Digital Insiders and Informed Trading Before Earnings Announcements

45 Pages Posted: 30 May 2018 Last revised: 15 Dec 2019

See all articles by Henk Berkman

Henk Berkman

University of Auckland - Business School

Jonathan Jona

Tulane University, A.B. Freeman School of Business, Finance & Economics, Students

Gladys Lee

University of Melbourne

Naomi S. Soderstrom

University of Melbourne

Date Written: November 28, 2019

Abstract

While it is widely acknowledged that companies face increasing cybersecurity risk stemming from hackers stealing customer information, a relatively unknown cybersecurity risk is from information leakage and subsequent trading by digital insiders – hackers who target corporations to obtain non-public corporate information for illegal trading. We use a firm-specific measure of cybersecurity risk mitigation based on textual analysis of 10-Ks to proxy for the organization’s ability to reduce the probability of digital insider trading. We find that a larger share of new earnings information is incorporated into prices prior to earnings announcements for firms with low cybersecurity risk mitigation scores. We also find that pre-announcement trading by short sellers is more predictive of earnings surprises for firms with low cybersecurity risk mitigation. Further, on days closer to earnings announcements, firms with relatively low cybersecurity risk mitigation scores experience a larger increase in bid-ask spreads, particularly the adverse selection component. These results suggest that weak cybersecurity risk mitigation provides opportunities for acquisition of private information and that trading by privately informed traders is more likely in stocks of firms with higher exposure to cybercrimes.

Keywords: cost of liquidity, cybersecurity, cyber risk disclosure, hacker, adverse selection, bid ask spread, price impact, Amihud ratio, insider trading, probability of informed trading, private information, adverse selection

JEL Classification: G14, G18, K24, M48, M41

Suggested Citation

Berkman, Henk and Jona, Jonathan and Lee, Gladys and Soderstrom, Naomi S., Digital Insiders and Informed Trading Before Earnings Announcements (November 28, 2019). Available at SSRN: https://ssrn.com/abstract=3180531 or http://dx.doi.org/10.2139/ssrn.3180531

Henk Berkman

University of Auckland - Business School ( email )

Private Bag 92019
Room: 577
Auckland
New Zealand
(64 9) 3737599 Ext. 7181 (Phone)
(64 9) 3737406 (Fax)

Jonathan Jona (Contact Author)

Tulane University, A.B. Freeman School of Business, Finance & Economics, Students ( email )

7 McAlister Drive
New Orleans, LA
United States

Gladys Lee

University of Melbourne ( email )

185 Pelham Street
Carlton, Victoria 3053
Australia

Naomi S. Soderstrom

University of Melbourne ( email )

Victoria
Melbourne, 3010
Australia

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