Insider Purchases Research Articles

The Credibility of Open Market Share Repurchase Signaling

AbstractOpen market share repurchase announcements are commonly associated with equity undervaluation, but their signal about firm value can often be misleading. We conjecture that executives who buy shares of their firm before an announcement add credibility to the undervaluation signal. Consistent with this hypothesis, we find that announcement returns are positively related to past insider purchases, especially for firms that are priced less efficiently. Firms whose insiders bought more shares are also more likely to complete their repurchase plans. Finally, we find that insider purchases predict post-announcement stock returns.

Dichotomous Expectations and Insider Trading Following Open Market Repurchases

The long-run performance of equity securities subsequent to announcements of open market repurchases (OMR) remains a contentious topic. In this paper we propose the “dichotomous expectations hypothesis” which posits that insider trading following share repurchase announcements reveals private information concerning the future operating performance of announcing firms. In particular, insider abnormal purchases (abnormal sales) should predict an improvement (decline) in operating performance that leads to higher (lower) long-run stock returns. Our hypothesis offers a credible economic link between insider trading and subsequent long-run stock performance through the intervening variable of operating performance. The empirical results show consistency with this linkage.

Time‐Varying Liquidity Trading, Private Information and Insider Trading

AbstractThis paper investigates the insider trading before scheduled versus unscheduled corporate announcements to explore how corporate insiders utilise their private information in response to the time‐varying liquidity trading. Using a comprehensive insider trading database, we show that: (1) the insider's propensity to trade increases in the amount of liquidity trading before both the scheduled and unscheduled announcements; (2) insiders buy (sell) more before positive (negative) announcements; and (3) insider purchases are more profitable before unscheduled announcements than before scheduled ones. They suggest that insiders time their trades around scheduled and unscheduled announcements to exploit the varying extent of liquidity trading.

When is Insider Trading Informative

Insider trades have been shown to earn abnormal returns. However, the information content of these trades is less certain. Based on the simple idea that insiders respond to benefi ts and costs in informative trading, this paper explores the relationship between insider trading informativeness and the information and regulation environments. We show that insider trades are more informative when firms are less transparent, and this correlation increases in the post-SOX period when reportings become timelier. Insider purchases are also more informative when SEC enforcement receives higher media attention. The correlation between informativeness and transparency, which is primarily driven by opportunistic trades, is manifested in long-term insider gains even after controlling for size and book-to-market. By asking \When is insider trading informative?, we provide an affirmative answer to the question \Is insider trading informative?

Disclosures of Insider Purchases and the Valuation Implications of Past Earnings Signals

ABSTRACTThis study examines whether disclosures of insider equity purchases on Securities and Exchange Commission (SEC) Form 4 resolve uncertainty regarding the valuation implications of reported earnings. Defining information uncertainty as ambiguity about firm value arising from low earnings precision, I predict and find that insider purchase filings trigger more positive market reactions in firms with greater information uncertainty (lower quality accruals). After controlling for future earnings changes, I further find that market reactions to purchase filings are predictably associated with prior earnings changes. The strength of this effect is increasing in the magnitude of insider purchases, as well as the level of information uncertainty. Overall, these findings suggest that, in addition to signaling future earnings information, Form 4 purchase filings help investors learn about the valuation implications of past earnings signals.Data Availability: All data are available from public sources.

Market Liquidity: Does Insider Trading Matter?

We examine the impact of reported insider trading on market liquidity, as measured by an order-size-dependent volume-weighted spread measure, which is called Xetra liquidity measure (XLM). This relationship is scrutinized for the German market both in an event study framework and through a panel data analysis. Overall, we see that insiders seem to trade on days that are very active, most likely to hide their information based trading in higher trading volumes. We discover that the liquidity impact of an insider transaction is highly dependent on the type of the transaction. Insider purchases impair market liquidity on and after the day of the insider transaction, whereas insider sales improve market liquidity on and after the day of the insider transaction. This liquidity impact is due to informational effects as uniformed market participants price protect against the adverse selection generated by informed investors. Uniformed market participants proxy the level of information asymmetry induced by insiders by the share of insider ownership. Hence, the price protection is therefore refl ected in the market liquidity on and after the day of insider purchases. As a consequence insider sales therefore alleviate the information asymmetry as the share of insider holdings is decreased and therefore market liquidity is improved on and after the day of insider sales.

