How Big Data Connects Bankers, Politics And Insider Trading
Wharton Accounting professor Daniel Taylor on politically connected bankers and insider trading
In the tense days before the big bank bailouts of October 2008 under the Troubled Asset Relief Program (TARP), highly unconventional deals worth hundreds of billions of dollars were being cut between then-Treasury Secretary Hank Paulson and the nation’s top bankers on a single sheet of paper. The U.S. economy seemed to hang in the balance. The Dow was in the midst of plunging some 50% from year-earlier highs and financial shocks eventually cost some 9 million jobs.
[drizzle]Yet, leading up to these events, it turns out, there was a large spike in stock trading activity by the bank insiders who were the most politically connected to politicians and regulators, according to new research by Wharton accounting professor Daniel J. Taylor, who used Big Data and algorithms to reach his conclusions in the paper he co-authored, “Political Connections and the Informativeness of Insider Trades.” In this [email protected] interview, Taylor describes how the methodologies outlinedin the paper could shine a “bright light” into areas where investigators could uncover potential wrongdoing. His co-authors are: Alan D. Jagolinzer, University of Colorado; David F. Larker, Stanford University; and Gaizka Ormazabal, University of Navarra. An excerpt from the abstract of the paper appears below, followed by an edited version of the conversation with Taylor.
“Examining insider trades around the announcements of TARP infusions, we find evidence of significant trading thirty days in advance of the announcement, and that these trades predict the market reaction to the announcement. Notably, we find these relations are present only for the trades of politically connected insiders. Overall, our results suggest that politically connected insiders had an information advantage during the Crisis and traded to exploit this advantage.”
[email protected]: I’d like to welcome Daniel Taylor to [email protected] — he’s a professor of accounting here at Wharton. And he’s written a very interesting paper on the links between political connections and insider trading during, or just after the financial crisis, and during the period where TARP was under consideration. TARP is the Troubled Asset Relief Program.
Please us a short summary first, and then we’ll get into more specific questions about what your paper found.
Daniel Taylor: What we did in the paper is, we looked at the trading of corporate insiders. So by corporate insiders we mean officers and directors of publicly traded corporations. All of these individuals have to file what’s known as Form 4 with the SEC and the public record that discloses their trades in their firm’s shares or their firm’s stock. So they’re allowed to trade in their firm’s shares and they file that information with the SEC.
We gathered all of the information that’s out there on these Form 4s — on their trading. And we looked at the trading before the financial crisis, during the financial crisis and after the financial crisis. So this is the trading of executives and directors in their own firm. We looked specifically at financial institutions. One of the big questions that comes out of the financial crisis that’s interesting on Wall Street and on Main Street is: Did anyone know — did anyone see the crisis coming?
“One of the big questions that comes out of the financial crisis that’s interesting on Wall Street and on Main Street is: Did anyone know — did anyone see the crisis coming?”
We initially started the project by looking at: Okay, can we see whether insiders, corporate insiders, officers and directors, traded in advance of the crisis? So at banks that did poorly during the crisis, did their executives sell shares before the crisis hit? And then we looked at the trading during the crisis — so around the bank bailouts, the TARP monies that you alluded to. And then after the crisis, did trading stabilize?
We found that there didn’t seem to really be any evidence of trading before the crisis. There was no evidence that insiders traded in anticipation of the crisis. But we did seem to find some evidence that insiders traded during the crisis in the period in which the TARP funds were dispersed. And then we investigate that a little bit more and what we find is, interestingly enough, that it’s only the insiders that had political connections, and by political connections I mean connected to a bank regulatory agency or the current House or Senate at the time.
So we looked at bank boards who had a director or officer who had work experience, current or past, at a bank regulatory agency, the Senate or the House, and we found that the boards of those banks that had those political connections traded more heavily during the financial crisis. Their trades had higher predictive ability of outcomes during the financial crisis. So they predict, for example, the market reaction to the amount of the bailout that the bank would receive. So we basically find that during the crisis there is some trading in anticipation of bank bailouts.
And then after the crisis … things go back to normal and we don’t really find that those trades or those individuals’ trades have any more information than other ones.
[email protected]: So this would seem to be the definition of insider trading on the face of it. I want to point out that this study had a very large sample. It looked at 7,300 corporate officers … across 497 publicly traded, TARP-eligible institutions.
Taylor: That’s correct.
[email protected]: This was a very wide net that you cast.
Taylor: One way to think about this paper is to think about it as using Big Data and computer algorithms to sift through public information on the trades of officers and directors, and to see which trades of the officers and directors are correlated with future outcomes. We would say if a trade is correlated with a future outcome, if it has a high predictive ability, it’s more likely that that trade might have been based on [private] information about that future outcome.
But I do want to clarify that … in the popular press and legal scholars, they use the term insider trading, they’re thinking of illegal insider trading. When we use the term insider trading, we’re thinking of the trading by officers and directors. So when we say insider trading, we mean trading by corporate insiders. And there are two types: The first type is the legal trading — the board or the CEO can trade in his shares, just like anyone else can.
“What we’re doing is we’re reporting correlations on … a large sample and casting sort of a suspicious eye in the direction of insiders that have political connections.”
[email protected]: With proper disclosure.
Taylor: With proper disclosure … as long as they do not have any private information. The illegal kind is when they have private information that they have not disclosed to shareholders. This relates back to a set of rules called “disclose or abstain.” If you’re a CEO or a manager, and you have private information, it’s your duty to either disclose it to shareholders or abstain from trading.