Abstract
A key assumption in many accounting and finance studies is that long horizon institutional investors are informed shareholders. Yet past empirical research finds no evidence that these institutions anticipate major corporate events, including earnings-based events. I find that long horizon institutions are better informed in that they sell more shares of impending bankrupt firms than of matched distress firms at least one quarter ahead of bankruptcy. Share sales are greater in impending bankrupt firms whose shareholders ultimately lose all of their equity. In additional analyses, I document greater share sales by long horizon institutions with supposedly superior information processing abilities and/or access to corporate management. Share sales are significantly less in the post Regulation FD era. Overall, my findings support the validity of the common assumption that long horizon institutions are informed. Regulation FD appears to mitigate (but not eliminate) their information advantage.
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Notes
Private information includes non-public information and/or the superior processing of public information.
Active long horizon institutions are typically private pension funds, endowments, foundations, and banks. Examples include Berkshire Hathaway, Yale University Endowment, Bank of New York Asset Management, etc.
The lack of evidence of informed trading raises the question whether long horizon institutions merely provide financial intermediary services, rather than invest based on private information as is commonly presumed.
“We measure our success by the long-term progress of the companies rather than by the month-to-month movements of their stocks” (Warren Buffett in An Owner’s Manual 1999, Berkshire Hathaway, Inc.).
“Blum Capital takes a substantial position in order to establish a productive ‘seat at the table.’ We generally strive to be the largest shareholder and, on a friendly basis, also will seek Board representation, if we feel that it will enhance our ability to create value…. Blum Capital is as disciplined when exiting an investment as we are when making one. Our sell decisions are based on a long-term perspective, rather than quarterly performance or short-term price fluctuations.” (Statement on Strategy, Blum Capital, http://www.blumcapital.com/strategy/index.html).
Lang and Stulz (1992) report an average CAR of −22 % for 2 days ending on the filing date (also see Clark and Weinstein 1983). Formal announcements of bankruptcy filings are commonly seen first in press releases (http://www.sec.gov/investor/pubs/bankrupt.htm). Once the company declares bankruptcy, it must file form 8-K with the SEC within 4 days stating whether the bankruptcy petition is under Chapter 7 or 11 of the bankruptcy code.
When Icahn Capital sold shares of Blockbuster Inc. prior to its bankruptcy filing, creditors filed a lawsuit alleging insider trading (http://www.insidermonkey.com/blog/2010/12/24/carl-icahn-accused-of-illegal-insider-trading).
One main reason for this is that some firms file for bankruptcy protection even though they are economically viable to achieve objectives that are unrealized outside the bankruptcy arena. Reasons include unilateral abrogation of contractual obligations. It is alleged that Texaco filed for chapter 11 protection to avoid paying litigation damages of $10.53 billion to Pennzoil, even though Texaco’ equity was estimated to be $13 billion and liquidation value of up to $26 billion (Delaney 1992).
Consistent with Bushee’s classifications, the average percentage of dedicated institutions in my sample that have held their existing stocks in their portfolios for more than 1 (2) year(s) is 74 (56 %).
I do not require that the matching firm be in the same industry as the bankrupt firm because with that restriction, I do not find matching firms that have BKPROB similar to the bankrupt firms, on average. However, untabulated analysis indicates that my results are robust when I incorporate this restriction.
Control variables that rely on Compustat information are measured at t−1 because quarter t−1 information (and not quarter t information) is publicly known in period t.
My sample of bankrupt firms experiences a price drop of around 21 % in the second year before the filing quarter, 60.1 % in the first year before the filing quarter, and 42.8 % in the 6 months before the filing quarter.
My results are robust when I include an indicator variable equal to one if the price is less than $5, zero otherwise. I do not control for stock delistings because all 128 sample firms are delisted in or after the bankruptcy filing quarter. Current quarter returns control for any public information on potential delistings.
I do not control for analyst forecast revisions because only 19 % of my sample of 128 bankrupt firms has analyst earnings forecast revision data in all 16 quarters prior to the bankruptcy quarter. Nevertheless, as a robustness check, I include analyst earnings forecast revisions as an additional control variable after assuming zero for any missing revision (Ke et al. 2008). My results are robust. Similarly, I add analyst recommendations as another control variable. My results are robust. Finally, my results are robust when controlling for going concern opinions issued by auditors.
Equation 2 does not include ZEROEQ as a standalone variable because of high collinearity between ZEROEQ and the matched-pair/firm dummies. However, my results are robust to including ZEROEQ and excluding the matched-pair/firm dummies in the regressions. Also, my results are robust to an alternate model, in which dCONTROLS are also interacted with ZEROEQ.
Data samples in prior research also range from 1980 to 2000s (e.g., Hillegeist et al. 2004), consistent with bankruptcy rules remaining largely unchanged.
In untabulated analysis, I examine the robustness of my results on the initial 1,268 bankrupt firms. In another robustness check, I require 12 consecutive quarters of data instead of 16. In both cases, the results are similar to findings on the final sample of 128 bankrupt firms.
Institutional ownership has increased overtime (e.g., Gompers and Metrick 2001). To account for yearly effects, my research design uses fixed effects. Also, my results are robust to the exclusion of any one of the following sets of years: 1987–1991, 1992–1996, 1997–2001, 2002–2005.