Aggressive Informed Trading by Corporate Executives and Shareholder Value

Proponents of insider trading argue that informed trading benefits shareholders and could have a positive effect on firm value, however opponents counter that insider trading could be detrimental to firm value. We measure the extent of strategic informed trading by the fraction of insider trades that are V-shaped purchases (defined as insider purchases that are preceded by negative abnormal returns and followed by positive abnormal returns) and Λ-shaped sales (defined as insider sales that are preceded by positive abnormal returns and followed by negative abnormal returns). Our strategic informed trading proxy is negatively associated with future earnings performance and Tobin’s Q, even after controlling for the direction of insider trading intensity. We adopt the view that there could be frictions that prevent the board from setting the level of informed trading at the optimal level at any given time. We find that our measure of strategic informed insider trading is positively related to restatements, another possible manifestation of agency problems resulting from the same frictions. Moreover, strategic informed trading declines significantly after announcements of earnings restatements, which are usually accompanied with significant corporate governance improvement. Overall our evidence indicates that the type of informed trading we identify represents suboptimal informed trading that is detrimental to firm value – consistent with the opponent view of informed trading.

Insider trading returns and dividend signals

The literature shows that insider trading activities and dividends contain information content and serve as signals to firm value. If insider return is a proxy for information asymmetry, we should expect a positive relation between dividends and insider returns. Using a sample of unambiguous (good and bad) news concerning earnings and dividend announcements from Hong Kong firms, we show that information asymmetry is stronger for bad news firms with insider sales than good news firms with insider purchases. In addition, we improve the methodology of Khang and King [Khang, K., & King, T. H. D. (2006). Does dividend policy relate to cross-sectional variation in information asymmetry? Evidence from returns to insider trades. Financial Management, 35, 71–94] and provide evidence that dividend is a credible signal for measuring information asymmetry.

Idiosyncratic Risk and Corporate Transactions

It has been documented that insiders trade when they perceive their firms are mispriced and when they hold private information about future cash flows. Based on these findings, we test whether insiders at firms with high-idiosyncratic risk (which is associated both with financial anomalies and with greater private information in prices) earn higher returns to their trades than insiders at firms with lower idiosyncratic risk. We document that, indeed, the profitability of corporate transactions (insider purchases and sales, and share repurchases) increases dramatically with idiosyncratic risk. Corporate transactions are contrarian and the magnitudes of returns prior to and following trades increase with idiosyncratic risk. In further analyses, we find little evidence that these patterns relate to private information: they are not explained by common proxies for future cash-flow news and are not mitigated by increased regulatory oversight of insider trading since mid-1990s. Conversely, we document evidence indicating that high-idiosyncratic risk stocks are priced less efficiently: institutional investors are slow to respond to corporate transactions and prices following trades drift for several months.

Intraday Behavior of Stock Prices and Trades around Insider Trading

Our evidence indicates that insiders’ trades provide significant new information to market participants and they are incorporated more fully in stock prices as compared to noninsiders’ trades. We find that market professionals do not front‐run insiders’ trades. Both insiders’ purchases and sales result in significant contemporaneous and subsequent price impact, while sales by large shareholders result in a contemporaneous stock price decline that is subsequently reversed. The arrival of insider purchases reverse the prevailing negative order imbalances from third party trades and lead to piggy‐backing by market professionals resulting in subsequent market purchase orders as well as stock price increases.

