Insider Sales Research Articles

Insider Trading, Litigation Concerns, and Auditor Going-Concern Opinions

We investigate whether insider selling affects the likelihood of firms receiving auditor going-concern opinions. Prior studies document significant negative market reactions to the issuance of going-concern opinions, indicating that such opinions convey bad news to investors. Insider sales followed by negative news are likely to attract regulators’ scrutiny and investor class-action lawsuits. Therefore, we predict that, to reduce the risk of litigation, managers have incentives to avoid receiving going-concern opinions after their insider sales by pressuring auditors for clean audit opinions. We evaluate this prediction empirically and find that the probability of receiving a going-concern opinion is negatively associated with the level of insider selling. Further analysis indicates that this negative relation is more pronounced for firms that are economically significant to their auditors but less pronounced when (1) auditors have concerns about litigation exposure and reputation loss and when (2) audit committees are more independent. Finally, the negative relation between going-concern opinions and insider sales is significantly weakened after SOX.

Do Retail Investors Follow Insider Trades?

Abstract On the basis of transaction records of retail investors provided by a large financial institution, this article analyzes whether, in the aggregate, retail investors do copy insider trades. The results suggest that insider trades are indeed an important piece of information for the transactions of retail investors, whose buy-sell imbalances (BSIs) increase in stocks which insiders buy, and whose BSIs decrease following insider sales. These results are robust when considering stock characteristics and general attention effects. With regard to trading insider stocks, retail investors’ preferences for growth and attention are less pronounced when compared with trades of noninsider stocks.

Mutual Fund Trading Pressure: Firm‐Level Stock Price Impact and Timing of SEOs

ABSTRACTWe use price pressure resulting from purchases by mutual funds with large capital inflows to identify overvalued equity. This is a relatively exogenous overvaluation indicator as it is associated with who is buying—buyers with excess liquidity—rather than what is being purchased. We document substantial stock price impact associated with purchases by high‐inflow mutual funds, and find the probability of a seasoned equity offering (SEO), insider sales, and the probability of a stock‐based acquisition increase significantly in the four quarters following the mutual fund buying pressure. These results provide new evidence that firm managers are able to identify and exploit overvalued equity.

Why does shareholder protection matter for abnormal returns after reported insider purchases and sales?

We use a unique data set of more than 240,000 reported insider transactions across 15 European countries and the USA to analyze the link between country-level shareholder protection and abnormal returns following insider trades. We show that abnormal returns after insider transactions are positively correlated with country-level shareholder protection against expropriation by corporate insiders, which supports the information-content hypothesis. Market reaction to insider purchases increases with shareholder protection because shareholder protection enhances the transparency and trustworthiness of insiders’ actions, and limits possibilities for direct profit diversion, so that more information is eventually reflected in stock prices. For insider sales, shareholder protection decreases their negative information content. We conjecture that this is due to the effect of greater transparency and trustworthiness strengthening the diversification and liquidity reasons for selling in better shareholder protection countries. We find limited support for the rent-extraction hypothesis that conjectures that shareholder protection is associated with insider trading dollar profits.

Corporate Governance and Insider Trading

This paper examines the influence of corporate governance systems on insiders’ ability to profit from their information advantage and the ways through which corporate governance systems influence such ability. We find that corporate governance significantly reduces the profitability of insider sales but not that of insider purchases. Given that sales involve greater legal risk than purchases, the results suggest that well-governed firms restrict informed insider trading mainly to reduce legal risk. We also find that better-governed firms reduce the profitability of insider sales by increasing the likelihood of adopting ex-ante preventive measures (e.g., voluntary insider trading restriction policies), implementing such measures more effectively, and taking ex-post disciplinary actions more actively. These results highlight how better-governed firms are able to restrict insiders from exploiting private information.

Why does Shareholder Protection Matter for Abnormal Returns after Reported Insider Purchases and Sales?

We use a unique data set of more than 240,000 reported insider transactions across 15 European countries and the USA to analyze the link between country-level shareholder protection and abnormal returns following insider trades. We show that abnormal returns after insider transactions are positively correlated with country-level shareholder protection against expropriation by corporate insiders, which supports the information-content hypothesis. Market reaction to insider purchases increases with shareholder protection because shareholder protection enhances the transparency and trustworthiness of insiders’ actions, and limits possibilities for direct profit diversion, so that more information is eventually reflected in stock prices. For insider sales, shareholder protection decreases their negative information content. We conjecture that this is due to the effect of greater transparency and trustworthiness strengthening the diversification and liquidity reasons for selling in better shareholder protection countries. We find limited support for the rent-extraction hypothesis, which conjectures that shareholder protection is associated with insider trading dollar profits.

