Asymmetric information consolidation and price discovery: Inferring bad news from insider sales

Due to the paucity of sources of negative firm‐specific information, US capital markets have more difficulty identifying and incorporating bad news into stock prices than they do good news. Even though insider selling is a potentially important proxy for undisclosed bad news, researchers have difficulty ex ante identifying information‐based sales due to an inability to separate liquidity‐motivated from information‐based insider trades. We hypothesize that when insiders in multiple firms sell shares of one firm in which they are insiders and at the same time buy shares of other insider portfolio firms, the sale is more likely to be information‐based, since the proceeds are reinvested. Conversely, when an insider sells one firm without purchasing others or sells multiple insider firms the sale is likely liquidity‐motivated. We find that insider sales identified as information‐based using this algorithm are followed by significant negative abnormal returns. Information‐based sales are also more likely to be associated with delistings, earnings declines and earnings restatements. Analysts are also more likely to revise their earnings forecasts downwards for these firms. It is thus possible to ex ante identify insider sales with information content. Our results will be of interest to investors and also to regulators designing insider trading rules.     

Insider trading,future earnings,and post-earnings announcement drift

This paper examines the association between insider trading prior to quarterly earnings announcements and the magnitude of the post-earnings announcement drift (PEAD). We conjecture and find that insider trades reflect insiders’ private information about the persistence of earnings news. Thus, insider trades can help investors better understand and incorporate the time-series properties of quarterly earnings into stock prices in a timely and unbiased manner, thereby mitigating PEAD. As predicted, PEAD is significantly lower when earnings announcements are preceded by insider trading. The reduction in PEAD is driven by contradictory insider trades (i.e., net buys before large negative earnings news or net sells before large positive earnings news) and is more pronounced in the presence of more sophisticated market participants. Consistent with investors extracting and trading on insiders’ private information, pre-announcement insider trading is associated with smaller market reactions to future earnings news in each of the four subsequent quarters. Overall, our findings indicate insider trading contributes to stock price efficiency by conveying insiders’ private information about future earnings and especially the persistence of earnings news.     

Insider trading and future stock returns in firms with concentrated ownership levels

We investigate the relationship between insider trading and stock returns in firms with concentrated ownership. To this end, we employ data from East Asian countries which span the period January 2003 to May 2012. Consistent with the previous literature, we find a significantly negative relation between the selling activity of insiders and stock returns. However, contrary to studies which focus on highly developed markets, we find that the buying activity of insiders is also inversely related to future stock returns. Our analysis shows that top directors with higher ownership levels drive this result, suggesting that the trading activity of insiders is not always associated with profit-making motives and can be explained by their level of ownership. Furthermore, we demonstrate that a trading strategy which focuses solely on purchases made by top directors with high ownership levels yields negative returns. The paper has important implications for outside investors who mimic the trading activity of insiders with the aim to realise profits.     

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.     

Insider-trading,discretionary accruals and information asymmetry

Using US data for the period from 2004 to 2012 and alternative discretionary accruals measures, we examine whether insiders manipulate earnings in an asymmetric information environment to profit from their informed trades, and whether the intervening information environment influences the relationship between earnings management and insider trading. We show that insider trading dominated by sell trades has a positive association with discretionary accruals. The incremental effect of information asymmetry as well as the interaction with insider trading is also prevalent in this relation, confirming the moderating effect of asymmetric information. Further, we show that the active involvement of some key insiders in high discretionary accruals is for personal benefit more in growth firms than in value firms. Our results also suggest that earnings management allows for insiders’ opportunistic, rather than routine, buy and sell trades. Our findings highlight that regulators should oversee and scrutinise both insider trading and earnings management to mitigate the risk of the opportunistic behaviour of insiders to avoid future corporate scandals.     

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.     

Do insiders trade on government subsidies?

We examine whether and how insiders trade on government subsidies, a major instrument through which the governments intervene in the economy. Using a novel dataset of government subsidies of Chinese listed firms, we find that net insider purchase increases significantly during the month of subsidy receipt. The effect of subsidies on insider trading is weaker in firms with a more transparent information environment and when subsidies are granted in a more predictable manner. In contrast, the effect is more pronounced for politically connected firms. Further analysis shows that the subsidy-trading relation may reflect both insiders’ informational advantage concerning subsidies and their superior ability to detect mispricing-related opportunities. Our findings provide new insights into the capital market consequences of government subsidies through the lens of insider trading.     

