Nejat Seyhun is the Jerome B. & Eilene M. York Professor of Business Administration and Professor of Finance at the University of Michigan Ross School of Business. This post is based on a recent paper by Mr. Seyhun; Sureyya Burcu Avci, Research Scholar at Sabanci University; Cindy A. Schipani, Merwin H. Waterman Collegiate Professor of Business Administration and Professor of Business Law at the University of Michigan Ross School of Business; and Andrew Verstein, Professor of Law at UCLA. Related research from the Program on Corporate Governance includes Lucky CEOs and Lucky Directors by Lucian Bebchuk, Yaniv Grinstein and Urs Peyer (discussed on the Forum here).
Would any of us refuse a gift? We typically do not, unless of course the gift resembles a Trojan Horse. In this blog, we hope to convince you that even if you do not refuse it, you should treat a gift from insiders with upmost care. The problem is that previous studies have shown that corporate insiders earn abnormal returns on not only open market sales and purchases of their firms’ stock, but also on their gifts. Specifically, corporate executives tend to make charitable gifts of their firms’ common stock just prior to a decline in the company’s share prices. If insiders win, who loses? The timing of these gifts is troublesome since the evidence suggests that corporate executives may be defrauding not only their shareholders but also the charities that receive the stock and possibly the taxpayers. If insiders manipulate the information flow in their companies to maximize their benefit, this can potentially hurt the shareholders. Similarly, if insiders’ actions send a wrong signal about corporate governance in their firms, this can also hurt the shareholders. If they donate overvalued stock, the donation will not benefit the charities as much as they claim. Finally, if they unfairly maximize their tax deductions, this can hurt taxpayers. Given the significant policy implications of these findings, we revisit this important issue in an attempt to clarify why insiders are able to time their gifts successfully.
A recent case that illustrates this troublesome development occurred on July 29, 2020 in Kodak stock. After surging 2,757%, a large shareholder and member of Kodak’s board of directors, George Karfunkel donated three million shares of Kodak shares on a day when stock prices fluctuated between $17.50 and $60, (or valued between $50 million and $180 million) to a charitable synagogue in New York state (See, Devine, Curt, CNN Business, “Kodak insider’s stock donation raises new concerns around the company’s government loan“.) Less than one month later, Kodak shares were trading below $6. Had the same donation taken place on August 27, 2020, it would have been worth less than $20 million. This suspicious donation contributed to concerns about unfair business practices at Kodak and jeopardized a large government loan promise to Kodak. In return, these troubling developments have contributed to a precipitous drop in Kodak stock price, thereby severely hurting Kodak shareholders.
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