Abstract
We study whether firms that voluntarily restrict insider trading have lower incentives for earnings management. Using a large sample of US firms, we measure these restrictions based on the extent to which insider transactions happen shortly after quarterly earnings announcements. We find that the adoption of insider trading restrictions is associated with a reduction of 9.92 percent in absolute discretionary accruals. Our findings are robust to controlling for changes in corporate governance, and we do not find evidence of a substitution effect between accruals and real earnings management, target beating or timeliness of loss recognition. Taken together, our results indicate that the voluntary adoption of blackout periods that limit insider trading improves the quality of financial reporting.
Highlights
We study whether the adoption of firm-level insider trading restrictions influences earnings management
There are no significant differences in observable characteristics in the adopters and non-adopters in the year of adoption. This suggests that propensity score matching (PSM) successfully identifies control firms that are similar to our insider trading restrictions (ITRs)-adopting firms across these observable determinants of voluntarily adopting ITRs
To further investigate whether this may be driving our results, we identify those firms in the PSM sample that go from greater to lower board independence in the period following adoption, by comparing the means of BdIndep across periods
Summary
We study whether the adoption of firm-level insider trading restrictions influences earnings management. In line with this view, regulators have expressed their concerns that insider trading opportunities create incentives for corporate insiders to garble the earnings signal (e.g., SEC, 1998) In reaction to these regulatory concerns, in recent years many firms have implemented restrictions on the timing of insider trades beyond mandatory regulation to avoid illegal insider trading, or accusations thereof, in relation to upcoming earnings announcements. These restrictions consist of self-imposed blackout periods that allow insiders to trade in a company’s shares only during a limited window following an earnings announcement, usually corresponding to the first third of the quarter immediately after the announcement (Bettis, Coles, & Lemmon, 2000). These restrictions are adopted on a voluntary basis by boards of directors
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