The COVID-19 pandemic has dramatically changed how businesses operate, resulting in unprecedented stock market effects. While the U.S. stock market has historically shown little to no reaction to an infectious disease outbreak, COVID-19 precipitated a global stock market downturn now known as the “stock market crash of 2020” (Baker et al., 2020). The natural inclination of investors and the media is to wonder whether anyone could have seen it coming. We suggest that corporate insiders with geographic proximity to China and the early developments of COVID-19 were more attentive to, and better understood, the potential effects of COVID-19 on their firm’s value.
The initial stages of the COVID-19 outbreak were characterized by a lack of transparency and clarity from the Chinese government. Despite a growing number of confirmed cases and deaths in China, the beginning stages of the pandemic corresponded to record high closings of both the NASDAQ Composite and the S&P 500 indices. The first indication that COVID-19 represented a major pandemic threat occurred in late January 2020, as Chinese officials announced that the virus could be transmitted between people. As a result, Wuhan, as well as several other cities within the province, were placed under immediate lockdown. It took roughly one month following this announcement for U.S. financial markets to fully react to the virus’ effects on global supply and demand chains. By March 23, COVID-19 was deemed a pandemic, much of the world was placed on lockdown, and the S&P 500 had fallen approximately 34 percent from its February high.
We examine whether insiders of corporations with greater geographic exposure to COVID-19 sold more stock before the market downturn than insiders of corporations without geographic exposure to COVID-19. If so, it would be consistent with the geographically closer insiders’ anticipation of the pandemic’s effect on their firm’s stock price. Although the market as a whole was relatively slow to respond, we expect that corporate insiders of firms with production or supply-chain activities in China (“China insiders”) were better able to incorporate and act upon information related to the COVID-19 outbreak ahead of other equity market participants (“non-China insiders”).
We do not suggest that China insiders had or traded upon material, private information about their firms (which would be illegal under the Securities and Exchange Acts of 1933 and 1934) because COVID-19 and the Wuhan lockdown were reported by the U.S. media and publicly disclosed in financial reports of China-connected firms as early as January 2020. Instead, we believe that China insiders, because of their firms’ production or supply chain connections to China, were more attentive to and better understood the implications of the COVID-19 related news being reported by the media and disclosed by their own firm. China insiders then acted upon this information sooner than non-China insiders by selling their own firm’s stock in advance of the overall stock market decline.
Corporate insiders must publicly report trades in their own firm’s stock to the SEC. We gather information about corporate insider trades from January 1, 2018 through April 30, 2020 and combine it with financial statement information, daily stock price data, and information about the countries to which the corporation exports or from which the corporation imports (Hoberg and Moon, 2017). We then compare patterns of insider sales both before and after the COVID-19 outbreak for China insiders and non-China insiders.
We find that, pre-COVID-19, China insiders and non-China insiders sold stock in their own firms following similar increases in value. In the COVID-19 period, however, the patterns of insider stock sales of China insiders and non-China insiders diverged. Non-China insiders appear to have sold their own firm’s stock only after their firm experienced initial stock price declines while the sales of China insiders appear to have been better timed to preempt any decline in the stock price of their firm. More specifically, we find that China insiders sold more of their own firm’s stock in the earliest stages of the COVID-19 pandemic and less in the later stages than did the non-China insiders. The earlier timing of their insider sales, therefore, allowed them to be significantly more profitable than the sales of non-China insiders during the COVID-19 period. We find that being a China insider is associated with an approximately 3 percent larger profit on the sale of their own firm stock in the COVID-19 period. In economic terms, this suggests that China insiders avoided approximately $300 million in aggregate losses by selling stock before the initial stages of the stock market crash brought about by COVID-19.
A corporation’s insiders are comprised of its C-suite officers, such as the CEO and CFO, as well as the members of its board of directors. The corporation’s officers are likely more attuned than the members of its board of directors to information affecting a firm’s supply chains and workforce and the virus’ potential to similarly affect other firms. However, the insider trades of CEOs and other top level officers are also more highly scrutinized, and more often litigated, than those of the corporation’s directors. This would reduce corporate officers’ willingness to sell their own firm’s stock even if they anticipated that the share price would decline. We find that the China insider trading activity we document is primarily driven by the trades of firm officers who were better able to assess the pandemic’s effects on their firm.
Overall, research on insider trading finds very little evidence that trades by corporate insiders preempt market movements. For example, previous research on whether corporate insiders of financial firms were able to predict the impending financial crisis of 2007-2008 finds that they did not, even though they were the market participants best positioned to do so (Adebambo et al., 2015). Our work suggests another unique aspect to the market effects of COVID-19 in that corporate insiders with more direct exposure to the effect of COVID-19-related risks were better able to anticipate their firm’s share price decline than other stock market participants. We also show that the aggregate total of China insider trades was a leading indicator of market returns in the early stages of COVID-19, suggesting that China insiders were able to profit from information that had not yet been incorporated by the overall stock market.
Adebambo, B., P. Brockman, and X. Yan. 2015. Anticipating the 2007-2008 Financial Crisis: Who Knew What and When Did They Know It? Journal of Financial and Quantitative Analysis 50 (4): 647-669.
Baker, S., N. Bloom, S. Davis, K. Kost, M. Sammon, and T. Viratyosin. 2020. The Unprecedented Stock Market Impact of COVID-19. NBER Working Paper No. 26945: https://www.nber.org/papers/w26945.
Hoberg, G., and S. K. Moon. 2017. Offshore Activities and Financial vs. Operational Hedging. Journal of Financial Economics 125: 217-244.
This post comes to us from professors Erin Henry at the University of Arkansas, George A. Plesko at the University of Connecticut, and Caleb Rawson at the University of Arkansas. It is based on their recent paper, “Geographic Proximity and Insider Trading: Evidence from Covid-19,” available here.