In a new research paper that investigates social networks, informed trading and shareholder costs, Drexel University LeBow College of Business professors concluded that the social ties of executives and directors to Wall Street can be quite costly to their shareholders.
The paper, “The Price of Street Friends: Social Networks, Informed Trading, and Shareholder Costs” was written by Drexel LeBow College of Business professors Dr. Jie Cai, professor of finance, and Dr. Ralph Walkling, Stratakis Chair in Corporate Governance and Accountability; along with Dr. Ke Yang, of Lehigh University.
For this study, the researchers investigated whether the social network between a public firm and the professional investment community impacts the cost of trading. They explain that executives and directors of a firm have social connections with Wall Street executives through education, employment or leisure activities, and information flows through these channels – sometimes even through non-verbal social cues.
Cai, Walkling and Yang examined the cost of such social connections to public firm shareholders using more than 18,000 firm year observations, and found that social ties significantly increase a firm’s trading costs.
Their findings indicate that one executive or director connected to Wall Street increases the typical firm’s annual trading cost by $ 1.3 million. Throughout the life of a typical firm (with eight connected directors and executives) this would be associated with about a $ 213 million dollar reduction in shareholder wealth.
According to Walkling, work in the area of ‘social ties’ is relatively new in finance. “This research offers new insights into previously unexplored areas related to informed trading,” he said. “One particularly interesting aspect of the social ties idea is the way information can be transferred even inadvertently through non-verbal cues. For example, we could observe the purchase of an expensive car, the cancellation of a shared vacation or the repeated absence at a social event.”
The paper has been awarded the Outstanding Paper recognition in the investments category for the 2011 Southern Finance Association Annual Meeting, to be held in Key West, Fla., from Nov. 16 to 19, where Yang will present the paper.