Abstract:
     The UK's new insider-trading laws were introduced on March 1, 1994, but regulators are
     finding it difficult to set meaningful rules about what company bosses can say to individual
     analysts or investors without creating opportunities for insider trading. A study by Ron
     Kasznik and Baruch Lev, 2 economists from the University of California at Berkeley, on why firms
     do not announce all news directly to the market through official channels, is presented.

     Full Text:Copyright Economist Newspaper Group, Incorporated Mar 5, 1994

     Confusion in the City of London about the implications of Britain's new insider-trading laws, introduced on March
     1st, was predictable. Regulators everywhere find it fiendishly hard to set meaningful rules about what company
     bosses can say to individual analysts or investors without creating opportunities for insider trading.

     The trouble is that a one-to-one briefing (or "lunch") can work two ways. It can make share prices more accurate
     by speeding the flow of information to the market; or it can allow managers and analysts to use privileged
     information to make a profit from less-informed investors. Go into a City or Wall Street bistro and try to judge
     which of these two activities is going on at the next table: you will understand the regulators' problem.

     Firms could help by simply announcing all news directly to the market through official channels. Yet in most
     countries they rarely do so. One possible reason emerges from a study by Ron Kasznik and Baruch Lev, two
     economists from the University of California at Berkeley*.

     They looked at more than 500 examples between 1988 and 1990 of American firms announcing a big "earnings
     surprise"--cases where profits were above or below the consensus of what analysts were forecasting 60-90 days
     earlier, by an amount equivalent to more than 1% of the firms' market capitalisation. During the 60 days before the
     big surprise, only 6% of firms with good news and 8% of those with bad issued "hard" profit warnings, although
     9% and 21%, respectively, made at least a "soft" announcement about the quality of sales or profits. Others made
     comments about, say, capital expenditure, new products, write-offs or likely dividend payouts. Around half gave
     no hints at all.

     The two economists then looked at the effect of the warnings on the firms' share prices. Firms with a good surprise
     that tipped off the market did no better than those which kept quiet. However, those which alerted the market to
     impending bad news actually saw their shares Fall much further than comparable firms that kept mum.

     Why do investors punish firms that air their problems in public? In a climate in which firms mostly say as little as
     possible, investors might reasonably assume that those which go public are doing so because they face an
     exceptional calamity. Thus profits warnings, far from reassuring investors as intended, maybe taken as pointing to
     even worse trouble ahead. Would this assumption hold true if all firms warned the market of coming earnings
     shocks? Probably not. But so long as openness is penalised, it is unlikely to become the voluntary norm.

     * "To Warn or Not to Warn: Managers' Dilemma Facing an Earnings Surprise" By Ron Kasznik and Baruch
     Lev, University of California, Berkeley working paper, February 1994