New Evidence on the Effects of the Insider Trading Sanctions Act of 1984

This paper analyzes the effects of the Insider Trading Sanctions Act of 1984, the first federal level insider trading statute since 1934 which substantially increased the penalties of illegal insider trading. I find that, around the passage of the Act on July 25, 1984, there were positive abnormal returns for stocks heavily traded by insiders in the past. After the passage of the Act, insider trading frequency decreased significantly and insider trading volume also declined once firm characteristics are controlled for. I also explore insider trading behaviors in merger target firms before the merger announcements between 1979 and 1989 and find a significant decline in abnormal pre-announcement insider net purchases. After the enactment the odds ratio of a positive net insider purchase decreased from 0.08 to 0.04. The price run-up before merger announcements also attenuated after the ITSA enactment. The five-day pre-announcement abnormal return accounted for about 48% of the total price increase before the enactment, but only about 27% after the enactment. Overall, the evidence supports the hypothesis that the ITSA effectively reduced informed insider trading.

Changes in insider ownership and changes in the market value of the firm

The empirically-observed cross-sectional relation between the level of insider share ownership and the level of firm value has often been interpreted to mean that a change in share ownership can lead to a change in firm value. Such an interpretation has been criticized for ignoring potential endogeneity. In this paper, we perform two sets of tests to circumvent this alleged endogeneity. First, we measure changes in value over the 6-day interval around announcements of insider share purchases and find that the cross-sectional variability in changes in value is described by a curvilinear relation between firm value and insider ownership where the value of the firm first increases, then decreases, as insider share ownership increases. Second, we conduct tests to determine (1) whether the insider purchases are a response to changes in firm characteristics that require a new optimal equilibrium ownership level or (2) whether insiders are purchasing shares to signal that the firm is undervalued. We find no evidence to support these interpretations. Overall, our results are consistent with a causal interpretation of the empirical relation between insider ownership and firm value.

Two-stage models for the analysis of information content of equity-selling mechanisms choices

Extant research offers mixed empirical results on if private placement firms are undervalued. [Hertzel, Michael G., and Smith, L. (1993), “Market Discounts and Shareholder Gains for Placing Equity Privately,” J Finance 48, 459–485] suggest that private placements convey favorable information. On the other hand, [Hertzel, Michael G., Lemmon, M., Linck, J., and Rees, L. (2002), “Long-Run Performance following Private Placements of Equity,” J Finance 57, 2595–2617] show that, similar to public offering firms, private placement firms experience significant negative long-run post-announcement stock price performance. This paper develops the two-stage estimation models to explore the information content of equity-selling mechanism. This paper uses estimated residuals from insider trading regressions (proxy for abnormal insider trades) to measure private information. The result shows that the probability of making private placements increases with abnormal insider purchases and decreases with abnormal insider sales. This suggests that, relative to the public offering firms, private placement firms are undervalued.

A Middle Ground Position in the Insider Trading Debate: Deregulate the Sell Side

Participants in the forty-year debate over whether insider trading should be liberalized have generally treated insider sales the same as insider purchases - they have argued that all such insider transactions should be either regulated or liberalized. This article contends that there is a principled basis for treating price-decreasing insider trading (e.g., insider sales) more leniently than price-increasing insider trading (e.g., insider purchases). Because equity overvaluation is more likely than equity undervaluation to occur and persist and is more likely to occasion harm to the corporate enterprise when it does occur, corporate constituents (managers and shareholders) would likely value a policy that permits price-decreasing insider trading more than a policy that permits price-increasing insider trading. Thus, the majoritarian default rule may be an asymmetric policy under which price-decreasing insider trading is generally permitted while price-increasing insider trading is generally forbidden.

The Credibility of Voluntary Disclosure and Insider Stock Transactions

ABSTRACTWe examine stock price reaction to voluntary disclosure of innovation strategy by high‐tech firms and its relation with insider stock transactions before the disclosure. We find that, despite the qualitative and subjective nature of strategy‐related disclosure, there is positive stock price reaction to the disclosure. The evidence suggests that investors view the disclosure as credible good news. We also find that the disclosure is associated with more positive stock price reaction when it is preceded by insider purchase transactions. This evidence is consistent with insider purchase enhancing the credibility of the disclosure. The credibility‐enhancing effect is found to be stronger for firms with higher degrees of information asymmetry (younger firms, firms with lower analyst following, loss firms, and firms with higher research and development (R&D) intensity). Our evidence also indicates that predisclosure insider purchase is associated with greater future abnormal returns, suggesting that managers are privy to good news shortly before the disclosure.

