Insider Trading Following Material News Events: Evidence from Earnings

By Sivakumar, Kumar; Waymire, Gregory | Financial Management, Spring 1994 | Go to article overview

Insider Trading Following Material News Events: Evidence from Earnings


Sivakumar, Kumar, Waymire, Gregory, Financial Management


Prior studies indicate that insider buying (selling) activity precedes positive (negative) abnormal returns that persist over relatively long horizons.(1) Presumably, investors may benefit from knowledge of previous insider trades, and consistent with this, the financial press and investment advisors frequently provide information on insider trading activity.(2) Recent efforts to reduce the incidence of insider trading based on non-public information have originated both from regulatory authorities and companies. Congress has passed several new laws regulating insider trading in the past decade, and the SEC has increased its enforcement of insider trading restrictions (see Arshadi and Eyssell |2, pp. 31-2^). Several companies have also adopted policies that restrict insider trading to time periods following news events such as quarterly earnings announcements. For instance, Compaq has a policy that limits insider transactions to the period following quarterly earnings reports (see "Heavy Insider Sales are Made at Compaq," The Wall Street Journal, June 9, 1993).(3) The intended effect of such policies is presumably to "level the playing field" between insiders and external investors and ensure that the firm and its officers comply with the law.

The purpose of this paper is to provide evidence on the incidence and profitability of insider trading following quarterly earnings announcements. If regulatory and corporate restrictions induce insiders to delay what otherwise would be profitable trades until after material news is disclosed, we would expect: (1) the incidence of insider trading will increase after earnings disclosure, (2) post-announcement insider buys (sells) will be preceded by positive (negative) abnormal stock returns, consistent with foregone trading profits, and (3) no systematic abnormal returns will follow post-announcement insider trades if public disclosure erodes managers' informational advantage.

Our results suggest that the incidence of insider trading is relatively high following earnings disclosure but that these trades are not associated with foregone trading profits. Also, these trades are not positively associated with earnings forecast errors, as would be expected if insiders delay purchases (sales) before positive (negative) earnings news. We find evidence of insiders buying (selling) following negative (positive) unexpected earnings announcements, suggesting that insiders have information not revealed by the earnings announcements. We also find that post-announcement insider trades are associated with significant abnormal returns. Overall, stock price behavior associated with insider trades following earnings announcements is not different from the results documented in numerous prior studies. Our results suggest that policies limiting periods of acceptable insider trades do alter when trades occur, but they do not eliminate insider trading profits. These policies do not impose significant opportunity costs in the terms of foregone trading profits on insider trades actually executed. This inference is consistent with the conclusions of prior studies (e.g., Givoly and Palmon |8^) which suggest that insider trading is not linked to foreknowledge of forthcoming disclosures. This conclusion, however, is conditional because we cannot measure the effects of trades that could have been executed but were not.

The rest of the paper is organized as follows. Section I describes the sample selection. Section II defines the variables for our tests. Section III reports the empirical results. Section IV provides concluding remarks.

I. Sample Selection

The sample was determined in the following manner. We identified an initial sample of firms included in the COMPUSTAT Quarterly File and the CRSP Dally Returns File where the Invest/Net database indicated at least one open market purchase or sale of common stock by an officer, director, or beneficial owner of more than ten percent of the firm's stock between January 1, 1984 and December 31, 1989. …

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