Bachelor Thesis, 2007, 68 Pages
1.1 Problem and Objective of the Paper
1.2 Organization of the Paper
2 Definitions and Basic Principles
2.2 Knowledge-based View and Asymmetric Information
2.2.1 Theoretical Impact of Asymmetric Informatio
2.2.2 Value Creation in the Light of the Knowledge-based View
2.3 Legal Regulations and Institutional Settings in Germany
2.3.1 Insider Trading
126.96.36.199 Illegal Insider Trading
188.8.131.52 Director Dealings
2.3.2 Patent Application Process and Publication
3 Director Dealings on Knowledge of Imminent Breakthroughs
3.1 Classical Rent Appropriation through Insider Trading
3.1.1 Director Dealings as Anti-Cyclical Investing
3.1.2 Abnormal Returns around Announcements
3.2 Research and Development as Instrument for Rent Appropriation
3.2.1 Research and Development, Patents, and the Value of a Firm
3.2.2 Managerial Foresight on Corporate Research and Development
3.3 Patent Application and Director Dealings
3.3.1 Measuring the Scope of a Patent
3.3.2 Abnormal Returns of Director Dealings on Patent Activity
4 Empirical Study
4.1 Sample Data
4.1.1 Director Dealings Sample
4.1.2 Patent Sample
4.1.3 Share and Index Return Sample
4.1.4 Balance Sheet and Profit and Loss Sample
4.1.5 Matching Director Dealings, Share and Index Return, and Patent Sample
4.1.6 Dependent Variables
4.1.7 Independent Variables
4.1.8 Control Variables
4.2.1 Organization of the Study
4.2.2 Long-Horizon Event Study
4.2.3 Short-Horizon Event Study
4.2.4 Regression Analysis
4.3.1 Abnormal Returns after Director Dealings on Patent Applications
4.3.2 Abnormal Returns after Patent Publication
4.3.3 Long-Run Abnormal Returns after Director Dealings and the Impact of Patent Publication
5 Discussion and Implications
List of Tables
Table 1: Insider trading profits grouped by the identity of trades
Table 2: Statistics on director dealings database, from own source
Table 3: Distribution of firms by industry, from own source
Table 4: Balance-sheet and profit and loss indicators as average and sum of all firms
Table 5: Minimum and maximum days during event-window
Table 6: Descriptive statistics of 783 trading-day event window
Table 7: Descriptive statistics of 522 trading-day event window
Table 8: Descriptive statistics of 1095 trading-days event window
Table 9: Comparison descriptive statistics event and reference sample over 522 trading-days event window
Table 10: Comparison descriptive statistics event and reference sample over 783 trading-days event window
Table 11: Comparison descriptive statistics event and reference sample over 1095 trading-days event window
Table 12: BHARs calculated as excess return of event-sample return compared to the reference-sample return
Table 13: Conventional t-statistic
Table 14: Skewness and Kurtosis of different samples compared to normal distribution
Table 15: Skewness-adjusted and bootstrapped skewness-adjusted t-statistic, from own source
Table 16: CAARs and t-statistics for different event samples
Table 17: Pearson correlation Matrix of dependent variable and absolute and natural logarithm of independent variables
Table 18: Regression coefficients of the three models
List of Figures
Figure 1: The different types of knowledge in organizational analysis
Figure 2: Estimation period and event window of long-horizon event study
Figure 3: Estimation period and event window of short-horizon event study
List of Abbreviations
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List of Symbols
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“The only real way to value a patent is as the result of a court case or from a cash settlement” (Stewart, 2007, para. 11). This citation ironically underlines the problem of valuating patents, even though their value to the firm cannot be neglected. On August, 9th 2000 a patent of Eli Lilly on an antidepressant named Prozac was expiring two years earlier than expected in a US-court decision. This resulted in a drop of the share price of 31 percent or 36.8 billion Dollars in total. Furthermore, out of the total market-value of the S&P 500, three-quarters consist of intangible assets. In Germany, a total of 467,000 patents have an enormous impact on the firms' revenues and profits (Beyerle, 2007, para. 2).
