Welcome to Darren Roulstone’s Homepage
Associate Professor of
Accounting and Director of the Accounting Ph.D. Program
The Fisher College of Business
The Ohio State University
Published or Forthcoming Papers:
Evidence
on the Non-linear Relation between Insider Trading Decisions and Future
Earnings Information (with Joseph D. Piotroski; Journal of Law, Economics, and Policy Volume 4 No. 2)
In this paper, we provide
evidence that the relations between insider trading decisions and next year's
earnings are not strictly linear. We find that insider purchases are
positively related to next year's earnings innovation and that this relation is
attenuated in the case of extreme positive innovations. We also find that
insider selling and option exercises are negatively related to next year's
earnings innovation and that these relations are attenuated in the case of
extreme positive and negative innovations. We conclude that the observed
variation in trading decisions is consistent with the existence of potential
legal liability costs. Our estimations also suggest that aversion to
trading due to legal liability concerns is stronger for insider selling and
option exercises than for insider purchasing. Finally, we investigate the
role of earnings persistence as an alternate explanation for our results. We find that insiders only trade on
persistent, future earnings innovations, and that, after controlling for
persistence, insiders still curtail trading when innovations are extreme.
Do Insider Trades Reflect
Both Contrarian Beliefs and Superior Knowledge about Future Cash-Flow
Realizations? (With Joseph D. Piotroski; Journal
of Accounting and Economics, Volume 39 No.1, 2005, pages 55-82)
This
paper examines whether insider trades reflect superior knowledge of future cash
flow realizations, as proxied by the firm’s future
return and earnings performance. We find
strong evidence that insider trades are positively associated with the firm’s
future earnings performance. This relation
is shown to be incremental to the book-to-market and past return relations
documented in Rozeff and Zaman
(1998), suggesting that insiders trade on both transitory security misvaluation and
private information about future cash-flow payoffs. These results are shown to be robust to
several measures of insider trading behavior and future earnings
innovations. We show that the relation
between insider trades and future earnings performance is amplified
(attenuated) as the likely ex ante benefits (costs) to trading on financial
performance information increase.
Finally, we find that insider trading behavior within book-to-market
portfolios varies with the horizon of the subsequent earnings news, with the
sign of the relation between insider purchases and contemporaneous earnings
being negative (positive) for glamour (value) firms.
The Influence of Analysts,
Institutional Investors, and Insiders on the Incorporation of Market, Industry
and Firm-Specific Information into Stock Prices (With Joseph D. Piotroski; Accounting Review Volume 79 No. 4, 2004)
This
paper investigates whether analysts, institutional investors and insiders
increase the amount of firm-specific versus industry-specific information found
in prices. We measure firm and industry
specific information in two ways: stock return synchronicity with market and
industry returns (Morck, Yeung
and Yu [2000]); and firm and industry-earnings response coefficients (Ayers and
Freeman [1997]). Using both measures we
find that analyst activity contributes to the incorporation of both types of information;
however, industry effects are greater than firm-level effects. Contrarily, insider transactions and changes
in institutional holdings have the net effect of increasing the amount of
firm-specific information in prices.
These results are consistent with the notion that insiders have the
greatest access to firm information, while analysts have more limited access to
this information.
The Relation Between Insider-Trading Restrictions and Executive
Compensation (Journal of Accounting Research, Volume 41 (June) 2003)
This paper investigates the impact of firm-level,
insider-trading restrictions on executive compensation. Using a trading-window proxy for the
existence of such restrictions I test theoretical predictions that insiders
will demand compensation for these restrictions and that firms will need to
increase incentives to restricted insiders.
I find that firms that restrict insider trading pay a premium in total
compensation after controlling for standard economic determinants of pay. Further, these firms use more incentive-based
compensation relative to firms that do not restrict insider trading, e.g.,
equity grants and bonuses are higher for these firms. Finally, insiders at these firms hold larger
equity positions than insiders at “unrestricted” firms. These results hold after controlling for the
endogeneity of the decision to impose the restrictions and support the idea
that insider trading plays a role in rewarding and motivating executives.
Analyst Following and Market
Liquidity (Contemporary Accounting Research, Volume 20 (Fall) 2003)
This paper investigates the
relationship between analyst characteristics (number of analysts following a
firm and their forecast dispersion) and market liquidity characteristics
(bid-ask spreads and depths and the adverse-selection component of the
spread). Prior research has found
contradictory results on the relation between analyst following and market
liquidity and has offered differing theories on how analysts affect
liquidity. While prior research has
posited analysts as proxies for privately informed trade or as signals of
information asymmetry, I hypothesize that analysts provide public information,
implying that analyst following (forecast dispersion) should have a positive
(negative) association with liquidity.
