“The Price of Street Friends: Social Networks, Informed Trading, and Shareholder Costs” by Jay Cai
Ralph A. Walkling
Cohen, Frazzini, and Malloy (2008, 2010) document that Wall Street professionals gain from their social ties with public firms and conclude that social ties can increase the transfer of information. In this study, we examine the cost of these social connections to public firm shareholders. We document a significant and positive relation between a public firm's social connections with Wall Street and the firm's trading costs. Social ties based on education, leisure activities, and local ties have stronger effects on trading costs. After Wall Street connections die, trading costs are reduced. This natural experiment addresses concerns about endogeneity and omitted variables. Firms with more ties to Wall Street also exhibit lower abnormal volatility, lower abnormal trading volume, and weaker return response around earnings announcements and greater price adjustment prior to acquisition announcements. Our evidence illustrates the importance of social ties in the transfer of privileged information and the significant consequences for shareholders.