While the theoretical impact of patents to the value of the firm has been discussed in detail, a contemporary, easy to employ, and a reliable solution for a practical approach has not been found. It is not only the value of knowledge, but also the knowledge of the existence of intangible assets within the firm that hinders investors from accurately evaluating their investment decisions. More than through developing the perfectly diversified portfolio at individual risk levels, individual and institutional traders try to appropriate their rent by adjusting their investment-decisions according to market expectations or other asset-specific information. While the perfectly diversified portfolio eliminates the asset-specific risk, resulting in a return which is equal to the market return, the attempt of rent appropriation aims to outperform the market.
Even though this is theoretically not possible over the long-run, all kinds of information are being utilized in order to increase profits, and there are only two criteria for this purpose: the market must not know it, and it must be valuable to the firm. This is the case for patent applications on imminent breakthroughs. Neither does the market know of the existence of an innovation before the patent application is being made public, nor can published patents be valued precisely. Nevertheless, the actual value to the firm can be high however, the amount of insiders with a technical understanding and the available information is limited, especially before a patent is being applied for. Even within the organization, only a few people are informed.
With knowledge of an imminent breakthrough, those insiders will certainly be willing to take advantage of their advanced information for their own interest. In theory, if the net-present value of the potential gains less the impending losses and the penalties at the likeliness of being caught is positive, then the insiders will conduct an illegal trade. Trading is only illegal if it is referred to insider information. Accordingly, the threat when trading on the knowledge of imminent breakthroughs is low, since the insider will often trade multiple months before a new patent is even applied for.
“Follow the patents? That's what one research boutique is doing--and its work suggests that investors should pay close attention to companies' patent activity” (Barker, 2002, para. 1). However, this may already be a little bit too late or imprecise. Why should someone take advantage of the signaling effect of a patent application, when an insider has already traded on the same information more than a year ago? This leads to the question of whether or not director dealings are informative or if the informational content of such dealing can or needs to be identified by private investors as a guideline for their own rent appropriation.
The implementation of the new insider law in 2002 introduced reporting obligations for director dealings in Germany. This represented a milestone for the German share-markets in two ways. First, the risks for insiders of illegal trading increased with the better monitoring through governmental institutions. Secondly, the public availability of data on director dealings decreased the information asymmetry between top management and investors. Related studies have shown that directors hold information upon which they are able to outperform the market. Aggregate insider trading appears to be able to predict whether or not the future performance of their firms' share price is able to achieve returns higher than the market. Furthermore, environmental conditions, which positively influence directors’ abilities to achieve abnormal returns have been found. This can be used by outsiders to adapt their investment strategies to those of insiders for participating in their rent appropriation.
But the question of which kind of information is being taken advantage of, remains unclear. The objective of this paper shall be, to prove the existence of abnormal returns of director dealings based on patent applications in a broader framework of indicators for the success of reported insider trading. Furthermore, the focus will be set on the role of patent importance on the actual performance of the different director dealings.
Before discussing the impact of patent applications on director dealings, the first step must be a definitional framework of the frequently used terms such as "insider trading" and "patent" which need to be placed in an economic context. Furthermore, chapter 2 explains basic principals of the two components of insider trading, namely: information asymmetry and corporate value creation. Additionally, the legal and institutional setting for insider trading and the patent application process is being discussed. Herein, the focus will lie on the reduction for information asymmetry through legal regulations. Chapter 3 discusses indicators for and information upon which successful insider trading is based. After distinguishing between the different classical information for directorial rent appropriation, the focus will lie on practically examining whether or not knowledge on imminent breakthroughs are an appropriate vehicle for insider trading. Then, the signaling effect of patent applications on imminent breakthroughs will be discussed, and the indications for a connection between patent applications and director dealings will be provided. In chapter 4 results of the empirical will be reported. The study is organized in three steps, aiming to provide evidence that with increasing patent importance, abnormal returns for related director dealings rise.
The Insider Trading Sanctions Act of 1984 (ITSA) represents the first foray into the legislative area of insider trading in the United States. While penalties for illegal insider trading were increased significantly, a definition for insider trading itself was not given. The Securities and Exchange Commission (SEC) argued that a definition could not be precise enough to include all forms of offenses. Furthermore, clever traders would only come up with schemes which would not violate the legal definition (Macey, 1991, p. 63). According to Sahlman, Stevenson, Roberts and Bhidé (1999), insider trading, from an economic perspective, is defined as “trading by someone who has material nonpublic information about a company and owes a duty to that company, its shareholders, or others, either by reason of employment by the company, or some other fiduciary relationship” (p. 431). More specifically, it is the directors, officers, employees, accountants, attorneys, and consultants who are potential insider groups.
