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E-MailNejat 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.
It is well known that insiders have access to material non-public information and they use this informational advantage when they engage in open market sales and purchases of their firm’s stock. Insiders tend to buy stock before good news and sell stock before bad news. One possibility regarding gifts of stock is that insiders may also use access to material non-public information to time their gifts.
Three hypotheses that can explain insiders’ success in timing their gifts include:
(1) Insiders utilize material, non-public information to delay or accelerate their gifts to correspond to a high stock price (information); 2) insiders delay or accelerate public disclosures to boost or protect the stock price at the time of a planned gift (access); 3) insiders falsely report their gift as occurring on some past date with a higher stock (backdating). One can argue that these three explanations cover a large spectrum from legal and ethical conduct to illegal and unethical conduct. At one end of the spectrum, postponing their donations until after the stock price has naturally appreciated seems fairly benign. At the other end of the spectrum, illegally backdating the donation dates raise both criminal and ethical concerns.
To clarify this picture, we reinvestigate the timing of gifts. In our recently published paper in Duke Law Journal instead of examining executives’ gifts, we focus on whether gift giving by large shareholders is well timed and whether this timing is explained by one of our three hypotheses, rather than by other explanations, such as luck.
We investigate the timing of gifts by utilizing a comprehensive database that includes all gifts of common stock by large shareholders in all publicly listed firms in the United States. Our data covers all reported gifts of common stock and contains over 9,000 observations between 1986 and 2020. The total volume of gifts contained in our dataset is approximately 2.1 billion shares, with a dollar value of approximately $50 billion. Consequently, our findings are general and apply to all large shareholders’ gifts of their firm’s stock. Given the policy implications, our findings are important from legal, economic, as well as corporate governance perspectives.
Overall, we find that large shareholders’ gifts are suspiciously well timed over the period of 1986-2020. Stock prices rise abnormally about 6% during the one-year period before the gift date and they fall abnormally by about 4% during the one year after the gift date. We show that this result cannot reasonably arise from explanations such as luck or general skill as investors. To the contrary, our research demonstrates that the lion’s share of this timing probably reflects access to information. Despite lacking an executive role or a seat on the board, these large shareholders are somehow learning about corporate announcements before they are made and using this foreknowledge to time gifts. While we do not conclude that backdating is the primary cause of insiders’ excellent timing, we nevertheless find evidence of backdating: abnormal returns are stronger for late-reported gifts, which is consistent with insiders looking back over a long window to select the very best date to claim as the gift date. Insiders’ comfort in using inside information and backdating arises from a lax reporting environment. While insider trades must be reported within just a few days, insider gifts can be concealed for over a year before any public filing. We suggest policy recommendations that should improve the timely reporting of gifts and compliance with general anti-fraud provisions of federal securities laws.
Our finding that large shareholders’ gifts are well timed also has tax law implications. Under U.S. tax law, the donor of gifts of stock to public or private charitable foundations may obtain a personal income tax deduction for the market value of the shares while simultaneously avoiding the capital gains tax that would be due if the shares were sold. Furthermore, gifting may avoid prohibitions of federal insider trading laws. These loopholes create a temptation for potentially illegal exploitation. We recommend immediate closure of these loopholes, and we are heartened to see that the SEC agrees. On December 15, 2021, the Commission proposed a new rule requiring timelier disclosure of insider gifts.
The complete paper is available for download here.