Information, Incentive Alignment and Company-Loan Financing of Insider Trades

Insider acquisitions of shares are supposed to align the interests of managers and shareholders. Thus, they are typically viewed as positive signals. However, if the transactions do not put insiders' wealth at risk, perhaps this conclusion is a bit premature. We focus on loan financing of insider share acquisitions to test this idea. Our results indicate that loan financed insider purchases and option exercises earn smaller profits than non loan-financed counterparts. Our results also suggest that loan-financed insider purchases are an additional method to move an executive quickly to a target level of incentives. Based on these results, we conclude that (a) not all insider trades are alike, (b) insiders recognize when they are playing with other people's money, and (c) loan-financed purchases play an important role in incentive alignment.

Insider trading in Hong Kong: Some stylized facts

This paper examines the characteristics and price movements of legal insider transactions in Hong Kong. Abnormal returns are analyzed for intensive trading, as well as for samples grouped by industry classification, firm size, book-to-market ratio, price–earnings ratio, and relative trading volume of the insider transactions. Results show that insiders are able to earn abnormal profits from both buying and selling activities. The magnitude of and duration for abnormal profits depend significantly on firm-specific and transaction-specific factors. We also document the persistence of abnormal returns associated with insider sales, while abnormal profits associated with insider purchases are concentrated in certain transactions.

Abnormal Returns in the Vicinity of Insider Transactions: Unbiased Estimates for Germany

Several studies focusing on the US and the UK have shown, that abnormal returns tend to be negative on the days before insider purchases, positive on the transactions days and on the following days. For insider sales it is the other way around, but the absolute effects are smaller. Around the announcement days similar effects exist. In many cases more transactions and/or announcements take place on subsequent days, possibly having different directions and/or involving different buyers/sellers. We argue that because of the different signs of the abnormal returns before and after day 0, estimates based on all available observations could be biased. This is the first study to our knowledge which proposes and uses non-overlapping observations in this context. We confirm the above findings using German data for the two year period following the introduction of insider regulations in Germany in July 2002. Like in the UK, the effects around the announcement date are considerably larger than in the US. Unlike in the US and the UK, the effects are much more pronounced around sales. Due to our use of non-overlapping data, we can show these effects much more clearly than prior studies of the German market. In our cross-sectional regressions, net trading intensity on the announcement day, a variable suggested by Lakonishok/Lee (2001) is the most important explanatory vari-able for the cumulative abnormal returns from day -1 to day +1. When we look at the days 0 to +5, the explanatory power of the net trading intensity (NI) is considerably smaller. We conclude that diversification and liquidity motives together with price pres-sure effects are mainly responsible for the results.

Characteristics of a firm's information environment and the information asymmetry between insiders and outsiders*1

We examine how financial statement informativeness, analyst following, and news, relate to the information asymmetry between insiders and outsiders. Corporations' timely disclosures of value relevant information and information collection by outsiders reduce information asymmetry, limiting insiders' ability to trade profitably on private information. We use the profitability and intensity of insider trades to proxy for information asymmetry. We find that increased analyst following is associated with reduced profitability of insider trades and reduced insider purchases. Financial statement informativeness is negatively associated with the frequency of insider purchases. However, company news, good or bad, is positively associated with insider purchase frequency.

Some Insider Sales Are Positive Signals

Not all insider sales are the same. In the study reported here, a variable for shares traded as a percentage of insiders' holdings was used to separate information-driven sales from sales driven by liquidity or risk-reduction needs. In the insider trades from 1987 through 2002, only large sales that also accounted for large percentages of insiders' holdings predicted significantly negative future abnormal returns. Small sales that accounted for small percentages of shares owned not only did not predict poor performance but were correlated with significantly positive abnormal returns. The percentage of shares owned by insiders is also useful for predicting future returns following insider purchases.