The Relation Between Insider-Trading Restrictions and Executive Compensation

In this study I investigate the relation between firm‐level insider‐trading restrictions and executive compensation. Using a trading‐window proxy for the existence of such restrictions, I test predictions that insiders will demand compensation for these restrictions and that firms will need to increase incentives to restricted insiders. I find that firms that restrict insider trading pay a premium in total compensation relative to firms not restricting insider trading, after controlling for economic determinants of pay. Furthermore, these firms use more incentive‐based compensation and their insiders hold larger equity incentives relative to firms that do not restrict insider trading. These results hold after controlling for the endogenous decision to restrict insiders and are consistent with the notion that insider trading plays a role in rewarding and motivating executives.     

The impact of governance reform on performance and transparency

This study examines the influence of Mexico’s efforts to improve corporate governance on firm performance and transparency. We utilize compliance data from the Code of ‘Best’ Corporate Practices, disclosed annually by public firms in Mexico, as a measure of corporate governance strength. We document a significant increase in compliance over 2000–2004 indicating Mexican companies view non-compliance as costly. However, we find no association between the governance index and firm performance, nor is there a relation with transparency. Instead, we find firms with greater compliance resort to the more costly mechanism of making dividend payments (higher propensity to pay and greater yield) to reduce agency conflicts. We conclude these associations are the direct result of the institutional features of the Mexican business environment, which is characterized by concentrated ownership of insiders, interlocked boards of directors, a lack of insider trading enforcement, and generally poor protection of minority investors. Our results show that monitoring mechanisms alone are not enough to fundamentally change economic behavior.     

Directors’ share dealings and corporate insolvencies: evidence from the UK

This paper investigates the relation between insider trading and the likelihood of insolvency with a specific focus on the directors’ sale and purchase transactions preceding insolvency. We use a unique data set on directors’ dealings in 474 non-financial UK firms, of which 117 filed for insolvency, over the period 2000–2010. We show that the directors of insolvent firms increase their purchase transactions significantly as the insolvency approaches. The results also reveal a significant relation between three different measures of insider trading activity and the likelihood of insolvency, which is observed to be positive only during the last six-month trading period. The relation is negative for the earlier trading periods. While the earlier purchase transactions appear to be motivated by superior information held by insiders, the purchase trades closer to the insolvency date are possibly initiated by directors’ motives to influence the market's perception of the firm in an attempt to avert or delay insolvency.     

卖空机制能够约束内部人减持吗？——基于融资融券制度的经验证据

本文以我国放松卖空管制为视角,探究其对内部人减持的影响。研究表明,卖空机制能够抑制企业内部人减持行为。机制分析发现,卖空对内部人减持的抑制作用是通过缓解股权高溢价实现的。进一步研究表明,卖空能够抑制大股东、董事以及管理层减持,但对监事减持无影响;卖空能够降低内部人减持的获利程度,并且在内部人减持动机更大时,对内部人减持的抑制作用更强;卖空通过约束内部人减持提升了股票定价效率,还有助于降低内部人增持行为。本文的研究结论丰富了卖空和内部人减持领域的文献,并对政府部门完善制度设计具有启示意义。     

Effect of ownership,governance, and transparency on liquidity – Chilean evidence

Companies with relatively thin trading, a high concentration of insider ownership, and a privatized pension system characterize Chile’s Santiago Stock Exchange. Within this setting, we study the relationship between ownership concentration, corporate governance, and stock market liquidity. Our results suggest that board independence, corporate disclosure and outside monitoring by institutions help moderate the effects that insiders have on trading costs and liquidity. We also find that market makers with inventory reduce the informational component of trading costs. Finally, the trades of insiders provide price guidance to market makers, while traders employ a follow-the-insider strategy when transparency is low.     

Do commonalities facilitate private information channels? Evidence from common gender and insider trading

We examine insider trading profitability and common identity between insiders and top executives. We argue that common gender and the resulting social connections influence access to private information, wherby insiders benefit from greater information-sharing with top executives of the same gender. Using a large sample of US firms between 1995 and 2016, we find higher (lower) insider trading profitability for female (male) insiders in the presence of a female CEO or CFO. We also find that, in isolation, other social and professional commonalities, such as age, ethnicity, having attended the same university or having worked at the same firm also increase insider profitability, albeit to a lesser extent. Our evidence suggests that some of these commonalities enhance the common gender effect when combined with it. We examine formal interactions and find that attending meetings and serving on committees with top executives of the same gender enables private information-sharing, consistent with gender acting as an informational channel. We also document greater clustering of insiders' trades around the trades made by common gender top executives. Our findings are consistent with flows of private information from CEOs and CFOs to less informed common gender insiders.     

Do technology spillovers affect the corporate information environment?