The insider trading itself may take place in many different vehicles. Herein, insiders acquire or dispose shares of their own company through open market transactions, private transactions, or option exercises. In a public transaction, an insider would contact a broker in order to perform the deal. While the broker might be aware of the insider status, the market maker or trader on the other side is unlikely to do so. This anonymity causes information asymmetry in the market (Seyhun, 1998, p. 2).
The motivation of insiders for trading shares is different form case to case. Generally, purchasing stock of a company, with which they are related as described above, has only the objective of making money by taking advantage of superior information. On the other side, selling corporate shares may have further reasons, such as: liquidity, tax considerations, or portfolio diversification (Stolz, 2006, p. 450). Also, the sort of information which leads to higher profits of insider trading, may vary from deal to deal and from insider to insider. This needs to be discussed more deeply at a later stage.
One sort of information being used by an insider to appropriate rent is his knowledge of imminent breakthroughs. While certain members of the corporate organization may be informed about major research and development (R&D) projects from an early stage on, this sort of information will not become public, either before the technology is used for a marketed product, or before a patent has been applied for and the application is officially made public by the according authority (Ahuja, Coff, & Lee, 2005, p. 795). According to Pienkos (2005) a patent is a “document that defines the scope of patent rights to exclude others from making, using, or selling an invention that is the subject of the patent” (p. 1). However, not all inventions are patentable. Overall, not any innovation which seems inventive enough will be patented, and some innovations which appear to be hardly inventive can nevertheless be patent non-obvious. Generally, whether or not a patent is granted depends on certain criteria: if the innovation is of specific subject matter, useful, novel, and non-obvious it may also be patentable (Pienkos, 2005, p. 41). Besides the legal background of patent applications, the question of whether a patent will be applied for a certain innovation also depends on the corporate patent strategy of the firm. A patent strategy implies which kinds of inventions are being patented for which reasons, and which market and production areas are being covered (Gassmann & Bader, 2006, p. 31). Consequently, the point in time at which information on a breakthrough becomes public is way after the information is available to corporate insiders. A director, employee, or any other insider in the organization is able to complete a transaction before the value adding information has been priced on the share markets.
When trading on insider information, two criteria are essential for rent appropriation. First, the information needs to be unknown by the market. Secondly, the informational content needs to imply the potential for adding value to the firm. In the following subsection, for both criteria, the theoretical foundations are discussed.
The theoretical foundation of information asymmetry can be found in new institutional economics. Herein, the principal agent theory is discussing subsequent issues like the solvability of such problems. The major difficulty is that different members of an organization have different objectives. While the agent is being selected for his specific knowledge, the principal will never be able to fully review the agent’s performance. One may expect that private information will be pursued by the agent for his own interests. A conflict in objectives may arise. Generally, two types of private information exist: either the agent can take actions without the risk of being observed by the principal (moral hazard or hidden action); or, the agent has some knowledge on his own cost or valuation which is ignored by the principal (adverse selection or hidden knowledge) (Martimort & Laffont, 2002, pp. 2-3).
This is displayed in the case of management and corporate stakeholders, “all corporate investments create information asymmetries because managers can continually observe changes in investment productivity on an individual asset basis… whereas outsiders obtain only highly aggregate information on investment productivity at discrete points of time” (Aboody & Lev, 2000, p. 2749). In order to be able to proxy the extent of information asymmetry, researchers use different indicators, such as: number of analysts following the firm, number of competing traders, insiders or institutional ownership. Furthermore, the size of the firm, the volume of the trade, financial analysts forecasting errors of earnings, and the volatility of abnormal stock returns have proven to be able to indicate on the level of information asymmetry. Nevertheless, these indicators are noisy, meaning susceptible to many other firm and market attributes (Aboody & Lev, 2000, pp. 2747-2748).
Information asymmetry between rivals is certainly to the advantage of the firm, and accordingly intentional. On the other side, this makes it hard to sufficiently inform shareholders about the firm’s future prospects. Especially in the field of R&D, breakthroughs are often kept a secret until full patent protection can be achieved. While patented knowledge should already be incorporated into the share price of the firm, the real value may also significantly depend on the early stage R&D efforts. It is a paradox that on the one side, by not informing shareholders on R&D progress their interests are being served, and on the other side this prevents them from fully understanding managerial actions and long-term goals. Thus, efficient monitoring is not given (Coff & Lee, 2003, p. 184). It is exactly for this reason why Aboody & Lev (2000) suggest R&D as a less-noisy measurement of information asymmetry (p. 2748). R&D of different firms is unique to the firm and mostly independent from the environment, while other indicators are not.
