Option Backdating Announcements and Information Advantage of Institutional Investors

Abstract

This paper uses a unique transaction-level fund trading dataset to evaluate institutional investors’ trading performance. Our research design follows a two-step procedure. In the first stage, we identify funds that heavily sold shares in firms before their public revelation of stock option backdating investigations, and thus establish fund-firm pairs of interest. Results show that the funds earn more than 9% on their paired firms in the backdating event. In the second stage, we focus on trading that takes place at other times and find that the funds are more likely to make correct trades before the earnings announcements of their paired firms, and they trade more actively and perform better on these paired firms in general. However, the superior performance is evident only in the pre-backdating-announcement period. We interpret our results as evidence that institutions possess information advantage on their paired firms, but this advantage deteriorates following the backdating revelation.

Keywords: Information advantage, fund-firm pair, institutional investors, option backdating, earnings announcements

JEL Classification: M41, K22, G14, G38