Technology spillovers across firms affect corporate innovation, productivity, and value, according to prior research, so information about technology spillovers should matter to investors. We argue that technology spillovers increase the complexity and uncertainty of value relevant information about the firm, which makes information processing more costly, discourages it, and thereby increases information asymmetry between insiders and outsiders. We find that not only does information asymmetry increase, but so does avoidance by sophisticated market participants, uncertainty, and insider trading. We also find that investors do not misestimate short-term earnings, but they underestimate long-term earnings, consistent with the higher future stock returns that we also find.     

Information trading by corporate insiders based on accounting accruals: forecasting economic performance

In this paper, we test whether directors’ (corporate insiders) trading in Australia, based on accounting accruals, provides incremental information in forecasting a firm's economic performance. We determine that directors’ trading on negative accruals in larger firms has greater forecasting content and is associated with 1‐year‐ahead bull market phases. Moreover, arbitrage portfolios set up to mimic insider trading can earn 1‐year‐ahead excess size‐adjusted arbitrage returns of up to 12.2 per cent. Results are consistent with directors hiding their trades in liquid well‐traded firms and in providing incremental information above that supplied by a continuous information regime.     

Predicting earnings in a poor information environment

Financial intermediaries, such as analysts, play an important role in providing information to investors. However, a large segment of the market (about 39% of CRSP firms between 1992 and 2009) is not served by financial analysts, leaving investors in a poor information environment. In this paper, we examine whether other publicly available information signals, such as insider trades, institutional holdings, and firms’ stock repurchases, can be used to predict information about earnings for these firms. We find that CFOs’ trading decisions are associated with new information contained in the annual earnings reports for firms with no or scant analyst coverage. In contrast, for firms with multiple analyst coverage, insider trading decisions are not predictive of new information in earnings reports. Our results suggest that some public information signals, such as insider trades, can be used to alleviate the poor information environment faced by investors. However, the market may not have fully priced the information contained in these signals.     

Why does shareholder protection matter for abnormal returns after reported insider purchases and sales?

We use a unique data set of more than 240,000 reported insider transactions across 15 European countries and the USA to analyze the link between country-level shareholder protection and abnormal returns following insider trades. We show that abnormal returns after insider transactions are positively correlated with country-level shareholder protection against expropriation by corporate insiders, which supports the information-content hypothesis. Market reaction to insider purchases increases with shareholder protection because shareholder protection enhances the transparency and trustworthiness of insiders’ actions, and limits possibilities for direct profit diversion, so that more information is eventually reflected in stock prices. For insider sales, shareholder protection decreases their negative information content. We conjecture that this is due to the effect of greater transparency and trustworthiness strengthening the diversification and liquidity reasons for selling in better shareholder protection countries. We find limited support for the rent-extraction hypothesis that conjectures that shareholder protection is associated with insider trading dollar profits.     

Do co-opted boards increase insider profitability?

Using a sample of U.S. firms over the period 1996–2014, this paper examines whether insider trading profitability increases with high board co-option. Indeed, we find that firms with a higher level of co-opted directors exhibit higher insider trading profitability, largely due to a lower level of managerial ability and analyst coverage. Co-opted boards are also unlikely to implement self-imposed insider trading restrictions, exacerbating this relationship. This positive association is mitigated by a higher level of external monitoring by institutional investors and if the CEO receives more performance-based incentives. Overall, co-opted directors demonstrate aligned interests with CEOs and corporate insiders rather than performing their role as monitors. As a result, a more co-opted board is positively associated with exploitative behaviour of insiders.     

Insider Investment Horizon

We examine the relation between insiders’ investment horizon and the information content of their trades with respect to future stock returns. We conjecture that an insider's investment horizon establishes a benchmark for expected patterns of continued trading behavior and thus helps identify unexpected insider trades, which should be more informative in efficient markets. Consistent with this conjecture, the trades of short-horizon insiders are both more unexpected and more informed, on average, than those of long-horizon insiders. Short-horizon insiders and their firms also tend to display characteristics that are associated with a greater focus on short-termism.     

Auditor Choice in Politically Connected Firms

We extend recent research on the links between political connections and financial reporting by examining the role of auditor choice. Our evidence that public firms with political connections are more likely to appoint a Big 4 auditor supports the intuition that insiders in these firms are eager to improve accounting transparency to convince outside investors that they refrain from exploiting their connections to divert corporate resources. In evidence consistent with another prediction, we find that this link is stronger for connected firms with ownership structures conducive to insiders seizing private benefits at the expense of minority investors. We also find that the relation between political connections and auditor choice is stronger for firms operating in countries with relatively poor institutional infrastructure, implying that tough external monitoring by Big 4 auditors becomes more valuable for preventing diversion in these situations. Finally, we report that connected firms with Big 4 auditors exhibit less earnings management and enjoy greater transparency, higher valuations, and cheaper equity financing.