Option Backdating Announcements and Information Advantage of Institutional Investors

This article uses transaction-level fund trading data from the United States to study the information advantage of institutional investors. Our research design follows a two-step procedure. In the first step, we identify funds that sell shares in firms before their unexpected revelation of stock option backdating (BD) investigations, and thus establish fund–firm pairs of interest. In the second step, we focus on trading that takes place at other times and find that the funds are more likely to make correct trades before the earnings announcements of their paired firms and that their trading performance for paired firms is better in general. This superior performance, however, is more evident in the pre-BD-announcement period and for firms whose BD investigations are initiated internally. The results imply that although institutions have access to private information on certain firms, this advantage disappears after the BD revelation, possibly due to reduced information leakage.