INFORMATION ASYMMETRY AND INSIDER
TRADING IN INDIAN EQUITY MARKET
Mohammed Iqbal M & Dr. Shijin Santhakumar
Department of Commerce
School of Management
Pondicherry University
INTRODUCTION
• Insider trading convictions in developed and developing economies.
Reliance Industries 2008 – 11 crore fine
Raj Rajaretnam in 2011– 600 crore
Rajat Gupta (2011) -130 crore
Mathew Marthoma in 2014 -2000 crore
• Powered by undisclosed price sensitive insider information.
• Raise question about the trustworthiness and effectiveness of legal framework and
the market as a whole
INFORMATION ASYMMETRY
• A state of disparity between Insiders and Outsiders in possession of
information. He et. al (2011)
• It can’t be eliminated! It can only be reduced and check illegal usage. Aboody and Lev
(2000)
• Insider trading backed by undisclosed price sensitive information is a by product
of information asymmetry. Frankel and Li (2004)
• It is difficult to identify an illegal insider trade. Frankel and Li (2004)
REVIEW OF LITERATURE
• Information asymmetry affects the trustworthiness of market. Akerlof (1970)
• Informational superiority of insiders for market gains. Seyhun (1986), Seyhun (1992), Ke et, al,
(2003), Frankel and Li (2004) and Cohen et, al, (2012
• Core insider trades are excessively profitable. Frankel and Li(2004)
• Analyst follow up, media coverage and R&D investment are contributing to high
information asymmetry. Frankel and Li (2004)
REVIEW OF LITERATURE
• Insider trading profits are reaped around six months after the trade with highest
profitability for core insiders. Seyhun (1998)
• Legal frameworks are a failure in checking the abnormal profitability of insider
trade in US. Seyhun (1992)
• 7% of total insider trades are excessively rewarded in the US market. Seyhun (1992)
DATA AND VARIABLES
• Insider’s trading dates, No of insider trades.
• Dividend adjusted buy and hold return.
• Book value, market cap, market return and 3M T-bill rate for calculation of Fama
& French factors.
• Analysis ranges from January 2005 to December 2013
• Data collected from Bloomberg.
METHODOLOGY
• Profitability of insider trading – proxy for information asymmetry. Frankel and Li (2004)
• Six month trade window. Seyhun (1998)
• Comparison of time-specific common expected return with actual insider return.
Frankel and Li (2004)
• Dividend adjusted buy & hold return = [(P1 – P0) + D]/P0
• Fama and French(1993) model to calculate expected return.
[R = Rf + β(Rm – Rf) + βHML + βSMB]
METHODOLOGY
• Portfolios created – SL/SM/SH/BL/BM/BH Fama and French (1993)
• All insiders were included. Based on SEBI definition
• Profitable insider trades. Frankel and Li (2004)
 For Purchase:- Actual insider return is higher than common expected return.
 For Sales:- Common expected return is higher than actual insider return.
• Insider trading trend of a month was decided based on Net purchase. Frankel and Li (2004)
Net purchase = Total number of insider purchase - Total number of insider sales.
RESULTS: SMALL CAP - INSIDER TRADE
PROFITABILITY
Company
Purchase
Profitable trade month
Sales
Un profitable trade
- month
Total trade - month
Un profitable trade
- month
Profitable trade month
Total
trade month
Aggregate trade month
Aarti Drugs
29
13
42
0
0
0
42
Astra Microvave
12
11
23
8
6
14
37
India Infoline
12
3
15
24
4
28
43
Khandwala Sec
7
32
39
5
8
13
52
Mindtree
2
7
9
24
22
46
55
Navbharat Vent
16
14
30
6
10
16
46
NCC Ltd
12
0
12
11
2
13
25
Raymond
8
3
11
6
5
11
22
Sughjith Starch
16
16
32
0
0
0
32
Usha Martin
19
8
27
2
1
3
30
133
107
240
86
58
144
384
TOTAL
MID CAP - INSIDER TRADE PROFITABILITY
Company
Purchase
Profitable trade month
Adani Power
Bajaj Holdings
Corromondal Intl
Dabar India
DLF India
Glenmark Pharma
GMR Infra
IndusInd Bank
JP Associates
