A research paper titled “The Price of Street Friends: Social Networks, Informed Trading, and Shareholder Costs” by LeBow College professors Jie Cai, Ph.D., professor of finance, and Ralph Walkling, Ph.D., Stratakis Chair in Corporate Governance and Accountability and executive director of LeBow’s Center for Corporate Governance, has been awarded the Outstanding Paper recognition in the investments category for the 2011 Southern Finance Association Annual Meeting. The paper was also co-authored by Ke Yang, Ph.D., 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 naturally, 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.
In other words, the social ties of executives and directors to Wall Street can be quite costly to their shareholders.
Walkling says that 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. 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.”
Walkling adds that he and his co-authors were “totally shocked … we didn’t even know the paper was being considered for any award.”
Walkling will attend the conference in Key West, Fla., from Nov. 16 to 19, where Yang will be presenting the paper.