Do Insiders Practice What They Preach? Informed Option Exercises Around Acquisitions

Abstract

We examine executive stock option exercise activity around a sample of acquisition announcements between 1996 and 2006, particularly focusing on a subset of exercises that we identify as potentially informed. For stock-financed acquisitions, we find a surge in informed exercises by acquirers' insiders in the year leading up to the acquisition announcement and significantly more option exercises when matched to control firms. On the other hand, target insiders display no increase in informed option exercises in the year preceding the merger announcement and significantly less ESO exercises compared to their matched firms. We find the market reaction upon the announcement for acquirers is negatively related to extreme early exercises and the dollar amount of such informed exercises. Firms with informed exercises underperform control-matched firms both from an operating and stock performance perspective. Overall, our evidence indicates that insiders knowingly bid for firms when they personally believe their own firm is overvalued, consistent with the theoretical predictions in Shleifer and Vishny (2003).