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Are individual investors less informed thaninstitutional investors? Unique evidence from investortrading behaviours around bad mergers in Koreanfinancial marketAreum Han a & Chune Young Chung aa College of Business Administration , Kookmin University , Seoul , 136–702 , South KoreaPublished online: 03 Jun 2013.

To cite this article: Areum Han & Chune Young Chung (2013) Are individual investors less informed than institutionalinvestors? Unique evidence from investor trading behaviours around bad mergers in Korean financial market, AppliedEconomics Letters, 20:12, 1145-1149, DOI: 10.1080/13504851.2013.791012

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Are individual investors less

informed than institutional

investors? Unique evidence from

investor trading behaviours around

bad mergers in Korean financial

market

Areum Han and Chune Young Chung*

College of Business Administration, Kookmin University, Seoul 136–702,South Korea

This article presents the trading behaviours of individual and institutionalinvestors in Korean mergers and acquisitions market. Based on Chen et al.(2007), we consider a bidder’s negative abnormal announcement-periodreturn as a measure for bad merger. To investigate the investor tradingbehaviours around the bad mergers, we employ a unique daily trading dataof different groups of investors in Korean stock market. Our finding showsthat institutional investors sell their shares on a bidding firm beforeannouncement of a bad merger, while individual investors buy the shares.In addition, we find that institutional investors continue to sell their shareson a bidding firm even after announcement of a bad merger, but individualinvestors keep buying them. Hence, our results newly support thehypothesis that individual investors are less informed and/or lesssophisticated than institutional investors.

Keywords: individual investors; institutional investors; informationasymmetry; bad corporate merger

JEL Classification: G14; G34; G15

I. Introduction

Individual investors are often considered to be noise

traders due to their informational disadvantages and

psychological biases. Literature documents that

investment performance by individual investors

tends to be worse than that of other groups of inves-

tors such as institutional investors (see, for example,

Nofsinger and Sias, 1999; Barber and Odean, 2000;

Grinblatt and Keloharju, 2000; Cohen et al., 2002;

Gibson et al., 2004; Amihud and Li, 2006; Choi and

Sias, 2012). Informational variation among market

participants influences their trading behaviours and

subsequently affects prices of assets. Especially,

informed investors could make abnormal profits

and/or prevent abnormal losses while uninformed or

less-informed investors could not have the opportu-

nity for abnormal profits and/or the prevention from

abnormal losses in the market. Hence, examining

asymmetric information and diverse information

*Corresponding author. E-mail: cychung@kookmin.ac.kr

# 2013 Taylor & Francis 1145

Applied Economics Letters, 2013Vol. 20, No. 12, 1145–1149, http://dx.doi.org/10.1080/13504851.2013.791012

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processing skills among heterogeneous groups ofinvestors has been an important and interestingmatter.However, direct empirical investigation for less

informed or uninformed trading by individual inves-tors has not been made extensively because access tohigh-frequency trading data of individual and institu-tional investors is often unavailable and limited.Literature often utilizes the quarterly net demand byinstitutional investors to infer not only their tradingbehaviours but also the trading by individual inves-tors. In addition, related studies rely on a small por-tion of the market for a short period or indirectlycapture trading by individual investors from theirtrade sizes.This article directly studies whether individual

investors have informational disadvantages andwhether they are too naive to digest important infor-mation from a firm, as opposed to institutional inves-tors. To do so, we observe and compare daily tradingpatterns of individual and institutional investorsaround a bad corporate event. Lang and Lundholm(1993) document that high level of information asym-metry could be pronounced among investors beforenegative corporate events. In particular, we consider abidding firm’s announcement of bad merger and itsassociation with investor trading behaviours inKorean financial market, in which the trading volumeof individual investors is significantly higher and themarket is less transparent than in developed marketssuch as the US market.1

We find that institutional investors sell their shareson a bidding firm before announcement of a badmerger, while individual investors buy the shares. Wealso find that institutional investors continue to selltheir shares on a bidding firm after announcement of abad merger, but individual investors buy them. Theseresults newly and uniquely support the literature doc-umenting that individual investors are less informedand/or less sophisticated than institutional investors.

