The Inside Game: Political Donations and Insider Trading

While he was visiting the University of Michigan during his PhD at HEC Paris, accounting professor Thomas Bourveau realized that many of his French classmates had something in common – almost none of them owned stocks.

“That’s a stark contrast to what I have experienced in the US where most of my classmates were already owning or even actively trading stocks” he says.

When Bourveau researched why his French friends had such an antipathy toward investments, he found that many in France believe the market only benefits the elites who had inside access to information on stocks.

“If you think that there are a lot of informed players who trade at the expense of the uniformed,” he says. “Then those uninformed players reasonably ask, ‘Why should I participate?”

“The natural question then becomes why informed players would be willing to trade in the French stock markets,” Bourveau says, noting that those actions are unlawful.

Although academic research has uncovered a variety of factors that can lead individuals to a commit crime, a key consideration, seen through the lens of Gary Becker’s classic model of crime as rational behavior, is the expected costs associated with this crime.

These costs depend on the likelihood of getting caught and the severity of the punishment. In his study, Bourveau examines whether a feeling of impunity arising from the proximity with politicians can explain the choice to engage in white-collar crimes in financial markets.

“Executives who feel protected from enforcement are more likely to engage in trading on private information and one factor that might favor this is their political connections,” he says.

Bourveau’s investigation led to a groundbreaking paper, “Political Connections and White-collar Crime: Evidence From Insider Trading in France,” which was recently accepted in the Journal of the European Economic Association. Co-written with Renaud Coulomb of the University of Melbourne and Marc Sangnier of Aix-Marseille University & the University of Namur, the article provides indirect evidence of insider trading by well-connected leaders at public firms in the aftermath of the 2007 French election.

They use the 2007 French presidential election as a setting to analyze the extent to which directors connected to future president Nicolas Sarkozy modified their trading behavior from the pre-to the post-election period, relative to non-connected directors. Connected directors are composed of large campaign contributors on a list that was leaked by a French news website Mediapart, and businessmen known publicly to be Sarkozy’s friends.

Their statistical tests lead to three findings. Connected directors experience higher abnormal stock returns around the public disclosure of their purchase transactions. Furthermore, connected directors are less likely to report their trades in a timely manner and more likely to trade closer to earnings announcement when the likelihood of holding private information is higher after the 2007 election.

“We did not find direct evidence – that needs to be clear—but we found a set of comprehensive, coherent, indirect evidence that executives and board members who contributed to Nicolas Sarkozy’s campaign traded, on average, more on private information after the election,” Bourveau says.

Bourveau says the research seeks to frame the regulatory gray area that exists in stock markets and cast it in a more ethical light.

“Say you cross at a red light, but there are no cars,” he says. “You’re not harming anyone outright; you’re taking a risk.”

“But in capital markets,” Bourveau continues, “if you allow individuals who have private information on their firms and trade on this information, they are trading at the expense of uninformed investors, in other words, you and me.”

Bourveau notes there is not an analogous set of circumstances in the United States, where individual investment in the market is much more widespread, and securities regulation is stronger and more efficient than it is in France.

Still, Bourveau says the US is not immune to the problems that occur when executives and political have a close relationship, citing David Perdue, the Republican senator from Georgia, whose stock portfolio has recently been scrutinized in the American press.

While Bourveau doesn’t suggest any specific policy changes or regulatory reforms, he hopes the paper continues the discussion on two important issues. The first is ensuring fairness in the stock market and consideration on how insider trading should be regulated. And second, Bourveau advocates continuing discussion about how the relationship between business and politics should 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?,” he asks.


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