Digital Insiders and Informed Trading before Earnings Announcements

Date
2019-06-13
Authors
Soderstrom, Naomi
Berkman, Henk
Lee, Gladys
Jona, Jonathan
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Abstract
We use firm-specific measures of cybersecurity risk mitigation based on textual analysis of 10-Ks to proxy for the probability of trading with digital insiders – hackers who target corporations to obtain non-public corporate information for illegal trading. We find that prior to earnings announcements, a larger share of new earnings information is already incorporated into prices for firms with low cybersecurity risk mitigation scores. We also find that pre-announcement trading by short sellers is more predictive of earnings surprises for firms with low cybersecurity risk mitigation. Further, on days closer to earnings announcements, firms with relatively low cybersecurity risk mitigation scores experience a larger increase in bid-ask spreads, particularly the adverse selection component. These results suggest that weak cybersecurity risk mitigation provides opportunities for acquisition of private information and that trading by privately informed traders is more likely in stocks of firms with higher exposure to cybercrimes.
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Keywords
liquidity, cybersecurity, cyber risk disclosure, adverse selection, bid ask spread, probability of informed trading, private information, hacking, cyber risk mitigation, price jump ratio, textual analysis, short selling
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