II. Data and Methodology

Our study is based on 156 completed takeovers in theData Analysis Retrieval and Transfer (DART) data-base of Korea’s Financial Supervisory Servicebetween 2000 and 2007. We obtain the daily tradingvolumes by institutional and individual investors andstock returns for firms listed in Korea Composite

Stock Price Index (KOSPI) market on KoreaExchange (KRX) from Data Guide Pro provided byFnGuide. We calculate the abnormal stock returns ofa bidding firm around announcement and completiondays of amerger to see correspondingmarket responseand firm performance. In particular, we examine thebidder’s cumulative abnormal announcement-periodreturn (CAR) over days (-1, 1), where day 0 is the dateof initial bid announcement. As in Chen et al. (2007),we consider the bid as a bad merger decision if the3-day CAR is negative. This leaves us with 51 badmergers for the sample to see the trading decisions ofheterogeneous investors around the specific corporateevent, not only ex ante but also ex post. Table 1describes our sample.To analyse the market reaction around the

announcement days of bad corporate mergers, weconstruct abnormal stock returns of sample firms.Especially, we compute the following average abnor-mal return (AR) based on the market adjusted returnmodel:

ARt ¼1

n

Pn

i¼1ERi;t

where ERi;t ¼ Ri;t � Rm;t: Ri,t and Rm,t indicate returnon stock i at time t and equally weighted market indexreturn at time t, respectively. We use equally weightedmarket index return rather than value-weighted mar-ket index returns. The value-weighted market indexreturns are significantly affected by returns on largefirms in the Korea’s stock market because a few largefirms represent the entire stock market. Since ouranalysis is based on the event study and our sample

Table 1. Sample description

Goodmergers

Badmergers All mergers

Number ofsample

105 51 156

3-day CAR 8.39% -4.67% 4.12%(0.000)*** (0.000)*** (0.000)***

Notes: This table presents the numbers of samples for goodand bad mergers and 3-day cumulative average abnormalreturn (3-day CAR) of each type of merger for (-1, +1) daysaround merger announcement. p-Values are provided in par-entheses.*** indicates significance at the 1% level for whether esti-mates are different from zero.

1The trading volume of individual investors in Korea’s stock market is significantly higher compared to the US marketdominated by institutional investors. According to the Korea Exchange (KRX), over January 2001 to December 2009 periodthe trading volume of individual investors accounted for 88.19% of total market activities. Also, the trading value of individualinvestors was 61.32% of the total trading value.

1146 A. Han and C. Y. Chung

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firms include small firms, using equally weighted mar-

ket index returns could treat each event equally and

better capture abnormal returns around the

announcement of bad mergers. We then calculate the

CAR for sample firms by adding daily AR during the

event period. We define the CAR as follows:

CARt ¼Pn

i¼1ARt

In addition to consider 3-day CAR, we also examine

CARs up to 60 days after completion of a deal to

measure ex post performance of merged firms.To investigate the trading patterns of individual

and institutional investors around the event days, we

calculate the ratios of trading imbalance (TI) for indi-

vidual and institutional, investors of each firm as

TIi;t ¼Buy Volumei;t � Sell Volumei;tNumber of Shares Outstandingi;t

For each type of investor, we then compute the cumu-

lative average trading imbalance (CTI) for the sample

firms up to 30 days before and after the announcement

of bad mergers.

III. Empirical Results

We find that bad mergers pronounce poor perfor-

mance after the mergers. Figure 1 shows the CAR

for (+2, +60) days after the completion of bad mer-

gers to measure firm performance after the deals. We

do not incorporate returns on day 0 and day 1 into

CAR to disentangle noise effects around the comple-tion days from the performance of merged firms. Thefigure shows that the average performance of themerged firms tends to be increasingly negative and itis about -8% for only about 60 days. This implies thatinvestors who hold and/or buy the shares of bidderfirms that make bad merger decisions would experi-ence significantly negative returns on investment.Also, this result supports that our ex ante measurefor bad merger is robust because the negative 3-dayCARs around announcement days of mergers reflectsubsequent negative performances after the dealcompletion.Figure 2 presents the CTI for 30 days before and

after the announcement of bad mergers between indi-vidual and institutional investors. This helps to iden-tify the information asymmetry and different levels ofinformation processing skills between individual andinstitutional investors. In particular, the figure showsthat institutional investor consistently sell their sharesbefore the announcement of bad mergers while indi-vidual investors buy the shares. This finding impliesthat individual investors may have informational dis-advantages compared to institutional investors beforeamaterial corporate event. Kim andVerrecchia (1991)suggest that information asymmetry may exist amonginvestors before corporate announcements and affectthe investors’ trading behaviours. They consider thatinvestors search for private information before and atearnings announcements. Campbell et al. (2009) docu-ment the diverse trading activities between individualinvestors and institutional investors around corporatedisclosures. They find that before earnings announce-ments the trading by individual investors tends to beless profitable than that by institutional investors.Hence, our finding is not only consistent with

