Date of Award

Winter 2014

Document Type

Dissertation

Degree Name

Doctor of Business Administration (DBA)

Department

Economics and Finance

First Advisor

Otis Gilley

Abstract

Research documents that insiders, who have access to private information, appear to trade with profits before major corporate events like mergers, bankruptcy, dividend announcements, and future cash flow news (see, e.g., Seyhun, 1990; Seyhun and Bradley, 1997; John and Lang, 1991; Jiang and Zaman, 2010). Another recent stream of studies find that the size and quality of a firm's patent portfolio are positively related to the firm's future stock returns (Hirshleifer, Hsu, and Li, 2012; Pandit, Wasley, and Zach, 2011). However, there is little systematic evidence on whether insiders act opportunistically when they possess private information about the firm's patent portfolio.

In this dissertation, I empirically investigate insiders' trading and option grants throughout the different phases of an influential patent's application. An influential patent is defined as a patent with high citation impact. Chapter One focuses on insiders' open market transactions before the filing year of an influential patent, while Chapter Two centers on informed executive stock option (ESO) exercises and unscheduled option awards before two milestone dates of an influential patent: the application date and the grant date.

In Chapter One, I examine the pattern of insider trading before the filing year of an influential patent, for a sample of 2,470 firm-years from 1987 to 2006. In regressions of three insider trading measures controlling for factors related to insider trading, I find that the level of insiders' net purchases is consistently and significantly higher in the year before filing an influential patent than in the application year. The abnormal higher level in net purchases is not from active insider trading — insiders increasing their purchases above normal levels, but from passive insider trading — insiders reducing their sales below normal levels in the year before filing an influential patent. In contrast, there is no such insider trading pattern for the industry-size matched firms. There is also no abnormal insider trading before the filing of an inconsequential patent.

Chapter Two studies whether executives' ESO exercises and options grants are related to superior information about the quality of a firm's patents, for a sample of 654 firm-events with an influential patent filed from 1996 to 2006. Using difference-indifferences (DID) regressions of two measures of option exercises, I find that executives significantly delay exercising their stock options by reducing option exercises in the year prior to the filing date of an influential patent and increasing option exercises in the year after that. In contrast, no such pattern of informed option exercises is found in the industry-size-performance matched control firms.

From the DID regression of the measure of option grants, I find no evidence of abnormal option grants around the application date of an influential patent. However, I find that executives receive more unscheduled stock options in the one-year period before the grant date of an influential patent than after that. In contrast, the matched control firms award fewer unscheduled stock options before a non-influential patent is granted than after that. My findings show that in addition to exercising options opportunistically, influencing the timing of unscheduled option grants is another channel through which insiders can pursue personal interests by exploiting the information advantages related to the quality of a patent. Moreover, I provide evidence that insiders possess private information throughout the lengthy application process, from the filing to the grant of an influential patent.

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