Cross-sectional OLS and simultaneous estimations provide support for
this hypothesis. The results are both
statistically significant and economically important. Granger-causality tests indicate that analyst
characteristics lead market liquidity characteristics. I also find that depths are negatively
correlated with the adverse-selection component of the spread, a finding that
reinforces the view that market makers adjust both spreads and depths in
reaction to information asymmetry problems.
These results clarify the role of analysts in providing information to
financial markets and highlight benefits of increased analyst following.
Effect of the SEC Financial
Reporting Release No. 48 on Derivative and Market Risk Disclosures (Accounting Horizons, Volume 13
(December) 1999)
This study compares the
disclosures about derivatives and market risk made by 25 SEC registrants in the
years before (1996) and after (1997) the adoption of Financial Reporting
Release No. 48 (SEC 1997) (FRR No. 48).
FRR No. 48 requires firms to disclose how they account for derivatives
and provide quantitative and qualitative disclosures about exposures to market
risk. Market risk disclosures,
encouraged but not required under FAS No. 119, improved greatly under FRR No.
48 but varied widely in detail and clarity.
The majority of registrants provided quantitative and qualitative
disclosures of market risk; however, only about half of these firms discussed
the details and limitations of their risk measurement models and
disclosures. Further, certain required
or strongly recommended contextual disclosures were almost completely
absent. Firms appear to prefer
relatively complicated but more discreet disclosure formats to simpler but more
revealing disclosure formats. Overall,
while registrants greatly increased their disclosures about market risk, the
disclosures leave room for improvement in future filings. These findings have significance for
disclosure choice in general and the adoption of FAS No. 133 in particular.
Recent Working Papers:
Insider
Trading and the Information Content of Earnings Announcements (Under
revision for third-round review at the Journal
of Accounting Research)
This paper addresses the
question of whether the net effect of insider trading is to promote accurate
pricing of stocks by conveying insiders’ private information to market
participants. I investigate this
question by examining the relation between insider trading and the information
content of earnings announcements. I
document two main findings: first, decisions to trade are influenced by future
earnings surprises and announcement returns.
Second, insider purchases and sales executed and disclosed prior to an earnings announcement preempt news in the
announcement and have a negative relation with market reactions to the
announcement, consistent with insider trading informing the market. These relations hold after controlling for
the endogenous relation between trading and market reactions and are of an
economically significant magnitude (particularly for insider purchases). These findings are consistent with insiders
trading on private information and their trading conveying information to the
market, two necessary conditions for insider trading to have a net positive
effect on securities pricing.
Do
Insiders Act As Arbitrageurs? (with Itzhak Ben-David)
Past research shows that
trades by corporate insiders (insider trading, repurchases, and SEOs) and firms
generate positive abnormal returns. In
this paper, we provide evidence that these returns are primarily due to
insiders and firms exploiting perceived market mispricing of
public information and not to exploiting private information as is
commonly believed. Our conclusion is
based on three observations. First,
idiosyncratic risk, which is associated with both private information and
limits to arbitrage activity, is associated with return reversals around trades
by corporate insiders. At highly
idiosyncratic firms, returns are low before purchase transactions and high
afterwards with the opposite being true for sale transactions. Second, these patterns are largely robust
when controlling for accounting-related proxies for private knowledge of future
innovations in operating performance and information asymmetry. Furthermore, reversal patterns exist in periods
of both low and high regulatory scrutiny of insider trades. Third, arbitrage forces are weak in highly
idiosyncratic stocks around corporate trades: in these stocks prices drift for
up to 12 months after corporate transactions and institutional investors shun
these stocks.
The
Effects of Insider-Trading Legislation on Trade Timing, Litigation Risk, and
Profitability (with Alan
Jagolinzer)
Prior research indicates that
insiders avoid trading ahead of major disclosure events such as quarterly
earnings announcements and that this avoidance is associated with firm policies
restricting the timing of insider trades (Bettis,
Coles and Lemmon, 2000; Roulstone, 2003).
Garfinkel (1997) provides evidence that this
behavior increased in response to the Insider Trading and Securities Fraud
Enforcement Act of 1988 (ITSFEA). Using
a 24-year sample of insider trades we show that insiders are, over time,
increasingly trading after earnings announcements especially since passage of
ITSFEA. This finding is robust to
controls for insider incentives to trade around earnings announcements. We investigate the economic effects of these
changes by documenting a relation between litigation risk (measured by the
expected probability of 10b-5 litigation) and insider trade timing. Specifically, litigation risk is decreasing
in the extent to which insiders trade following
earnings announcements rather than before earnings announcements. However, while insiders are increasingly
trading during times of lower litigation risk, we fail to find a decrease in
insider-trading profitability over our sample period, suggesting that
regulation (economy-wide and firm-specific) has not limited the ability of
insiders to exploit private information.
