Are corporate managers savvy about their stock price? Evidence from insider trading after earnings announcements

We find that insiders trade as if they exploit market underreaction to earnings news, buying (selling) after good (bad) earnings announcements when the price reaction to the announcement is low (high). We also find that insider trades attributable to public information about earnings and the price reaction generate abnormal returns. By demonstrating that managers spot market underreaction to earnings news, our results imply that managers are savvy about their company’s stock price.     

Does option trading convey stock price information?

After executing option orders, options market makers turn to the stock market to hedge away the underlying stock exposure. As a result, the stock exposure imbalance in option transactions translates into an imbalance in stock transactions. This paper decomposes the total stock order imbalance into an imbalance induced by option transactions and an imbalance independent of options. The analysis shows that the option-induced imbalance significantly predicts future stock returns in the cross section controlling for the past stock and options returns, but the imbalance independent of options has only a transitory price impact. Further investigation suggests that options order flow contains important information about the underlying stock value.     

Do voluntary corporate restrictions on insider trading eliminate informed insider trading?

We investigate whether voluntary corporate restrictions on insider trading effectively prevent insiders from exploiting their private information. Our results show that insiders of firms with seeming restrictions on insider trading continue to take advantage of positive private information while being more cautious when exploiting negative private information. The results suggest that insiders continue to exploit their informational advantages in a way that minimizes their legal risk. We also find that the degree of information asymmetry is significantly lower in firms with restriction policies and that corporate governance significantly affects firms' decisions to adopt these policies.     

Does exposure to product market competition influence insider trading profitability?

We examine whether and how product market competition affects insider trading profitability. We empirically show that the insiders of firms in highly competitive industries make higher abnormal profits. Our identification strategy includes both a quasi-natural experiment setting and an instrumental variable approach to address endogeneity concerns. We also run an extensive array of robustness checks and find that our baseline results remain substantially unchanged. Our cross-sectional analyses show that insider trading profitability is more pronounced for firms with: a higher level of trade secrecy, a higher level of R&D, a lower level of management voluntary disclosures, less readable 10-K reports and highly tone-ambiguous financial disclosures. We also find that our results are robust to the inclusion of corporate governance mechanisms. Overall, this study is consistent with the theoretical predictions that support the information asymmetry and proprietary cost channels of competition and that increases in competition lead insiders to undertake more rent-seeking activity.     

Does insider trading have information content for the bond market?

This study documents that there is significant information content in stock trading by registered corporate insiders for the bond market. We report significant positive price reactions for convertible and straight bonds in response to the Wall Street Journal's Insider Trading Spotlight publication of insider buy transactions and significant negative reactions for insider sell transactions. The stock market response to the publication of the insider transactions, although weaker than the bond market reaction, is also found to be significant. Cross-sectional results suggest that bond market participants extract the quality of the insider-trading signal by observing factors such as the dollar volume of the trade, the percentage change in the holding of the insider, and the insider's position in the firm. Lower-rated (riskier) bonds are found to be more sensitive to the information than higher-rated issues. The empirical evidence presented in this paper suggests that the absence of any reporting requirement for insider bond transactions may create aan enhanced opportunity for the insiders to exploit private information to expropriate wealth from uninformed bond traders.     

Does stronger corporate governance constrain insider trading? Asymmetric evidence from Australia

We investigate the role of internal corporate governance in limiting opportunities for ASX company ‘insiders’ to extract abnormal returns from trading ‘own shares’. We show that stronger governance translates into more restrictive insider trading policies and, while not resulting in lower insider purchase volumes, values or profits, it does reduce insider selling profitability. Firm size and increasing trading policy restrictiveness is associated with reduced insider purchase profitability while insider sale profitability is reduced by aggregate governance, trading restrictions and increasing trading policy restrictiveness. We conclude that internal firm governance constrains insider sales but not purchases, providing contrarian trading signals.     

Does takeover activity affect stock price crash risk? Evidence from international M&A laws

We exploit the staggered initiation of merger and acquisition (M&A) laws across countries as a plausibly exogenous shock to the threat of takeover to examine whether the market for corporate control has a real effect on firm-level stock price crash risk. Using a difference-in-differences regression on a large sample of firms from 32 countries, we find that stock price crash risk significantly decreases following the passage of M&A laws. This effect is stronger for firms domiciled in countries with poorer investor protection and information environments and for firms with weaker firm-level governance. Further, financial reporting opacity and overinvestment significantly decrease in the post-M&A law periods. Our study suggests that an active takeover market has a disciplining effect on managerial bad news hoarding and leads to lower future crash risk.     

