The dual purpose of insider trading: Signaling quality and battling shorts

Abstract

This paper contributes to explaining the benefit-cost puzzle of insider trading activity. We show that net insider purchase is a convex function of the quarterly earnings surprise decile in terms of mean, median, and purchase frequency. The convexity suggests that the magnitude of net insider purchases is positively associated with information asymmetry. Further evidence indicates that the majority of insider purchases are not designed to earn abnormal returns; instead, they signal firm quality when firms are in adverse situations and fight against short sellers when short interest is high.