Confidential Information: Can Banks Resist Profit Incentives?
Mergers and acquisitions often create big fluctuations in stock prices. On the day a merger is announced, the stock price of the firm being bought – sometimes called the “target” firm –increases by 20% on average. Clearly, advance knowledge of a merger brings with it major financial incentives.
Target firms often hire an investment bank to advise them on their acquisition, and in this role, investment banks are privy to non-public information. Many investment banks also have investment management divisions that oversee mutual funds. A bank’s own mutual funds stand to gain from inside information about a takeover that their investment banking division is working on. Although information barriers are mandated to isolate non-public information, anecdotal evidence suggests these barriers are not always respected.
To investigate these relationships, Timothy Mooney, PhD, assistant professor of Finance at Jefferson delved into publicly available finance data surrounding mergers and acquisitions. He found evidence that a bank’s mutual funds buy the stock of about 22% of target companies that their bank advises, whereas they buy only 2% of takeover-targets where the bank is not involved.
We spoke with Dr. Mooney about his study and what it says about the banking industry.
What is single most surprising thing you discovered about mergers?
The most surprising finding of this paper is evidence suggesting banks have and use advance knowledge of takeovers across divisions (investment banking and investment management). A mutual fund is 10 times more likely to buy the stock of a target leading up to a merger announcement when the fund’s investment bank is advising the target. By doing this, the mutual funds are able to earn the 20% average stock price increase around the merger announcement date. That’s a substantial return earned in a very short period of time.
How did you do your analysis – what is the data based on?
We looked at data on 3,846 mergers held across 10,803 mutual funds from publicly available databases. Using a number of analytical methods, we identified affiliations between investment banks and their mutual funds by studying annual reports, SEC filings and company websites.
Is it a smoking gun? Could regulatory agencies use your data to find banks that are misusing private information?
I’m hesitant to call it smoking, or even a gun. There is a lot of variability and noise in both merger data and mutual fund holdings, so it is extremely difficult to show causality between a target hiring an investment bank and that bank’s mutual funds buying the target’s stock. Nevertheless, the patterns we identify indicate a meaningful association between investment banks and their mutual funds surrounding a merger event. Overall, I think the results of this study show there is more work to be done in understanding how banks handle sensitive information.
What are the next steps in your research?
Further research in this area could provide insight into what factors drive information sharing between investment banking and mutual fund management divisions. It could also help policymakers and well-meaning investment bank and mutual fund managers mitigate the potential conflict of interest across divisions.