This leads us to the question: do scientific breakthroughs add value to a firm? In the context of this paper, this question plays a major role. After having found that information asymmetry exists, if the information of an insider is valuable. The knowledge-based view is the theoretical answer, following the resource-based theory. Herein, it is distinguished between core and peripheral resources: while factors like technological capability, advantageous location, high market share, product design and customer loyalty contribute to abnormal profits, a high rentability and the corporate advantage; other resources, such as communication, computer and production facilities merely add value (Spencer, 1994, p. 356). For the purpose of this paper, we shall focus on technological capability.
The question following this particular resource is, where technical knowledge is actually located within an organization. According to Nelson and Winter (1982) the possession of technical “knowledge” is an attribute of the firm as a whole, as an organized entity, and is not reducible to what any single individual knows, or even to any simple aggregation of competencies and capabilities of all the various individuals, equipments and installations of the firm (p. 63).
Other than that, Simon (1999) states that the only possibility of “learning takes place inside individual human heads; an organization learns in only two ways: (1) by the learning of its members, or (2) by ingesting new members who have knowledge the organization didn’t [sic!] previously have” (p. 17). Moreover, the acquisition of rent-yielding resources takes place through luck, initial disposition or economic irrationality, or across imperfect or less than efficient markets. While the resource-based-view focuses on the acquisition and protection of core resources, the actual transformation into a competitive advantage is often overseen. Even a core resource only represents a rent-potential, but not yet revenue. Often, one resource on its own is simply not enough: the core of the theory of a firm is the coordination of all organizational activities and to bundle all resources (Spencer, 1994, pp. 356-357). This is of special importance, referring to the insider problem. It simply means that the information on a breakthrough which represents a core resource does not automatically have to lead to additional value of the firm and to insiders' gains.
After having provided the causality of how corporate knowledge can provide value to the firm, we will now go on analyzing which type of knowledge is applicable for this study. Therefore a framework by Spencer (1994) introducing four different types of organizational knowledge will be utilized (See figure 1) (p. 365).
Abbildung in dieser Leseprobe nicht enthalten
Figure 1: The different types of knowledge in organizational analysis, from Spencer, 1994, p. 12
Conscious knowledge is explicitly reported by the individual members; automatic knowledge is applied in practice, however members are unable to report it, knowing more than they are able to actually say; objectified knowledge is explicit but spread throughout the entire organization, meaning that it is scientific but localized, for example, in the company’s rules and operating guidelines; collective knowledge are collective practices having emerged during the organizations history (Spencer, 1994, p. 365).
Since implicit knowledge can hardly represent a breakthrough, as required for the informational content, in which an insider may base his trading, the influence of automatic and collective knowledge to the value of a firm will not be analyzed further. As of its implicit nature, being non-reportable, insiders will not be able to gain explicit information for trading. While implicit knowledge is being characterized through its practical appeal, explicit knowledge, such as conscious and objectified knowledge, needs to find its way into practice, first, “We all know from everyday experience that conscious knowledge and the mastery of a skill are very different thinks” (Lamberts & Shanks, 1997, p. 248). On the other side, both variations of individual and social explicit knowledge are reportable, meaning technically patentable. Consequently, both categories can be identified as the relevant organizational knowledge for this analysis.
After having discussed a framework of organizational knowledge which will be the basis for this analysis the following section will introduce legal regulations and institutional settings in Germany. Herein, the focus will be on the differentiation between illegal insider trading and director dealings and the role of information in this context.
Internationally, legal regulations on insider trading have their origin in the United States. Already in the years of 1933 and 1934, President Franklin D. Roosevelt reformed the legislation on corporate financing and security trading with the Securities Act (1933) and the Securities Exchange Act (1934). This needs to be seen in connection with the crash of share-markets in 1929 (Rau, 2004, p. 10). Similarly, caused by immense losses in the European stock markets, starting in 2002, measures haven been taken nationally and throughout Europe, in order to improve the transparency and integrity of capital-markets.
