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The Injury From Insider Trading

Economic Trends


Mergers become far more costly

In terms of sheer opportunity, those with private information who hope to make a big score in the stock market have never had it so good. So far this year, the nation's mergers-and-acquisitions boom has already clocked an eye-popping $781 billion worth of deals (chart). And the Securities & Exchange Commission continues to unveil cases of alleged illegal insider trading.

While no one knows its extent, the prevalence of such trading in merger deals has sparked a lively economic debate. Worried that overzealous regulation could impede the flow of news to the market, some experts claim that the harmful effects of illegal trading are exaggerated. Such transactions provide early information to investors, they say, and don't really drive up the final price paid for acquired companies.

In a new study in European Finance Review, Harvard business school economist Lisa K. Meulbroek and consultant Carolyn Hart of Ernst & Young conclude that such views are mistaken on a key issue. They find that illegal insider trading boosts acquisition premiums by as much as a third.

It's well known that stock prices of targets in takeovers tend to rise as early as a month before a tender offer is announced. In recent decades, shares of acquired companies have appreciated by 30% to 40% on average by the time a deal is done, with a third or more of the rise occurring before a bid is unveiled.

Such pre-bid runups don't necessarily reflect insider activity. Prices may rise because of news leaks or because a prospective bidder is acquiring shares, or brokers are pushing likely merger candidates. So Meulbroek and Hart analyzed 112 acquisitions from 1974 to 1989 in which illegal trading was detected to see whether their takeover premiums differed from those in a similar group of deals (matched by industry, year, and size) with no detected illegal trading.

The results were striking. After controlling for such merger factors as number of bidders, payment form, and hostile or friendly bid, the researchers found that takeovers with illegal trading wound up with final premiums averaging 43%, vs. only 33% for the control group. Further, an analysis of daily activity in both pre-bid and post-bid periods revealed that price increases were 10 times as large on days that insider trading was detected as on other days.

Thus, illegal trading appears to cost shareholders of merger-minded companies a bundle. And that, notes Meulbroek, raises the ominous possibility that its impact on acquisition premiums may also derail many otherwise economically efficient mergers.BY GENE KORETZReturn to top

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In part, because the risk of jail fell

While crime rates have fallen across the U.S. in recent years, they have risen among the nation's youth. Indeed, as the adult arrest rate for murder fell 7% from 1978 to 1993, the juvenile murder rate surged by 177%. At the same time, the arrest rate of youngsters for all violent crimes (involving the use of force) climbed 79%, almost three times the rise in the adult rate.

This divergence in juvenile and adult crime trends has led some experts to argue that America is now confronted with a generation of juvenile "superpredators" who are impervious to the threat of punishment. In a new study, however, Steven D. Levitt of the University of Chicago offers evidence that much of this sharp rise in youth crime actually reflects changes in the relative punishment young criminals face.

While a lot more adult criminals are winding up behind bars these days than used to be the case, notes Levitt, that's not true of juveniles. From 1978 to 1993, the number of federal and state adult prisoners per violent crime committed by adults soared by 60%. But the corresponding ratio for youths in juvenile detention centers--which paralleled that of adults in 1978--fell by 20%.

Thus, by 1993, the chances of violent young criminals being jailed were only half those of their adult counterparts. And since incarceration cuts crime--if only because it takes criminals off the streets--it's not surprising that youth and adult crime rates diverged.

More important, Levitt finds sharp changes in criminal behavior in the year when youths become subject to the adult criminal-justice system--usually when they reach 18. In states where youth-incarceration rates are high and adult rates are low, violent crime rates among 18-year-olds rise 23%. But in states where the punitiveness of the juvenile justice system is low and that of the adult system is high, violent crime rates drop by nearly 4%.

In short, says Levitt, "deterrence appears to play an important role in juvenile criminal involvement. Young would-be criminals are not mindless sociopaths--they respond to incentives."BY GENE KORETZReturn to top

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