Can Adverse Effects of Private Management-Investor Meetings Be Mitigated by Board Independence?

Private meetings between management and investors (site visits) occur worldwide and are generally held at corporate headquarters with invited investors and sell-side analysts.  Ng and Troianovski (WSJ, 2015) report that U.S. investors spend $1.4 billion a year for face time with executives.  In-house meetings differ from other management-investor interactions such as investor conferences and analyst or investor days in that they are generally not publicized in advance and their content may never become public unless hosting firms are required to publish the meeting details by regulation.  While private meetings between investors and corporate management are common in the U.S., these meetings are a black box to public investors, as there are generally no requirements to disclose anything about their timing or content.  The Shenzhen Stock Exchange (SZSE) in China is the only stock market that requires disclosure of the existence, participants, and content of these private meetings.  The SZSE provides a unique setting to look inside the black box to examine the attributes and consequences of private in-house meetings.

We recently conducted two studies of the consequences of private meetings between managers and investors. Using firms listed on the SZSE, we compiled a large hand-collected dataset of over 17,000 private meeting summary reports from mid 2012 through the end of 2014.

Potential adverse effects of private meetings

In our first paper published in the Review of Accounting Studies, we find that (1) the stock market reacts strongly around private meeting dates (despite those dates being undisclosed publicly) suggesting that these meetings are informative to investors, (2) corporate insiders of SZSE-listed firms conducted over one-half of their stock sales (totaling $8.7 billion) around these private meetings, (3) those insiders who attended private meetings made more than 90 percent of their purchases around these meetings, (4) at least some of these insider trades appear to be opportunistic in that some insiders are able to time their transactions by selling (purchasing) relatively more shares before bad (good) news disclosures, while postponing selling (purchasing) when there is good (bad) news to be disclosed in the meeting, and (5) insiders earn substantial gains by trading around private meetings, and these gains are larger for insiders who participated in the private meetings.

Can board independence enhance the benefits of private meetings?

In our second study, we argue that private meetings have benefits and costs, and that a more independent board structure may boost the benefits of hosting private meetings while lowering their potential costs.  Using the same hand-collected sample of over 17,000 private meetings of SZSE-listed firms, we find an association between board independence and (1) private meeting frequency, which suggests better communication with key outside investors, (2) timeliness of disclosures to the public, and (3) relatively subdued market reactions to these private meetings, suggesting that a more independent board may discourage managers from sharing price-sensitive information with private meeting participants.

Can board independence mitigate the potential adverse effects of private meetings?

While we also detect a strong positive association between the number of private in-house meetings and the extent of insider trading activities, we find that board independence is associated with (1) reduced insider trading around private in-house meetings, and (2) reduced insider trading profitability around private in-house meetings and in general among SZSE-listed firms.  Further, by manually matching meeting participants’ names in the meeting summary notes with the directory of independent board directors in the CSMAR (China Stock Market & Accounting Research) database, we also find that insider trading is incrementally lower when outside directors attend private meetings.

Overall, results of our second study suggest that a relatively independent board can influence the nature and extent of disclosures during private site visits and perhaps limit potential adverse effects associated with these meetings.  Greater board independence may be a partial substitute for additional disclosure regulation.  Implementing this simple board governance device likely costs less than instituting new formal regulatory disclosure requirements, which can impose unforeseen side effects.

In summary

Private meetings between management and select investors occur worldwide behind a veil of secrecy.  Given that human behavior is likely universal, our results have potential implications beyond China.  Our first paper raises questions about potential unforeseen consequences of private meetings in the U.S. and other Western economies.  Our second paper suggests that more independent boards yield benefits due to improved communication through private meetings while reducing associated negative consequences such as insider trading around these meetings.

Some have recommended that the U.S. and other Western economies adopt disclosure rules similar to those required by the SZSE.  The goals of such requirements include: exposing potential negative consequences of these previously private meetings, leveling the playing field between private meeting participants and general investors, and curtailing documented opportunistic insider trading around these private meetings.  Our results suggest that, while greater board independence mitigates some negative consequences of private meetings, simple disclosure requirements would shine a bright light directly on the practice of private meetings – and perhaps change behavior.

This post comes to us from professors Robert M. Bowen at the University of San Diego and the University of Washington, Shantanu Dutta at the University of Ottawa, Songlian Tang at East China University of Science and Technology, and Pengcheng Zhu at the University of San Diego.  It is based on their recent papers, “Inside the ‘black box’ of private in-house meetings,” available here and here, and “Does board independence mitigate potential adverse effects of private in-house meetings?” available here.