Do Insiders Use Investor Relations for Their Personal Benefit? An Empirical Investigation of Hong and Huang (2005)

Investor relations (IR) are costly activities, and a widely held view is that companies undertake them to increase share price over time. However, Hong and Huang (2005) assert that companies undertake IR for the personal benefit of company insiders with large ownership stakes. We test Hong and Hong (2005) empirically, specifically by investigating the association between the IR activities of newly listed companies and insider equity ownership, as well as insider sales. The results support Hong and Huang’s predictions where newly listed companies are more likely to engage in broker presentations when insiders have a valuable ownership stake. Furthermore, companies where insiders sell a large portion of their shares undertake different group presentations. The results suggest that insiders in these companies contemplate their personal incentives when setting IR policy such that IR is not necessarily undertaken for the benefit of all shareholders.

Signalling, Insider Trading, And Post-Offering Performance: The Case Of Initial Public Offerings

Previous IPO studies have concluded that, on average, (1) the shares of firms going public are underpriced at the time of the offering, (2) prices adjust rapidly in the aftermarket, and (3) IPOs are generally poor performers over the longer-term. This study reevaluates the IPO pricing phenomenon utilizing more recent data and empirically tests the signaling models of Leland and Pyle (1977) and Gale and Stiglitz (1989), which imply that both first-day and aftermarket returns may be related to insiders transactions. Our results suggest that initial returns are inversely related to the proportion of the offering representing insiders share and that corporate insiders are, on average, net sellers in the year subsequent to the initial public offering. We also find that the greatest volume of post-offering insider sales occurs in those firms in which insiders are sold shares at the offering.

Insider Trading in Hong Kong: Tests of Stock Returns and Trading Frequency

The main purpose of this paper is to examine the legal insider trading activities by directors of companies listed on the Hong Kong Exchange over the period 1993 to 1999. One characteristic of insider trading in Hong Kong is the high frequency of transactions and the large amounts of money involved. Inside purchases appear to signal and correct undervaluation and inside sales appear to signal and correct overvaluation. In contrast to research from Britain and the United States, insider sales are more informative than purchases. On average, insiders earn HK$91,297 per trade, while outsiders who mimic insiders' transactions earn minimal returns. Many firms suffer from infrequent trading and our results are consistent with directors engaging in inside transactions so as to help create a market for the shares. In additional tests, we find that the frequency of insider trading is a function of information asymmetry.

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.

Overvalued Equity and the Accruals Anomaly: Evidence from Insider Trades

This paper examines the accruals anomaly in an agency context where managers of overvalued firms engage in various activities, including accruals-based earnings management, to sustain overvaluation. We use managerial trading to operationalize the empirical investigation, hypothesizing that mangers anticipate the ultimate share price reversals, and use high accruals to temporarily sustain overvaluation while at the same time sell their shares. There is no incentive to deflate earnings of undervalued firms, leading to the prediction of an asymmetric relationship between trading and accruals. We contrast this to the fixation hypothesis where high (low) accruals are associated with negative (positive) returns. Although investor errors are operative in both agency and fixation, the causes, mechanisms and implications are very different. Our results, which are important to the distinction, support an agency explanation for the anomaly. Quadratic and binary regressions confirm an asymmetric relationship between trades and accruals concentrated on the selling side. The relationship between accruals and trading is only significant within the overvalued, low book-to-market (BM) firms. There is also evidence that low BM firms manage their earnings upward compared to high BM firms. Tests using a subset of firms sorted on valuation ratios and past growth provide evidence of a strong relationship between insider sales and income increasing accruals for the glamour firms while buying and accruals are not related for the value firms.

Registered Insider Sales and Long-Run Performance of New Security Issues

This paper investigates the information content of registered insider sales in the Seasoned Equity Offering (SEO) process from 1997-2009. We find that initial market reactions and long-run post-issue stock performance are negatively related to C-level executive insider sales, but unrelated to participation by non-executive insiders. We also find significantly lower post-issue abnormal earnings surprises for SEOs with C-level executive sales. Overall, the findings are consistent with the predictions of asymmetric information and agency theories.

Insider Trading Around Stock Split Announcements

This research examines the trading behavior and motives of corporate insiders around announcements of firms' stock splits. Our empirical analyses document significant increases in insider sales prior to the announcement. Further, pre-announcement insider sales are found to be positively related to pre-announcement-period abnormal returns. These findings suggest that insider trading before stock split announcements is motivated mainly by portfolio diversification needs rather than by the information content of the announcements.