Does common ownership constrain managerial rent extraction? Evidence from insider trading profitability

This study identifies a new economic benefit of common institutional ownership, which refers to the increasingly contentious phenomenon of U.S. firms sharing stockholders with their industry competitors. We find a significantly negative relation between common ownership and insider trading profitability. The disciplinary effect of common ownership on opportunistic insider trading is particularly evident when the information effects of common ownership are greater, when common owners are more likely to benefit from positive governance externalities, and in the subset of trades made by opportunistic insiders. Using the exogenous variations in common ownership induced by financial institution mergers, we conduct a difference-in-differences analysis and find consistent results. We also provide evidence that common owners encourage firms to impose ex-ante restrictions on insider trading and take ex-post actions to discipline opportunistic insiders by voting against management. Overall, our findings suggest that common institutional shareholders have information advantages, governance incentives, and effective means to constrain opportunistic insider trading.     

Does the threat of takeover affect default risk?

We examine the impact of the threat of takeovers on default risk. Using a sample of 50,189 firm-year observations for US firms over the period 1990–2015, we find that the threat of takeovers has a negative relation with default risk. We use difference-in-difference analysis to address potential endogeneity concerns and propensity score matching to control for self-selection bias. The results are robust to alternative measures of default risk and exclusion of the dot com and financial crisis periods. Our results also hold after controlling for Governance Index and Entrenchment Index. We identify improvement in performance and earnings quality in response to the threat of takeovers as channels underlying our main result. The effect of the threat of takeovers on default risk is more pronounced for firms with opaque information environment and low institutional ownership. Our findings provide important insights for the market for corporate control as a disciplining mechanism in reducing default risk.     

Double signals or single signal? An investigation of insider trading around share repurchases

We examine directors’ dealing activity around share repurchasing periods in Hong Kong. There are significant insider trading activities before the share repurchasing period. Consistent with the signaling hypothesis, the directors’ purchase activities during the share repurchase period are significantly higher than the expected level while the directors’ sale activities are significantly lower than the expected level. Double signals of share repurchase and directors’ purchases create a stronger signal in conveying undervaluation, while insider sales around share repurchase reduces the undervaluation signal. We find some evidence that is consistent with the free cash flow and signaling arguments for share repurchases.     

Aggregate insider trading: Contrarian beliefs or superior information?

We decompose realized market returns into expected return, unexpected cash-flow news and unexpected discount rate news to test the relation between aggregate market returns and aggregate insider trading. We find that (1) the predictive ability of aggregate insider trading is much stronger than what was reported in earlier studies, (2) aggregate insider trading is strongly related to unexpected cash-flow news, (3) market expectations do not cause insider trading contrary to what others have documented, and (4) aggregate insider trading in firms with high information uncertainty is more likely to be associated with contrarian investment strategy. These results strongly suggest that the predictive ability of aggregate insider trading is because of insider’s ability to predict future cash-flow news rather than from adopting a contrarian investment strategy. These results hold even after we control for non-informative trades and information uncertainty.     

Does stardom affect the informativeness of a CEO's insider trades?

This study examines whether the celebrity or star status of a chief executive officer (CEO) affects the informativeness of his insider trades. Using three different measures to identify star CEOs in a sample of S&P 1500 firms, we find that trades of non‐star CEOs predict future abnormal returns and earnings innovations and that trades of star CEOs do not. The predictive power of non‐star CEO trades is mostly attributable to opportunistic trades, not routine trades. We also find evidence suggesting that the abnormal returns associated with non‐star CEO insider trades are due to the lower visibility and consequently less scrutiny of non‐star CEOs compared with star CEOs.     

Does vega-neutral options trading contain information?

This study suggests a novel approach for decomposing net options demands into the options order imbalances with and without volatility risk. By analyzing a high-frequency index futures and options dataset, we examine the information content of (i) the direction-motivated order imbalance induced by a single option type, which is exposed to volatility risk, and (ii) that constructed by both calls and puts, which is vega-neutral. The aggregate options order imbalance does not convey information after controlling for futures market trading. However, the intraday options order imbalance by trading without volatility risk significantly predicts spot index returns, though its longer-horizon forecasting ability is relatively weak because of a possible cross-market hedging effect. The predictive abilities of informed foreigners’ trades and out-of-the-money options trading are prominent. Our empirical results suggest that the vega-neutral options trading conveys additional information distinct from the futures order imbalance.     

