An International Meeting of the American Accounting Association American Accounting Association 2006 Annual Meeting August 6–9, 2006 Washington, D.C.

Mingshan Zhang
Hong Kong University of Science and Technology

Abstract: Previous empirical research by Aboody, Hughes, and Liu (2005) finds evidence of positive associations between earnings quality, insider trading, and cost of capital. In this study, I consider whether there exists a set of informed traders who trade in sufficient magnitude to drive a measurable risk premium. Employing a classification scheme by Bushee (1998) based on turnover and diversification, I first examine the trading profitability for institutions from each of Bushee's classes. Our findings in terms of abnormal returns suggest that the so-called “transient” institutions (high turnover, high diversification) trade on both the idiosyncratic and systematic components of private information similar to corporate insiders. Second, extending the analysis to a setting where R&D is used to proxy for information asymmetry does not find consistent evidence to support transient institutions' superior information advantage as well as conjectured pricing effect of R&D related information risk.

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