2 4 6 8 10

(%)

12 14 16 18 20 22 24 26 28 30

2

1

0

–1

–2

–3

–4

–5

–6

–7

–832

Days34 36 38 40 42 44 46 48 50 52 54 56 58 60

Fig. 1. Cumulative average abnormal return for (+2, +60) days after completion of bad mergers

Notes: This figure presents the cumulative average abnormal return (CAR) for (+2,+60) days after completion of badmergers tomeasure firmperformance after the deals. The horizontal line in the figure indicates 0% CAR. The CAR does not incorporate returns on day 0 and day 1 todisentangle noise effects around the completion days from the performance of merged firms.

Are individual investors less informed than institutional investors? 1147

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asymmetric information hypothesis but it also pro-vides new supporting evidence for the hypothesis.The figure also shows that individual investors con-

tinue to buy the shares of bidder firms making badmerger decisions even after the announcement, butinstitutional investors sell the shares. This result sug-gests that individual investors are not sophisticatedenough to digest information released from a firm.Field and Lowry (2009) argue that individual inves-tors tend to imprecisely recognize and/or unsophisti-catedly analyse the information released from a firmcompared to institutional investors, and thus theyappear to make a negative return on investment.Overall, in addition to the findings above that theperformance of merged firms are significantly nega-tive, the buying propensity of individual investors asopposed to the selling propensity of institutionalinvestors supports the evidence of less informed and/or less sophisticated trading by individual investors infinancial markets.

IV. Concluding Remarks

Are individual investors less informed and/or lesssophisticated than institutional investors in financialmarkets? To address this research question, we studyheterogeneous trading behaviours of individual inves-tors and institutional investors in Korean mergers andacquisitions market. In particular, we investigate theinvestor trading behaviours around a bad merger,which is clearly associated with a decreasing firmvalue. Our study relies on a unique daily trading dataof different groups of investors in Korea’s stockmarket to overcome limited data availability for

individual trading in previous literature. Our finding

shows that bidding firms considered to make bad

mergers around deal announcement tend to perform

poorly after completion of the deals. More impor-

tantly, our result shows that institutional investors

sell their shares on a bidding firm before announce-

ment of badmerger, while individual investors buy the

shares. This implies that information asymmetry

could exist between individual and institutional inves-

tors, and individual investors could have informa-

tional disadvantage. Also, we find that institutional

investors continue to sell their shares on a bidding firm

after announcement of a bad merger, but individual

investors buy them. This suggests that individual

investors make poor trading decisions even after infor-

mation is released. Hence, our results together support

the evidence that individual investors are less

informed and/or less sophisticated than institutional

investors and their investment performance is inferior

to that of institutional investors. Based on the unique

daily trading data in Korean financial markets, our

study can further extend to study trading behaviours

by different groups of investors around other corpo-

rate events that may materially affect a firm value.

This would provide more fruitful comparison between

individual investors and other types of investors.

Acknowledgements

For helpful conversations and constructive comments,

we wish to thank seminar participants at Kookmin

University. This work was supported by the faculty

research program 2013 of Kookmin University in

Korea.

1.2

0.7

0.2

–0.3–30 –27

Individual investorsInstitutional investors

Days

CT

I –24 –21 –18 –15 –12 –9 –6 –3 3 6 9 12 15 18 21 24 27 30

–0.8

–1.3

–1.8

Fig. 2. Cumulative average trading imbalance (CTI) for 30 days before and after announcement of bad mergers between individual and

institutional investors

Notes: This figure presents the cumulative average trading imbalance (CTI) for 30 days before and after announcement of bad mergers betweenindividual and institutional investors. The grey area in the figure indicates the 3 days around announcement and we determine whether thetakeover is a bad merger based on the 3-day CAR.

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Barber, B. M. and Odean, T. (2000) Trading is hazardous toyour wealth: the common stock investment perfor-mance of individual investors, Journal of Finance, 55,773–806.

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