Are CEOs’ purchases more profitable than they appear?

Abstract

Little is known about why CEOs voluntarily purchase shares of their firm other than to earn direct profits. Since CEOs are risk-averse, undiversified, and face litigation costs from trading on private information, direct profits are unlikely to be the sole motive—especially since many purchases are ultimately unprofitable. We find that CEOs who have recently purchased shares are less likely to be terminated following poor performance and that this relation varies predictably with (i) their cost of purchasing shares, (ii) the profitability of their prior purchases, and (iii) their board's access to alternative sources of information about them. We find that some CEOs voluntarily purchase shares despite the cost of foregone diversification—and, sometimes outright unprofitability—to indirectly benefit by prolonging their tenure. Our estimates imply that the average abnormal returns that CEOs earn from their purchases increases from 3% to 58% after incorporating the indirect benefit of prolonged tenure.