Jindal Steel
JSW Steel
Jubilant foods
Marico ltd
Mphasis
Oracle Fin Serv
Piramal Ent
Power Finance
Shriram Transport
TATA Steel
YES Bank
TOTAL
3
3
3
3
14
11
13
2
19
9
9
0
4
4
1
2
2
5
9
10
126
Sales
Un profitable
trade - month
Total trade month
4
13
3
5
1
12
15
0
5
5
1
0
3
14
4
5
2
9
0
2
103
Un profitable
trade - month
7
16
6
8
15
23
28
2
24
14
10
0
7
18
5
7
4
14
9
12
229
Profitable trade month
0
2
8
10
10
5
0
27
1
15
0
4
4
4
14
11
5
4
4
7
135
0
1
9
50
5
9
0
0
4
2
0
14
7
5
33
26
0
3
0
2
170
Total trade month
0
3
17
60
15
14
0
27
5
17
0
18
11
9
47
37
5
7
4
9
305
Aggregate
trade month
7
19
23
68
30
37
28
29
29
31
10
18
18
27
52
44
9
21
13
21
534
LARGE CAP - INSIDER TRADE PROFITABILITY
Company
Purchase
Profitable trade –
month
Asian Paints
Sales
Un profitable
trade - month
Total trade month
Un profitable
trade - month
Profitable trade month
Total trade month
Aggregate
trade month
17
2
19
10
8
18
37
Axis Bank
8
2
10
20
6
26
36
Bharti Airtel
2
9
11
1
14
15
26
Cipla
0
9
9
1
3
4
13
HDFC Bank
2
1
3
21
26
47
50
Hero Moto Corp
2
4
6
1
1
2
8
Idea Cellular
2
3
5
9
3
12
17
Infosys
0
2
2
4
10
14
16
ITC LTD
1
2
3
6
59
65
68
14
2
16
55
8
63
79
L&T
6
1
7
21
6
27
34
Lupin
9
13
22
16
42
58
80
M&M
16
22
38
4
1
5
43
Reliance Ind
2
9
11
5
5
10
21
TATA Motors
9
1
10
10
0
10
20
90
82
172
184
192
376
548
Kotak Mahindra
TOTAL
THE STATE OF INFORMATION ASYMMETRY IN
INDIA
• The level of information asymmetry in India proxied by profitability of insider
trade is alarmingly vulnerable.
• Mid cap companies followed by large cap and small cap companies are mostly
affected by the problem of information asymmetry.
Size of Companies
Small Cap
Mid Cap
Large Cap
Total Companies
Excess profit firmmonths for Purchase
55.42%
55.02%
52.33%
54.25%
Excess profit firmmonths for Sale
40.28%
55.74%
51.06%
49.02%
Excess profit firmmonths in Aggregate
49.74%
55.43%
51.46%
52.46%
SUMMARY RESULT
600
500
400
300
200
100
0
SC
MC
PROFITABLE TRADE
LC
TOTAL TRADE
CONCLUSION
• Evidence shows that level of information asymmetry in Indian equity market is
very high.
• About 52.46% of insider trade firm-months are excessively profitable.
• Purchase insider transactions are more profitable than sales insider transactions.
• Mid cap companies followed by large cap and small cap companies are very
vulnerable to this market imperfection.
• It also points to the deficiency of the existing legal frame work and need for strong
and effective laws.
Bibliography
• Aboody, D., & Lev, B. (2000), Information Asymmetry, R&D, and Insider Gains, The Journal of Finance, LV(6): 2747–2766.
• Cohen, L., Malloy, C., & Pomorski, L. (2012), Decoding Inside Information, The Journal of Finance, LXVII(3): 1009–1043.
• Fama, E. F., & French, K. R. (1993), Common Risk Factors in the Returns on Stocks and Bonds, Journal of Financial Economics, 33(1): 3–
56.
• Frankel, R., & Li, X. (2004), Characteristics of a Firm’s Information Environment and the Information Asymmetry between Insiders and
Outsiders, Journal of Accounting and Economics, 37(2): 229–259.
• He, Y., Wang, J., & Wei, K. (2011), Do Bond Rating Changes Affect the Information Asymmetry of Stock Trading, Journal of Empirical
Finance, 18(1): 103–116.
• Knill, A., Minnick, K., & Nejadmalayeri, A. (2012), Experience, Information Asymmetry, and Rational Forecast Bias, Review of Quantitative
Finance and Accounting, 39(2): 241–272.
• Seyhun, H. N. (1986), Insiders’ Profits, Costs of Trading, And Market Efficiency, Journal of Financial Economics, 16(2): 189–212.
• Seyhun, H. N. (1992), The Effectiveness of the Insider-Trading Sanctions, Journal of Law and Economics, 35(1): 149–182.
• Tetlock, P. (2007), Giving Content to Investor Sentiment: The Role of Media in the Stock Market, The Journal of Finance, LXII(3): 1139–
1168..
Thank You