Are banks opaque? Evidence from insider trading
BIS Working Papers No 697
We contribute to a long literature on whether banks are more opaque than other firms. By opaque we mean that outsiders, such as investors or depositors, are less able to assess the soundness of a bank than that of another type of firm. An answer to this question has important implications for regulation. For instance, bank opacity could undermine market discipline.
We test whether banks are more opaque than other firms by looking at how equity prices respond to trades by bank or firm insiders. These are purchases or sales by senior company officials, who presumably have better information on the future performance of their institutions than outside investors. If companies are opaque, then insider purchases should be followed by increases in equity prices and insider sales by drops, at least on average. We believe that price responses to insider trades provide a better measure of opacity than the variables used in previous studies, such as bid-ask spreads, which are also affected by a range of other factors.
Our results do not support the conventional wisdom that banks are more opaque than other firms. Yes, purchases by bank insiders are followed by positive stock returns, indicating that banks are opaque. But banks are not special as we find the same effect for other firms. Where banks are special is when bad news arrive. We find that sales by bank insiders are not followed by negative stock returns. This suggests that bank insiders do not receive bad news earlier than outsiders. By contrast, insider sales at non-banks tend to be followed by a decline in stock prices.
We use trades by US corporate insiders to investigate bank opacity, both in absolute terms and relative to other firms. On average, bank insider sales do not earn an abnormal return and do not predict stock returns. By contrast, bank insider purchases do, even though less than other firms. Our within-banking sector and over-time analyses also fail to provide evidence of greater opacity of banks vis-à-vis other firms. These results challenge conventional wisdom and suggest that, to assess bank opacity, the type of benchmark (transparency vs. other firms) and transaction/information (purchase/positive vs. sale/negative) are crucial.
JEL classification: G14, G20, G21
Keywords: bank opacity, insider trading, financial stability