Initiations of Analyst
Coverage and Stock-Return Synchronicity
(With Steven Crawford and Eric So)
Prior research shows that
analysts are mainly involved in producing industry- and market-related
information about the firms they cover (Piotroski and Roulstone, 2004; Chan and
Hameed, 2006), but other evidence indicates that analysts
also provide firm-specific information (Liu, 2007). In this study, we
examine how the information produced by analysts when they initiate
coverage contributes to the mix of firm-, industry-, and market-wide
information available about the firm. We use stock return synchronicity
as our measure of the mix of information available about a particular firm,
with more industry and market information being associated with higher levels of
synchronicity. We show that coverage initiations of firms with no prior
analyst coverage increase stock return synchronicity. This result suggests
that an analyst who begins to cover a firm with no existing coverage largely
produces industry- and market-wide information for that firm. On the other hand, analysts initiating
coverage on firms with existing coverage appear to focus on producing
firm-specific information as these initiations lead to reductions in synchronicity.
Our results indicate that the type of information analysts produce in their
initiation reports depends critically on the information being provided by
other analysts.
Why Do Small Stock Acquirers
Underperform in the Long-term? (With
Itzhak Ben-David)
We study the long-term
performance of acquirers with respect to their size and form of payment. Our results shed new light on why stock
acquirers appear to underperform cash acquirers in some studies. We present two main results. First, there is no economically or
statistically significant difference between the performance of large stock
acquirers and large cash acquirers.
Conversely, small stock acquirers underperform small cash acquirers by up
to 12% (18%) in the first 12 (36) months following mergers. Hence, the previously documented
underperformance of stock acquirers is associated primarily with the
underperformance of small stock acquirers.
Second, we find evidence that this underperformance is likely related to
overvaluation at the time of the merger due to limits to arbitrage. We find that underperforming stock acquirers
are hard to value and hard to short. We
find no evidence, however, that underperformance is related
to acquirer-target integration problems or to earnings management prior to
mergers.
Works-in-progress:
Insider Trading and
Executive Turnover (with Rachel Hayes
and Xue Wang)
We investigate the trading
and option exercise behavior of executives prior to executive turnover
events. Preliminary results indicate
that trading and option exercise behavior are associated with upcoming turnover
events and these associations vary with the turnover event characteristics
(e.g., routine versus non-routine turnover).
We are in the data analysis phase of this project.
Early Evidence on
Insider-Trading Activity (With Suraj
Srinivasan and Joseph D. Piotroski)
We examine insider trades
reported to the SEC between 1935 and 1944, a time period marked by lax
enforcement of insider-trading laws (Jaffe, 1973). Our goal is to assess the relative ability of
insiders during this regulatory era to exploit private information as compared
to insiders in the modern era (e.g., after passage of the Insider Trading
Sanctions Act of 1984). Insider trading
activity in the early time period is hand-collected from the official SEC
summaries of insider activity. We are
currently in the data collection and preliminary data-analysis phases of this
study.
What Limits Arbitrage?
Costly Arbitrage, Information Uncertainty, and the Profitability of Fundamental
Analysis (With Joseph D. Piotroski)
A growing literature
investigates the effect of limited arbitrage on the persistence of financial
anomalies (Pontiff, 2005). While most
papers use idiosyncratic risk as a proxy for the cost of arbitrage, information
uncertainty (proxied by measures of earnings quality)
has also been associated with financial anomalies and returns to informed
trading (Francis et al., 2005). As these
measures are correlated, the incremental effects of both idiosyncratic risk and
information uncertainty on market mispricing are an open issue. This project sheds light on this issue by
examining the joint effects of idiosyncratic risk and information uncertainty
on the returns to fundamental analysis.
Analyst Coverage
Initiations and Institutional Holdings
(With Steven Crawford and Eric So)
Security analysts and
institutional owners are two of the major contributors to the information
environment of a firm and a long line of research has investigated the benefits
and costs of coverage by security analysts and institutions. We investigate the relation between
initiations of analyst coverage and changes in the level and breadth of
institutional holdings in order to provide evidence on these questions. We are in the preliminary data analysis phase
of this project.
Insider Activity in
Alleged Earnings-Manipulation Firms
(With Chad Larson and Jonathan Rogers)
We examine the activity of
corporate insiders at firms alleged by the SEC to have manipulated
earnings. We do this by examining firms
that are the subject of Accounting and Auditing Enforcement Releases over the
years 1986-2005. We are in the
data-gathering phase of this project.
Accounting, Finance, and Economics Research Links:
Journal of Accounting
Research
Journal of Accounting and
Economics
American Accounting
Association Homepage
The American Finance Association
and the Journal of Finance
Journal of Financial Economics
Social Science Research Network
Selected Online Business
and Economics Journals