Academic journal article Journal of Economics and Finance

Insider Trading around Open-Market Share Repurchases

Academic journal article Journal of Economics and Finance

Insider Trading around Open-Market Share Repurchases

Article excerpt

1 Introduction

It has been documented that corporate insiders trade according to their foreknowledge of the company's future performance (Seyhun 1998; Lakonishok and Lee 2001; Piotroski and Roulstone 2005). As corporate events often have significant implications on future stock returns, researchers have investigated how insiders trade around earnings announcements (Huddart et al. 2007), managerial voluntary disclosures (Noe 1999; Cheng and Lo 2006), seasoned equity offerings (Karpoffand Lee 1991; Kahle 2000; Jenter 2005), bankruptcy filings (Seyhun and Bradley 1997), dividend announcement (John and Lang 1991), and merger and acquisitions (Bris 2005). However, the study of insider trading around open-market share repurchases has been limited. This paper aims to fill the research gap by investigating how corporate insiders trade around open-market repurchase announcements. We try to answer two questions. First, does insider trading exhibit any special patterns during this sensitive period? Second, is the insider trading around repurchase announcement intended for short-run announcement returns or for long-run post-announcement returns? The answer to the first question unveils the trading strategy of insiders around repurchases and that to the second question reveals the investment horizon of insiders in the events.

Examining insider trading activity during four quarters preceding and four quarters following open-market stock repurchase announcements that occur during a period from 1990 to 2004, we find that compared with their normal trading insiders reduce both purchases and sales around repurchase announcement, indicating that insiders intentionally curtail their trading during the sensitive period around repurchase announcements. We further show that insiders exhibit negative abnormal net sales around repurchase announcements. This means that insiders reduce sales more than they reduce purchases, suggesting a passive trading pattern. It has been well documented that open-market repurchases are often accompanied by positive abnormal stock returns. Yet, the risk of violating insider trading regulations may restrain insiders from directly purchasing shares prior to an announcement and selling shares right after it to gain a profit. Our findings are consistent with the notion that insiders adopt a passive trading strategy around corporate disclosures, and that they do so to minimize litigation risk (Noe 1999; Huddart et al. 2007; Rogers 2008; Jagolinzer and Roulstone 2009).

Next, we investigate whether insiders' trading behavior around repurchase announcements is related to their foreknowledge about firms' future performance. We find that the abnormal insider sales ratios during 3 months before repurchase announcements are unrelated to the 3-day cumulative abnormal returns (CAR) around the announcements but negatively correlated with the 1-year and 2-year buy-and-hold abnormal returns (BHAR) following the announcements. We further document that abnormal net insider sale ratios in various post-announcement periods are also negatively correlated with the post-announcement long-term BHARs and unrelated to the 3-day CAR. These findings suggest that insider trading around repurchase announcements largely aims to capture the long-term post-announcement abnormal returns as opposed to short-term announcement returns. In addition, we find that while abnormal insider trading around repurchase announcement is significantly correlated with 1-year and 2-year post-announcement BHARs, such relation does not hold for 3-year BHAR. The result suggests that insiders have better knowledge of repurchase-related returns for up to 2 years ahead, and this is consistent with the prior evidence on the forecast horizon of insider trading (Seyhun 1998; Ke et al. 2003). Finally, we investigate whether managers' trading behavior around repurchase announcements is related to their better knowledge of the future operating performance of the firms and document such relation in firms with above-average post-announcement earnings. …

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