Four matching firms are included in the sample twice.
Information on the ultimate equity position is unavailable for the remaining 22 bankrupt firms mainly because these cases are not yet resolved or because documentation of resolution, if any, is unavailable.
In all tables, standard errors are clustered by firm. Further, inferences made from all tables are robust to the deletion of outliers according to the DFITS influence statistic or the R-student ratio.
Untabulated results indicate that the coefficient on QTR1 is significantly more negative than that on QTR2 at the 5 % level (one-tail) in Columns 1 and 2.
In an untabulated analysis, I mitigate the concern that share sales by dedicated institutions may be capturing some unknown omitted factors that drive their trading behavior. Specifically, I find that dedicated institutions sell more shares than other less informed long horizon institutions do (i.e., quasi-indexer institutions), consistent with dedicated institutions selling based on their private information and not unknown omitted factors that drive trades by long horizon institutions in general.
Abnormal returns are calculated relative to the CRSP equal weighted index. Specifically, an abnormal return for each firm is the buy-and-hold raw return minus buy-and-hold CRSP equal weighted index return.
Ninety-three percent of DEDICATED_TOP5 are also DEDICATED_LT. Thirty-seven percent of DEDICATED_LT are also DEDICATED_TOP5.
Untabulated analyses indicate that these results stem from share sales in bankrupt firms and not share purchases in matched firms. Also, the results are robust to when dCONTROLS are interacted with TOP5 and LT.
In untabulated analysis, I find that Reg FD affected the trading behavior of dedicated institutions with longer-term positions in bankrupt firms (DEDICATED_LT) and of dedicated institutions with larger stakes in bankrupt firms (DEDICATED_TOP5). Specifically, dedicated institutions with longer-term positions sell zero equity bankruptcies more than other dedicated institutions do, in both pre- and post-Reg FD periods. However, incremental sales are significantly less post-Reg FD than pre-Reg FD. Dedicated institutions with larger stakes sell zero equity bankruptcies more than other dedicated institutions do, only in pre-Reg FD periods. There is no such evidence in post-Reg FD periods. Further, incremental sales are significantly less post-Reg FD than pre-Reg FD periods.
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Acknowledgments
I am grateful to James Ohlson (the editor) and anonymous reviewers for their helpful suggestions. I also appreciate helpful comments from Ben Ayers, Linda Bamber, Jenny Gaver, Joel Houston, Bin Ke, Jim McKeown, Harold Mulherin, Karl Muller, Yong Yu, and the workshop participants at the following institutions: London Business School, Penn State University, University of Florida, University of Georgia, and University of Minnesota, as well as Shuba V. Raghavan (senior research associate, Yale Endowment), and Elysia Wai Kuen Tse (associate research and strategy, Lasalle Investment Management) for informative discussions about their funds’ investment objectives and style. I thank Brian Bushee for sharing his institutional ownership classification scheme.
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Appendix: Illustration of the matching process
Appendix: Illustration of the matching process
This appendix illustrates how a matching firm is chosen for Chyron Corp (SIC 3663) which filed for bankruptcy on September 17, 1990. First, I retain all firms that have data on regression variables (including aggregate percentage ownership by dedicated institutions) for at least 16 consecutive quarters prior to the quarter Chyron filed for bankruptcy. This step provides 1,115 potential matching firms. Next, I delete firms that filed for bankruptcy in any of the years up to 5 years following the filing by Chyron. This step results in 1,078 potential matching firms. In step three, out of 1,078 firms, I choose the one whose probability of bankruptcy (BKPROB) is closest to that of Chyron, 2 years prior to Chyron’s bankruptcy filing quarter. The matching firm with the closest BKPROB is Valpey-Fisher Corp (SIC 3679). The absolute difference in BKPROB between the two companies is 0.002.
The table below lists the pattern of aggregate percentage ownership by dedicated institutions in Chyron and Valpey-Fisher at the end of each quarter for 3 years before the bankruptcy quarter. At the matching quarter, dedicated institutions own 7.83 % in Chyron and 6.19 % in Valpey-Fisher. In the subsequent quarters, dedicated institutions decrease their ownership significantly in Chyron, with most of the selling occurring in the two quarters prior to bankruptcy quarter. In contrast, dedicated institutions appear to be retaining their shares in Valpey-Fisher.
QUARTER | DEDICATED it | |
|---|---|---|
Bankrupt firm (Chyron Corp) | Matched firm (Valpey-Fisher Corp) | |
−1 | 2.90 | 7.07 |
−2 | 5.39 | 7.03 |
−3 | 6.73 | 7.03 |
−4 | 7.94 | 6.99 |
−5 | 7.94 | 6.79 |
−6 | 7.93 | 6.78 |
−7 | 7.46 | 6.24 |
−8 | 7.83 | 6.18 |
−9 | 7.83 | 6.19 |
−10 | 7.83 | 5.88 |
−11 | 7.95 | 5.88 |
−12 | 7.82 | 5.81 |
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Ramalingegowda, S. Evidence from impending bankrupt firms that long horizon institutional investors are informed about future firm value. Rev Account Stud 19, 1009–1045 (2014). https://doi.org/10.1007/s11142-013-9271-6
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DOI: https://doi.org/10.1007/s11142-013-9271-6