The effect of insider trading on financial analysts' forecast accuracy and dispersion

Abstract

While the United States Securities and Exchange Commission prohibits corporate insider trading based on non-public information, critics (e.g., Manne 1966, Carlton and Fischel 1983) of this policy argue that allowing insiders to trade would increase the amount of information impounded in stock prices and thereby increase stock market efficiency. Our study provides evidence on this issue by examining whether corporate insider trading increases the amount of information available to financial analysts forecasting corporate earnings. We examined the impact of insider trading on the dispersion of financial analysts' earnings forecasts and magnitude of analysts' forecast errors. Our test results showed that as insider purchasing increases both forecast errors and forecast dispersion decrease. Insider selling, however, appeared to be unrelated to forecast errors or forecast dispersion. Insider purchasing had a greater impact on forecast errors than on dispersion and a greater impact on large firms than on small firms. We interpret these tests as evidence that the execution or disclosure of insider trading reveals information about firms' future prospects which is used in analysts' earnings forecasts.