Article 2 (1) of the EU-Market-Abuse directive sets the minimum standard of all national regulation in the European Union. Article 18 requires all national legislation to be passed and brought into action before October 2004 (Heidorn, Meyer, & Pietrowaik, 2004, pp. 3-5). In Germany the Wertpapierhandelgesetz (WpGH) includes the implementation of the new German insider law (Stolz, 2006, p. 449). Section 3 regulates the monitoring of insiders. Herein, §§ 12 and 13 WpHG provide definitions of insiders and financial instruments which may utterly be an insider trade. § 14 WpHG generally forbids an insider to do the following: buying or selling insider papers by taking advantage of insider knowledge in his own or any other name; telling or making available insider information to any other person; or recommending, on the basis of insider information, any person to buy or sell insider papers. Still, insiders are not generally prohibited from trading financial instruments of their related company. This results in most countries “have restrictions in order to prevent insiders from making profit from their information advantage” (Klinge, Seifert, & Stehle, 2005, p. 7).
One instrument to prevent illegal insider trading requires insiders to report transactions to an according authority. Therefore, different nations have introduced various regulations which may differ in the following aspects: Definition of insiders required to report their transactions; threshold volume that must be reported; beneficial owners; reporting obligations for resigning directors; reporting periods; and special rules. In Germany all members of the executive and the supervisory board of a nationally listed corporation and their relatives are required by § 15a WpGH to report transactions of shares and equity related securities of their firm. Both, the firm itself as well as the German regulator, (Bundesanstalt für Finanzdienstleistung [BaFin]) need to be informed. While the firm is obliged to publish these transactions, either on their homepage or in a nationally recognized newspaper with a good coverage of financial news, the BaFin provides a database, which is accessible online. When the new legislation was introduced, directors were required to report “without delay.” Since December 2004 a maximum of five days after execution is permitted, before reporting; in the United States the limit is two days (Klinge et al., 2005, p. 7).
The requirement of reporting a transaction is excluded if the cumulated transaction-volume of to be reported transactions is below 25,000 Euros within a 30 day period (Heidorn et al., 2004, p. 6). In contrast to many other countries, non-board executives or those without decision making authorities are also excluded from the reporting requirements. Also beneficial owners must not report their transactions. Furthermore, directors which were formally obliged to report are no longer required to do so after their resignation (Klinge et al., 2005, pp. 7-8).
The BaFin database contains different information on the trade. Besides the transaction date, the database is also providing the date of publication. Transactions which were reported to the BaFin but not published are not listed in the database. In contrast, transactions which were reported and published on a voluntary basis, meaning not required to be reported by law, are nevertheless listed (Bundesanstalt für Finanzdienstleistungsaufsicht [BaFin], n.d., para. 1).
For the purpose of this paper, director dealings shall be all transactions listed by the BaFin under § 15 WpHG. Comparable databases have internationally been used to statistically analyze abnormal returns of such dealings. With the proof of higher returns than at normal market transactions, one might argue that the reason for this are insider information or at least an advanced knowledge on the firm. Studies in the US-share market are those of Jaffe (1974), Finnerty (1976), and Seyhun (1986) mentioned in Klinge et al. (2005, p. 5). In Germany the topic of abnormal returns in connection with insider trades has come up with the new reporting requirements of 2002. Heidorn et al. (2004), Klinge et al. (2005), and Stotz (2006) are recent examples for such studies.
Patents have a signaling effect on many corporate attributes for the market. The informational content of a patent is large. For the purpose of this study it appears to be important to give a brief overview, of how the information is being communicated throughout the patent application process.
The patent process in Germany is being regulated by the national patent law (PatentGesetz [PatG]). §§ 34, 37 and 38 PatG provide the legal settings for the formal patent application. The filing of the patent takes place either in written or electronic form at the German Patent Office (Deutsches Patent und Markenamt [DPMA]) or at a patent information center, which is to be appointed by the department of justice (Kraßer, 2004, p. 485). The informational content, in particular the informational scope to be provided with the application, is set in § 34 (3) PatG: The name of the applicant; an application for an assignation of the patent, with a brief and accurate description of the invention; one or more patent claims, naming what is to be protected as patentable; a description of the invention; and a drawing, upon which patent claims or descriptions are referred to. The patent office considers the application according to § 44 PatG on request, therefore, the requirements for an application in §§ 34, 37 and 38 PatG as well as requirements for the patentability in §§ 1-5 PatG are being regarded to. The patent is considered redeemed if the request is not filed in due time. (Kraßer, 2004, p. 6). With the issuing of a patent the different patent claims arise.
