Political Connections and Insider Trading
The ties between businessmen and politicians have received close scrutiny in recent years. The 2016 presidential election in the United States has increased the public feeling that business and politics are more co-mingled than ever. In a recent academic study, we investigate whether political connections affect individuals’ propensity to engage in white-collar crime. In particular, we focus on trading activities in financial markets by managers and board members of French listed firms.
Managers and board members of listed companies often receive stocks as part of their compensation packages. They can also directly purchase additional stocks and sell them later in financial markets. However, regulations around the world prevent insiders from trading stocks of their company using private material information. That is, they cannot trade based on information that is not yet available to other financial markets participants. In France, the French Monetary and Financial Code prohibits insiders from carrying out or facilitating transactions before the public has knowledge of the privileged piece of information (Article L465-1). The 2005 version of the code lists a maximum penalty of two years imprisonment and a fine of 1.5 million euros, which can be increased up to ten times the amount of the alleged illegal profit.
Suspicious trading activities have received ample attention from regulators, media and scholars because of their potential detrimental effects on the economy. They can reduce public trust in the stock market, discourage outsiders from investing in equities and can also create conflicts of interest for board members. Academic research has uncovered a variety of factors that can lead individuals to rationally commit crimes. A major consideration is the expected cost of being caught and punished. This cost depends both on the performance of judicial authorities and on individuals’ own characteristics, such as their social network that can be used to reduce exposure to prosecution. In this paper, we examine whether a feeling of impunity arising from the proximity with politicians can explain the choice to engage in white-collar crimes in financial markets.
We use the 2007 French presidential election in a difference-in-differences framework and measure the extent to which directors connected to Nicolas Sarkozy modified their trading behavior from the pre- to the post-election period, relative to non-connected directors. We define political connections to Nicolas Sarkozy via two channels. Our first source is the group of major individual contributors to Nicolas Sarkozy’s presidential campaign, which we obtained from a French news website—Mediapart.fr—that leaked the list in 2012. The second is the list of businessmen known publicly to be Sarkozy’s friends constructed by Coulomb and Sangnier (2014). We compare those 43 individuals to various groups of managers and board members of French listed companies that are not directly connected to Nicolas Sarkozy.
Our scientific approach consists in comparing the trading behavior in financial markets of connected and non-connected managers and board members around the 2007 French presidential election. We study 7385 trades made by 1643 directors from 493 listed companies. France in 2007 provides a particularly appropriate context to examine the effect of political connections on individuals’ trading behavior. First, both the regulatory framework and de facto prosecution of insider trading were stable around the 2007 French presidential election. In addition, a European directive implemented in 2006 made it compulsory for all board members of publicly listed French firms to report their trades of their company’s shares to the Autorité des Marchés Financiers (AMF), the French regulatory body. This means we have access to detailed, trade-level and presumably comprehensive data. Second, the victory of Nicolas Sarkozy in the 2007 French presidential election represents a large and positive change to the value of pre-election connections to him because of the central role of the president in France. Third, France is particularly well-suited to an examination of directors’ social ties, because the country’s elites are highly concentrated and politically connected. Finally, a key feature of the French context is that companies are not allowed to directly contribute to the financing of political campaigns. Hence, unlike other settings, we are able to observe the effects that arise from individual rather than firm-level connections.
The detailed data on trades by French directors allow us to perform three analyses to capture different dimensions of their trading behavior. We first focus on market abnormal returns around the public disclosure of insider purchases, to determine whether connected directors’ trades contain more private information after Sarkozy’s victory. Abnormal returns are computed as the realized returns minus the expected returns based on market models. Our baseline estimations provide us with a difference-in-differences estimate that ranges between 0.5% and 1.5% around the purchase disclosure date, an economically significant effect. This finding on stock returns may simply reflect the fact that politically connected directors have better information about the government’s future decisions. To disentangle this confounding interpretation from the possibility that directors are breaking the law due to expected impunity, we examine changes in trade reporting behavior as well as in the timing of directors’ trades relative to corporate results announcements. We find that individuals connected to Nicolas Sarkozy are less likely to respect the reporting time limit on their trade and more likely to trade closer to earnings announcement, when the likelihood of holding private information is higher.
Overall, our analyses allow us to offer multiple indirect evidence of illegal behavior. While caution is required to interpret our results, we do find evidence that connected individuals modified their behavior in financial markets after the election. Our results contribute to two regulatory debates at play worldwide: (1) How should insider trading be regulated? (2) How should the relationship between business and politics be governed? If connected individuals that contribute personally to campaigns can extract benefits from their political ties, what is the optimal funding system for political campaigns?
Thomas Bourveau is an Assistant Professor at the Hong Kong University of Science & Technology, Renaud Coulomb is an Assistant Professor at the University of Melbourne, and Marc Sangnier is an Assistant Professor at the Aix-Marseille University - Aix-Marseille School of Economics.
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