Does ETF trading affect the efficiency of the underlying index?

This study finds that both contemporaneous and lagged ETF trading volumes in both absolute and relative terms are significant contributors to the price efficiency of the underlying index. The variation in ETF shares outstanding is also positively associated with the index efficiency but it weakens the effect of ETF trading on the index efficiency. Moreover, the synthetic ETF price dominates the index in information share and the dominance increases in ETF trading. However, the relation between an individual ETF's information share and its trading volume varies, which is significantly positive for the leading ETF but ambiguous for other ETFs.     

Does program trading contribute to excess comovement of stock returns?

Daily returns of stocks with high program trading comove more with each other but less with others. This significant comovement is disconnected with market movements and news of fundamentals and becomes stronger when market uncertainty is higher. It can be explained by neither the hypotheses of gradual information diffusion and liquidity provision nor the effects of quantitative trading signals, earnings announcements and index fund trading. Its non-fundamental nature is further demonstrated by the observation of program trading stimulating return reversals. Underlying this comovement is the high persistence of program trading. Our findings support the theory of habitat investing and demonstrate program trading creates a distinct source of excess return comovement.     

Rumors and pre-announcement trading: why sell target stocks before acquisition announcements?

We track trading activity in the days preceding acquisition announcements for target firms and find that abnormally high trading volume precedes significant price movement. Using additional intraday data, we find increased active-selling in target stocks before acquisition announcements that offsets increased active-buying. This is unexpected because sellers often lose money when an acquisition is announced. After ruling out alternative explanations, we find evidence that sellers are rational investors who trade on the market??s perceived overreaction to takeover rumors. While sellers lose money when a rumor precedes an actual announcement, in most cases rumors fail to materialize into public announcements. We provide evidence that the significant pre-announcement volume we document reflects the market??s processing of highly uncertain information in takeover rumors.     

Does FOMC news increase global FX trading?

Does global currency volume increase on Federal Open Market Committee (FOMC) days? To test hypotheses of abnormal currency volume on FOMC days, a new data set from the Continuous Linked Settlement (CLS) Bank is used. The CLS measure captures more than half of the global trading volume in foreign exchange (FX) markets. The evidence shows that FX trading volume increases about 5% in the spot and the spot-next market following FOMC deliberations. The novelty of this result is that the aggregated CLS data controls for responses in various derivatives markets: a feature that existing studies based on intradaily data for specific trading platforms do not consider.     

Does Limited Attention Constrain Investors’ Acquisition of Firm‐specific Information?

According to the framework outlined in Peng and Xiong ( 2006 ), attention‐constrained investors tend to process more market‐ and sector‐level information. We empirically test this theory. We find that firms with higher media coverage have lower contemporaneous stock return synchronicity. Such an effect is robust to analyses within size deciles, inclusion of firm fixed effects, estimation using a matched sample, and a two‐stage least squares approach. The effect becomes less pronounced during the financial crisis period when both the quantity and quality of firm‐specific information decrease. Further, the attention from media coverage has a spillover effect on the firm's industry peers without media coverage. Finally, investors of firms with higher media coverage are more efficient in incorporating future firm performance into current stock prices. Collectively, our findings support the theory in Peng and Xiong ( 2006 ) that investors increase their acquisition of firm‐specific information when a firm captures their attention.     

Is managerial rent extraction associated with tax aggressiveness? Evidence from informed insider trading

Review of Quantitative Finance and Accounting - Despite the agency perspective of corporate tax avoidance, there is little empirical evidence that managers do extract rents derived from aggressive...     

Price and trading volume reaction: the case of Hong Kong companies’ earnings announcements

In this paper, we investigate the price changes and trading volume reactions during the days surrounding the announcements of annual earnings based on a 31-day observation window for a sample of Hong Kong firms listed on the Stock Exchange of Hong Kong (SEHK). The major findings of our study: (1) materially support the findings of Morse (1981), (2) demonstrate significant price and volume reactions over four days surrounding the annual earnings announcement over the years 1992 to 1995, (3) show similar market reaction for Blue Chip stocks compared to Non–Blue Chip stocks, and (4) indicate a larger overall price reaction for Non–Blue Chip stocks and mixed results regarding volume reaction when comparing the Blue Chip and Non–Blue Chip stocks. These results show that, although the Hong Kong results are largely in line with the U.S. and international evidence, the Blue Chip stocks are followed more and remain the mainstream stocks for Hong Kong investors.