% CI 0·688–1·140], p=0·35). 10-year metastasis-free survival was 79·2% (95% CI 75·4–82·5) in the no ADT group and 80·4% (76·6–83·6) in the short-course ADT group. Toxicity of grade 3 or higher was reported for 121 (17%) of 737 participants in the no ADT group and 100 (14%) of 743 in the short-course ADT group (p=0·15), with no treatment-related deaths. Interpretation Metastatic disease is uncommon following postoperative bed radiotherapy after radical prostatectomy. Adding 6 months of ADT to this radiotherapy did not improve metastasis-free survival compared with no ADT. These findings do not support the use of short-course ADT with postoperative radiotherapy in this patient population

Duration of androgen deprivation therapy with postoperative radiotherapy for prostate cancer: a comparison of long-course versus short-course androgen deprivation therapy in the RADICALS-HD randomised trial

Background Previous evidence supports androgen deprivation therapy (ADT) with primary radiotherapy as initial treatment for intermediate-risk and high-risk localised prostate cancer. However, the use and optimal duration of ADT with postoperative radiotherapy after radical prostatectomy remains uncertain. Methods RADICALS-HD was a randomised controlled trial of ADT duration within the RADICALS protocol. Here, we report on the comparison of short-course versus long-course ADT. Key eligibility criteria were indication for radiotherapy after previous radical prostatectomy for prostate cancer, prostate-specific antigen less than 5 ng/mL, absence of metastatic disease, and written consent. Participants were randomly assigned (1:1) to add 6 months of ADT (short-course ADT) or 24 months of ADT (long-course ADT) to radiotherapy, using subcutaneous gonadotrophin-releasing hormone analogue (monthly in the short-course ADT group and 3-monthly in the long-course ADT group), daily oral bicalutamide monotherapy 150 mg, or monthly subcutaneous degarelix. Randomisation was done centrally through minimisation with a random element, stratified by Gleason score, positive margins, radiotherapy timing, planned radiotherapy schedule, and planned type of ADT, in a computerised system. The allocated treatment was not masked. The primary outcome measure was metastasis-free survival, defined as metastasis arising from prostate cancer or death from any cause. The comparison had more than 80% power with two-sided α of 5% to detect an absolute increase in 10-year metastasis-free survival from 75% to 81% (hazard ratio [HR] 0·72). Standard time-to-event analyses were used. Analyses followed intention-to-treat principle. The trial is registered with the ISRCTN registry, ISRCTN40814031, and ClinicalTrials.gov , NCT00541047 . Findings Between Jan 30, 2008, and July 7, 2015, 1523 patients (median age 65 years, IQR 60–69) were randomly assigned to receive short-course ADT (n=761) or long-course ADT (n=762) in addition to postoperative radiotherapy at 138 centres in Canada, Denmark, Ireland, and the UK. With a median follow-up of 8·9 years (7·0–10·0), 313 metastasis-free survival events were reported overall (174 in the short-course ADT group and 139 in the long-course ADT group; HR 0·773 [95% CI 0·612–0·975]; p=0·029). 10-year metastasis-free survival was 71·9% (95% CI 67·6–75·7) in the short-course ADT group and 78·1% (74·2–81·5) in the long-course ADT group. Toxicity of grade 3 or higher was reported for 105 (14%) of 753 participants in the short-course ADT group and 142 (19%) of 757 participants in the long-course ADT group (p=0·025), with no treatment-related deaths. Interpretation Compared with adding 6 months of ADT, adding 24 months of ADT improved metastasis-free survival in people receiving postoperative radiotherapy. For individuals who can accept the additional duration of adverse effects, long-course ADT should be offered with postoperative radiotherapy. Funding Cancer Research UK, UK Research and Innovation (formerly Medical Research Council), and Canadian Cancer Society

An empirical analysis of institutional liquidity trading

I investigate the trading decisions of a large institutional liquidity trader by using a detailed data set from a transition management firm. The data set contains records for all trades of transitions completed between January 2008 and September 2008. Effective execution involves a trade off between trading patiently over time to minimize price impact costs and trading quickly to avoid opportunity costs due to price volatility. I estimate a model of transition duration that accounts for volatility, an order's percentage of average daily volume, and the bid--ask spread to uncover the firm's strategy of how quicklyto trade. To understand the firm's intermediate trading decisions, I estimate a vector autoregression that summarizes the dynamic relationship of volatility, trading volume, the bid--ask spread, and order type and order duration. My analysis suggests that the firm behaves strategically to minimize the total costs of trading

Corporate Lobbying, Political Connections, and the Bailout of Banks

Political involvement has long been shown to be a profitable investment for firms that seek favorable regulatory conditions or support in times of economic distress. But how important are different types of political involvement for the timing and magnitude of political support? To answer this question, we take a comprehensive look at the lobbying expenditures and political connections of banks that were recipients of government support under the 2008 Troubled Asset Relief Program (TARP). We find that politically engaged firms were not only more likely to receive TARP support, but they also received a greater amount of TARP support and received the support earlier than firms that were not politically involved