Most of the patent application process takes place between the patent office and the applicant. The disclosure of the invention is the most essential event within the patenting process for our study, since this is the moment when the information asymmetry between directors and the market partly disappears. According to § 34 (4) PatG an invention is to be disclosed within the application to the degree that an expert can execute it. In a first step this information will only be available to the patent office. But at the latest after 18 month, the information will be made accessible to the public, unless the application is being cancelled before, where the only exceptions are state secrets. This informational effect is one of the functions of a patent, encouraging professional cycles to advancements or alternative solutions (Kraßer, 2004, p. 498). Additionally, financial markets gain information on the performance of corporate R&D.
Various studies have analyzed the performance effects of reported insider trading. In the US, since reporting was mandatory much earlier than for example in Germany, first studies have already taken place in the 70th. Other than that, an obligation for reporting director dealings to an according authority was introduced relatively late for the German stock-market. Consequently, comparable results for firms, listed in Germany, are quiet recent.
A more recent study on the US-Market performed by Lakonishok & Lee (2001) provides statistical evidence, that shares with extensive purchases outperform stocks with extensive sales by 7.8 percent on a 6-month basis (p. 109). In the short run, the same study reports cumulative average abnormal returns (CAARs) of .59 percent with purchase- and .13 percent with sale-transactions five days after the transaction has been announced (Lakonishok & Lee, 2001, p. 89). According to an early study of insider trades in Germany by Rau (2004) the 10-day CAAR after the announcement date is about 2.75 percent for purchases and -2.13 percent for sales (p. 163). Under the impression of this study, sales appear to be more informative for the German market than purchases (Klinge et al., 2005, p. 5). In contrast, a study by Stotz (2006) found a 25-day CAAR of 2.73 percent for all German insider transactions from July 2002 until July 2003, which is slightly more than comparable results in the United States and the United Kingdom (p. 454).
These results show, that aggregate insider trading is able to predict market movements. Consequently, the question arises, how insiders are able to time the market. This is where the indicators being discussed in subsection 2.2.1 are playing a major role. The ability of insiders to predict future market movement, depends for example on the size of the firm. Insiders of companies with small stock are able to time the stock performance more exact than those of large stocks. Also strong signals seem to predict future market movements more precisely. This is, when at least three insiders trade a sizeable amount of their firms stock. (Lakonishok & Lee, 2001, pp. 108-109). But stock size and strong signals are only criterions, for the firm, whether or not an environment exists for insiders for generally being able to achieve abnormal returns. Rather than that, the information upon which the insider is executing the trade is more important. The question is: why are insiders able to predict market movements? One reason may be due to the fact, that they act as contrarian (Klinge et al., 2005, p. 15). Herein, insiders tend to buy stock with poor performance in the past and sell stock with high performance. This anti-cyclical investing may be due to the ability of insiders of judging, if their related firm is under- or overvalued. An indicator which is used for analyzing this phenomenon is the companies` book-to-market ratio (Lakonishok & Lee, 2001, p. 109).
While this is only a relatively abstract knowledge on the general performance of the firm relative to the market, other studies have analyzed the impact of certain events which are not part of a company’s day-to-day business. Accordingly, insiders might use their information on upcoming events for approaching their rents.
Herein, different corporate events are playing a role. For example, earnings, dividend, or new issue announcements are potential events for directors to profit privately from abnormal returns. One study focusing on the effect of earning announcements, analyzed, if so-called breaks of strings are being used as information for insider trades. A string is a sequence of consecutive quarters with increasing earnings compared to the previous quarter. The event that ends a string, meaning the first quarter with lower earnings than in the year before, is called the break (Ke, Huddart, & Petroni, 2003, p. 316). Such a break is economically and statistically associated with a significant drop of share prices. (Barth, Elliott, & Finn, 1999, p. 393) Consequently, an insider who sells shares prior to the announcement of such a break would be able to avoid private losses. Surprisingly, studies on this matter were not able to significantly prove this kind of directorial behavior in the previous quarter to a break announcement. Trading which takes place one quarter prior to earning announcements are not correlated to errors in analysts’ forecasts of the next quarter’s earnings. One reason for these findings is the legal jeopardizes, applying to an abuse of such insider information. This argument is being underlined by the fact that after an enforcement of insider trading regulation in the US in 1988 according trades, 30 days prior to earnings announcements, decreased significantly (Ke et al., 2003, pp. 316-320).
