This past six weeks have seen a resurgence in M&A activity, despite the on-going COVID-19 pandemic. Marathon Petroleum’s recent $21 billion sale of its Speedway gas station business to 7-Eleven parent Seven & i Holdings is just one of the most notable megadeals among a slew of recent transactions.
No fewer than eight deals worth more than $10 billion have been announced since June 30, the fastest start to a second half of the year since before the 2008 global financial crisis, according to a Financial Times analysis of data from Refinitiv.
How can you spot the next megadeal before it happens? Well, newly-published research suggests it pays to keep careful tabs on the stock sales of top execs.
Researchers from from Concordia University in Montreal and the University of Missouri have found that the top managers at companies targeted for acquisition significantly reduced sales of their own company’s stock in the 12 months prior to the possibility of a deal surfacing.
Shares in takeover targets typically climb on deal news, even if the rumors turn out to be false. Rumors that a firm may be purchased typically send its shares up an average 3.72% compared to the benchmark index for firms of that size in the 24 hours after the rumor first appears, the researchers found. Over the next 20 days, the cumulative average excess return is as high as 13.92% if the rumor proves true and a deal is announced. But there is still some excess return—1.55%—20 days out even if the initial report proves to be inaccurate and no deal materializes.
This, of course, gives executives a big incentive to purchase shares in their own companies prior to any news leaks about a possible deal. But, in the U.S., it is illegal for executives to buy or sell shares on the basis of material non-public information. And, in fact, the researchers found little evidence that executive blatantly violate the law: top managers at acquisition targets didn’t typically purchase more stock in the run-up to news of a possible deal leaking.
But, the researchers note in a paper published in the journal European Financial Management and posted to research repository SSRN earlier this week, that it is not illegal to refrain from sales that would have otherwise taken place. And this, the academics claim, is exactly what the top managers at target companies tend to do.
The researchers examined 1,642 publicly-traded U.S. companies that were subject to takeover rumors between 2002 and 2011. In the year prior to rumors of an M&A deal surfacing in the press, top executives at alleged takeover targets cut back on selling to the extent that the overall number of shares they held grew on average 28% relative to their usual pattern of activity.
By comparing this activity with those from executives in a control group of similar companies that were not subject to takeover rumors, the researchers conclude “that the high level of pre-rumor net purchasing is driven by insiders’ use of privately available knowledge, rather than an astute capacity to anticipate stock price movements.”
This latest paper, which was co-written by Concordia’s Frederick Davis, Hamed Khadivar, and Thomas Walker, and Missouri’s Kuntara Pukthuanthong, confirms a similar study from 2012 that looked at a slightly different time period and also found target company insiders reduced sales significantly prior to takeover rumors.
It also comports with previous research showing stock prices in takeover targets tend to increase even prior to rumors of a deal being made public, indicating that information about a deal may be leaking, or that insiders are trading on non-public information.
A 2015 study also found clear evidence of abnormal trading volumes in short-dated options of target companies in the 20 days prior to a deal rumor being reported, also indicating possible trading on inside information, although the same research noted that the Securities and Exchange Commission brought insider trading cases in very few instances in which researchers found abnormal activity.
The new paper’s authors write that their research points to possible holes in insider trading laws. The target company executives’ activity, they write, “[strikes] at the spirit of insider trading policy: profiting from material private information is contrary to both the stated intention of the regulatory legislation and to the implicit concept of moral fairness which is required for investor confidence.”
In the meantime, the phenomenon the researchers have uncovered presents an opportunity. By carefully monitoring the net purchases of top executives compared to prior periods, savvy investors may be able to scoop up shares in the next megadeal target and earn a tidy profit.
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