Assessment of Potential Insider Trading in the Saudi Stock Exchange Before and After the Introduction of Financial Reforms: An Event Study Market Cleanliness Methodology

Abstract

The purpose of this research is to investigate the impact of the amended regulatory changes introduced with financial reforms in 2016 on the integrity of the Saudi Stock Exchange (Tadawul) with a particular focus on potential insider trading practice. The major objectives seek to assesses and compares the level of potential insider trading in the Tadawul over periods both before and after the introduction of financial reforms. The level of possible insider trading is estimated by employing an event study market cleanliness methodology that identifies the ratio of significant announcements (SAs) that were preceded by abnormal pre-announcement price movements (APPMs) and abnormal pre-announcement volumes (APAVs). The research question is examined using a sample consisting of 1,958 unscheduled announcements published by firms listed in the Tadawul from 26 April 2011 to 25 April 2020 (the relevant period). The study uses event study approaches with daily stock returns and trading volumes to find evidence of APPMs and APAVs that have taken place prior to the release of SAs. The analysis is carried out using several statistical models fitted to time series data, including the simple linear regression (SLR), generalised autoregressive conditional heteroscedasticity (GARCH) (1,1) and autoregressive distributed lag (ADL) (1,1) models to estimate abnormal returns and volumes performance. In an additional analysis, the study examines seven factors that may influence the market cleanliness measure and builds on the literature by adding two new factors. The study provides empirical evidence for the presence of suspicious insider trading activities among the firms listed in the Tadawul over the relevant period where significant abnormal returns and abnormal volumes are observed prior to the arrival of unscheduled announcements. The findings indicate that the level of potential insider trading in the Tadawul, as assessed by market cleanliness measures, is lower after the introduction of financial reforms. The trading volumes analysis suggests that the decrease in the measures is statistically significant at 10%. However, the returns analysis reveals that the observed reduction is not statistically significant. A possible explanation for this is that the regulatory changes have not yet had a statistically significant effect in reducing the level of potential insider trading activities. Moreover, the lengthy time required for the prosecution procedures and enforcement actions may help interpret insignificant changes in the returns analysis. Further, the literature documents that the efficacy of insider trading laws lies in their efficient enforcement rather than their mere introduction. Moreover, considering that the present study covers the periods preceding and following the entry of foreign qualified investors, the market reactions and investors behaviours may have witnessed changes across the periods examined. Thus, further evidence on insider trading practice in the forthcoming years is needed to have more understanding about the overall impact of the emended regulations. The study makes several contributions that are of major importance to policymakers, firms and investors. The research satisfies the need to understand the effectiveness of insider trading laws as well as their enforcement in the Tadawul and provides recommendations for how the regulatory agency may determine whether additional regulations are required to improve regulatory performance. The findings may be beneficial in notifying regulators’ enforcement mechanisms for strengthening market surveillance and combating market misconduct by more actively implementing disciplinary actions to enhance market efficiency and foster investors’ confidence. Apart from this contribution, the results may be of interest to firms seeking to better maintain private information and regulate the release of material-sensitive information through appropriate channels. Finally, the findings may benefit investors by boosting their understanding of market integrity and confidence because the results provide valuable information about market condition and risk.