In some aspects, also new issue announcements have proven to be empirically correlated with a change in stock prices. Again, insiders will take advantage of their advanced knowledge by trading on their own account. Even though this would be an illegal action, a study by Karpoff and Lee (1991) found that insiders are more frequently selling than buying shares prior to announcements of new issues of common stock and convertible debt (pp. 18-19). This fits to the observation that share prices decrease upon announcements of new issues of common shares or other securities, which are convertible to common stock (Karpoff & Lee, 1991, p. 19).
A more complex event for insider trades is dividend announcements. This is because the signal of such an announcement cannot unambiguously be identified as either positive or negative, even though there is considerable evidence on share price reactions on announcements of dividend changes (John & Lang, 1991, p. 1361). According to Seyhun (1992) dividend yields predict 5-7 percent of the variation of the one year-ahead stock returns (p. 1304). Still, the valuation of an increase of dividends does not always have to be considered as good news. High dividends may also have a signaling effect for the firms` future investment opportunities and not only for the existence of high distributable profits. Some studies have even used director dealings to interpret the informational content of dividend announcements. An unexpected increase of dividends in connection with unusual insider buying should signal good news and elicit a positive share price response (John & Lang, 1991, pp. 1361-1363).
Besides earnings, new issue, and dividend announcements also other information may exist, which are being used by insiders for rent appropriation. The causality behind the discussed examples is always the following: Firstly it needs to be found that the information has an influence on the performance of share prices. Then, insider trades around the events are being compared to their expectable return in order to prove abnormal returns. Similarly, we will now go on providing causality between R&D, patents, and the share price, before coming to the analysis of insider trades. The theoretical foundation has already been introduced for this purpose (Subsection 2.2.2).
Recently, a relatively new way of investment management was introduced. Herein, the patent portfolio is being evaluated, in order to determine the companies share price. First evidence has shown the role in picking the winners is promising (Barker, 2002, para. 2). The knowledge-based-view provides theoretical evidence that inventions are able to create positive cash-flows. This again increases the value of the firm and as a consequence the share price. The causality between patents and share price is not that direct. Generally, there are two aspects of a patent, which create value. Firstly, a patent can be seen as a mechanism for privatizing information. Secondly, a patent can be seen as an instrument for credibly publicizing information (Long, 2002, p. 625). Privatizing information has the effect of excluding competitors of taking advantage of intellectual property. R&D conducted by private firms represents an investment activity with an output of intangible assets. If this asset positively contributes the future cash-flows, the increase in the firms’ knowledge-stock should be reflected in the market value of the firm. Herein, the effect of a patent is that competitors are not able to participate from such cash flows, reducing the effect on the developers’ firm value (Hall, Jaffe, & Trajtenberg, 2005, p. 18).
Long (2002) provides a framework for the contribution of the informational effect to the value of the firm. The most straight forward instance is the fact that information can be communicated at relatively low cost. A patent provides two parts of information, being accessible to anyone who is interested: the claims and the specification. While claims represent the scope of an invention, the specifications, as the body of the patent, describe the invention in detail. This informs observers on the existence of aspects they would have otherwise not noticed (Long, 2002, p. 647). This information will be valuable for all kinds of stakeholders. Especially, shareholders will increase their valuation towards the firm because of decreased opportunity cost. Furthermore, an according discount for the risk of wrong information can be reduced. While press releases may be intentionally or accidentally wrong, an inadequate information within a patent would either lead to losing the patent upon a challenge by a third party, or to penalties in the case of fraud (Long, 2002, pp. 649-650). As a third potential contributing factor to the market actor’s valuation of the firm, the fact that patents are correlated with various other firm attributes may play a role. For instance, patent signals have been used as a measure of firm productivity, innovative activity, firm size, and other less measurable factors. In particular, the sheer number of patents has often been applied as indicator for such attributes (Long, 2002, p. 651).
For the purpose of this study, the cash-flow impact of R&D to the value of the firm is more significant than the patentable value creation of informational effects. Still, it needs to be recognized that potential value increases through R&D may be increased even more through the patent of such intangible assets.
 European directive 2003/6/EG of the European Parliament and the Council of the European Union of 28 January2003
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