Public Information and Communication in Stock Trades
Caleb Rawson: Absolutely. This study was a really fascinating project to work on. As you recall, way back in January of 2020, there were news stories that were starting to come out about factory workers in China being locked down in their factories in sections of major cities being placed under quarantine. Yet for most of us in the U.S., life just continued on, albeit with probably more lively discussions about colds and flus and the World Health Organization than we probably ever had before. Business activity continued mostly under the assumption that this would be a minor hiccup and would blow over shortly. But, at the same time that the stock market was reaching record highs and the February the death toll in China was surpassing that of the SARS epidemic, outbreaks and lockdowns were happening all over the world in Italy and Spain and Iran. And then on March 9th, the bottom fell out of the U.S. stock market, dropping more than 30% and becoming the fastest fall in worldwide financial markets in history. It was clear that for U.S. stock market investors, even though there were signs of as early as January that COVID 19 had the potential to pose a threat, nobody thought it would really take a hit to stock values or business profits. So the question that my coauthors Erin Henry and George Plasco and I ask in this paper is why not? And if most people didn’t think it would be a problem, who did think that it would potentially become important? And while we don’t have access to most people’s individual stock trades, if you’re an officer or director at a publicly traded company, you have to file purchases and sales of your own company’s stock with the Securities and Exchange Commission, the SEC, and that allows us to look at how these corporate insiders traded stock during COVID. And what we found was if you were a corporate insider at a company with operations in China, say, a factory or a major supplier, you were more likely to sell your stock in the days and weeks leading up to the stock market crash in March, than if you were a corporate insider at a company that didn’t have those operations in China. And we posit that this is because they were better able to incorporate and act upon public information about COVID before other investors. In other words, they not only heard the news about COVID, like the rest of us, they saw the impact that COVID was having on their own factories and supply chains and knew that it was going to be a big deal and pose a threat to their business. This resulted in them being much more likely to sell stock before the stock market crashed. And on average, insiders at firms with operations in China saved over $91,000 more per stock trade than insiders at firms without connections. And as a group, they avoided over $375 million in stock market losses.
MM: In a subsequent study, Rawson and his research partners found that firms will often issue a press release touting positive news at the same time they’re forced to disclose bad news.
CR: So when something major happens at a firm, managers are required to file what’s called a Form 8-K with the SEC, normally, within four business days. This is so investors and regulators can get a gauge on what’s happening at the firm and make informed decisions. These material events include a wide range of things, including things like bankruptcy, changing your accountant, which normally is not considered to be a good thing, entering into a merger or making an acquisition decision and having a change in leadership, either at the board or at the executive level, or dozens of other types of similar event. Now, 8-Ks are pretty standardized and formulaic, and firms really don’t have a lot of leeway about how or what they say in these forms. They’re pretty barebones and to the point. Now, some of these events are good things, but around 40% of the time, these filings are communicating negative information. Something bad has happened at the firm and managers are being required to publicly disclose it. So what my co-authors Brady Tweet and Jessica Watkins and I look at is we wanted to know whether firms were strategic about trying to distract investors from reading or being aware of bad news 8-K filings. And what we found was that when a firm had to disclose bad news to the SEC in an 8K, they were significantly more likely to provide an easier-to-read press release on the same day that was about some different unrelated event. Further, this behavior was more likely when there is a senior executive who had an upcoming stock sale and when investors were already more cognitively constrained or more easily distracted. And this distraction behavior appears to work really well. It results in fewer people reading the 8-K forms on the SEC’s website. And it makes the stock price take longer to actually incorporate the underlying bad information. Now, importantly, the practice of providing the simultaneous 8-K and press release, it’s not illegal or violating any regulations, but our findings do shed light on a tool that managers can use to exploit investors and hide negative news and sweep it under the rug.
MM: In a third study, Rawson looked at the impact local news has on stock information about companies. As he mentioned in the paper, and this is a quote, employment at U.S. newspapers has declined more than 75% since 2000. This trend has been going on for decades, but really kicked into high gear during the digital revolution. Several studies have shown an increase in corruption or lack of governmental accountability or transparency on the local level – perhaps less scrutiny of government decisions and contracts and the like – because of less news coverage. Rawson’s study is similar, except it’s focused on business and the stock market.
CR: So I’ll start with some of the depressing numbers. Here in Arkansas in the last 20 years, even though the number of jobs has increased significantly, in newspapers, in 2001, there were 4,059 newspaper employees. And in 2021, there were only 954 left. Removing the fact that the overall workforce in Arkansas has increased like that is a substantial and as you mentioned, it’s a depressing number. When we think about how many fewer journalists there are looking into what’s going on in their communities. Of which companies and publicly traded companies are only a small facet of what the role that local newspapers are playing. So the study ties, as you mentioned, quite nicely with the prior two studies we were talking about, because information is fundamental to an effective and efficient stock market. And investors, they can’t make good decisions if they don’t know what’s happening at the firms. So. Christa Lee, Ryan Koeting and I, in this paper, we look at the role of local newspapers in providing information to investors about what’s going on with companies in their areas and specifically, as you’re aware, like newspapers do a lot, but there’s two major roles for our purposes in the study that they do. They generate information. So news generation and they disseminate information. They take information that’s already been generated by somebody else and they broadcast it out to their local readers here. And so what we expect few investors to explicitly seek out news articles at local papers when making an investment decision. We expected that local newspapers played a big role in the generation of information about companies in their areas. That then gets picked up by the broader business press and relayed to a broader audience here. Thus, local newsrooms shrunk over time. We expected there to be less information that was communicated to investors, and that’s exactly what we found. When newspaper employment decreased, local firms, stock volatility and the number of days where they had large stock price movements either up or down increased significantly, indicative of there just being less consistent information available about the firm. Additionally, financial analysts whose job is to forecast firm’s earnings and performance performed worse when there is less newsroom and newspaper coverage. So taken together, we think that these results paint a pretty clear but, to your point, somewhat depressing picture about the importance of local journalists in providing news coverage about firms operating in their local areas.
MM: Your research is really important and these findings are really important. Are there any major takeaways, a kind of salient takeaway from all of this work that you that you’d like to impart to us?
CR: So one of the things I do here at the university is I teach the principles of accounting class, which is our freshman level. I get students who are in their first or second year here taking accounting, and they often don’t know what accounting is. And I always start the class by saying, you know, you think accounting is debits, credits and numbers, but accounting is the language of business. It’s how we take in information about what’s going on at a company and we communicate it. And when we think about communication, there’s a lot of ways you can kind of twist or frame communication to emphasize certain things that you want emphasize. And so I think it’s really important… I hope my research tries to hint at this as well, that managers have a lot of incentives. Sometimes they’re good, sometimes they’re maybe not the incentives that the stockholders or regulators want. But I think it’s really important, either as an individual investor or as a future manager of a company or as a journalist or as a potential regulator, to be aware that manager incentives exist and to think about what they are, because that may then change how you interact with the company from your specific role and maybe change your decision process individually as well.
MM: Really appreciate that, Caleb. Thank you so much for your time and for being with us here today on Short Talks from the Hill.
CR: Thanks.
MM: Short Talks from the Hill is now available wherever you get your podcasts. For more information and additional podcasts, visit arkansasresearch.uark.edu, the home of research and economic development news at the University of Arkansas. Music for Short Talks from the Hill was written and performed by local musician Ben Harris.