Are Insider Sales Always Bad News? Evidence On Large Sales By Key Insiders

<p class="MsoNormal" style="text-align: justify; margin: 0in 40.3pt 0pt 0.5in; mso-pagination: none;"><span style="font-family: "CG Times","serif"; font-size: 10pt;">Investors often scrutinize stock trades by corporate insiders, hoping to infer the nature of any privileged information which may have motivated the trades. Conventional wisdom suggests that sales of stock by insiders reveal negative information; this interpretation is supported by empirical work such as the series of papers by Seyhun. However, this common interpretation fails to distinguish between sales by atomistic insiders and sales by controlling blockholders.<span style="mso-spacerun: yes;">  </span>In this paper, I present evidence which suggests that sales by controlling insiders should not be considered bad news. Using both a series of logit regressions and traditional event-study tests, I examine the relationship between a firm's performance and the willingness of its controlling shareholder to sell a significant proportion of his shares. I find that firm value is just as likely to rise on the news of large insider sales as it is to fall, so that large sales need not imply negative private information.<span style="mso-spacerun: yes;">  </span>One possible explanation for a positive response to a controlling blockholder's large sale is that such a sale makes the insider vulnerable to meaningful oversight by outside shareholders. Thus, a large sale may be a signal of the insider's willingness to expose himself to shareholder monitoring and discipline. However, regardless of the interpretation, the empirical evidence presented in the paper forces the conclusion that it is inappropriate to interpret all insider sales as bad news: insider sales occur in a variety of contexts, and creating buy/sell rules which ignore those contexts is simplistic and erroneous.</span></p>

Do Short Sellers Front-Run Insider Sales?

We study the behavior of short sellers as informed market participants and examine potential sources of their information. Using a newly available dataset with high-frequency short sales data, we find evidence of significant increases in short sales immediately prior to large insider sales, but not prior to small insider sales. We examine a number of explanations that the increase in short sales is driven by public information, either about the firm or about the impending insider sale. The evidence is inconsistent with these explanations, but is consistent with front-running facilitated by leaked information.

Mutual Fund Trading Pressure: Firm-Level Stock Price Impact and Timing of SEOs

We use price pressure resulting from purchases by mutual funds with large capital inflows to identify overvalued equity. This is a relatively exogenous overvaluation indicator as it is associated with who is buying – buyers with excess liquidity – rather than what is being purchased. We document substantial stock price impact associated with purchases by high-inflow mutual funds, and find the probability of an SEO, insider sales, and the probability of a stock-based acquisition increase significantly in the four quarters following the mutual fund buying pressure. These results provide new evidence that firm managers are able to identify and exploit overvalued equity.

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.

How do quotes and prices evolve around isolated informed trades?

This article investigates the order imbalance and price behavior of trades and quotes around isolated informed trades intraday. Different patterns of order flows around informed trades are documented because of the originating stock exchange, the type of informed trader, the size of the order, and the type of the firm whose shares are traded. The informed trader acts contrarian to prior trades. Informed purchases follow price declines, and sales are after price increases. The informed trade is recognized by the market maker. The purchase is executed at a significantly higher price, while the sale is executed at a significantly lower price. Trades contain more information if the insiders are at small firms. Larger orders and orders by top executives also contain more information. The order imbalance changes around an informed trade. Orders are seller-initiated prior to the purchase and become buyer-initiated after the trade. On the other hand, the order imbalance changes from buyer- to seller-initiated right around insider sales. Reversals in order imbalance are more pronounced for informed trades in small firms, for larger trades, and by top executives. There are important policy implications of the results. The recognition of informed trades by market makers justifies more scrutiny by the Securities and Exchange Commission in order to ensure fair trading.

Maximizing Short-Term Stock Prices through Advertising

This paper provides evidence that managers use firm advertising, in part, to maximize short-term stock prices. First, this paper shows that increased advertising spending is associated with individual investors' intensified buying activities, as well as a contemporaneous rise in abnormal stock returns that is subsequently reversed. The paper further documents a significant increase in advertising spending prior to insider sales and seasoned equity offerings, but a significant decrease in the following year. Using the vesting of restricted shares held by top executives as an instrument for insider sales, I show that the inverted-V-shaped pattern in advertising spending around equity sales is most consistent with managers' exploiting the temporary stock return effect of advertising to their own benefit and, potentially, to that of existing shareholders.