A substantial body of academic literature examines the personal trades of corporate officers and directors in their company shares, commonly referred to as “insider trades.” Much of the early work, either in the aggregate or in the cross-section, ignores the likelihood that an insider’s motivations or trading patterns are likely to change over time. In other words, each insider’s successive trade is assumed to be independent of their prior trading behavior or outcome. Motivated by various behavioral finance theories, in our current project we provide evidence that an insider’s trading performance changes significantly as the insider proceeds through successive transactions.
The stock market crash of 1929 led to the US Securities Acts of 1933 and 1934, which together comprise the foundations of modern securities law. The 1934 Act covers transactions occurring in the secondary market, with a focus on transparency, accuracy, and preventing fraud. One post-crash Congressional finding integral to shaping the 1934 Act was that public company insiders had disproportionally avoided losses by selling their companies’ shares before other investors. The 1934 Act established a criminal and civil structure, forbidding insiders of public corporations from trading their own company shares based on Material Nonpublic Information. Insiders can (legally) trade securities of their own companies subject to a range of restrictions, including a requirement that insiders publicly disclose their activities via filings with the US Securities and Exchange Commission (SEC).
Starting in the 1960’s, researchers began using data from these disclosures to investigate the trading activities of insiders. Much of the literature explores the natural tensions and subtle stratagems arising from an insider’s desire to make a profit, balanced against the need to avoid legal jeopardy. The early works in the 1960’s and 1970’s largely established that insiders realize significant abnormal returns, especially when buying as opposed to selling. More recent studies confirm this earlier finding and provide evidence that buyers are more likely to be motivated strictly by profit, whereas insiders might sell for liquidity or to diversify. One avenue of inquiry explores whether heterogeneity in the access to company information affects insider-trading performance. These studies focus on insiders of varying title groupings such as officers (including higher and lower ranking), and board members. These studies report conflicting results. Other related works look at the number of insiders transacting and dollar amounts involved.
More recently, a large number of studies investigated insiders’ trading before corporate events. This line of research seeks to shed light on whether insiders are likely to push the boundaries of insider trading laws during information rich environments. These studies may also be viewed as tests of strong-form market efficiency. An interesting finding in this strand of the literature is that insiders appear more reticent to sell before bad news than to buy before positive announcements. In the case of selling, insiders appear to time exits particularly well ahead of poor earnings releases or restatements or in advance of defaults or bankruptcies. There is also evidence that insiders tend to reduce selling prior to receiving a takeover bid. Many companies have steered insiders toward preprogrammed selling through what are commonly known as SEC Rule 10b5-1 plans, an arrangement typically envisioned as occurring over a multi-year period, although insiders tend to instead front-load their sales with timing under 10b5-1 plans exhibiting better performance than normal insider sales.
Whereas much of the earlier research on the source of insider trade performance focused on firm events such as earnings releases, or firm attributes such as company size or corporate governance, an emerging body of work examines the individual attributes and backgrounds of insiders beyond their titles, expanding to consider other attributes such as gender, age, education, and social connectedness. These studies fall within the realm of behavioral finance. For example, one recent paper finds that insiders with MBA’s are more likely than those with PhD’s to reverse their trading directions (buyers becoming sellers, or vice versa), reversals being more predictive than normal insider trades.
Our line of research on insider trades falls at the intersection of market efficiency and this more recent behavioral stream of the literature as we focus on the specific trading patterns of company insiders. In investigating the trading patterns of insiders, our main goal is to perform a comprehensive analysis of the similarities and differences between the sequential trading patterns and performances of insiders. We seek to provide answers to a set of questions that should be of interest to policy makers and market participants. These include questions such as: (i) Do insiders learn from their prior trade experience and improve their returns? (ii) Does the performance of a previous trade affect the likelihood that an insider will trade again? (iii) Is the performance of an insider’s successive trades correlated, and does this correlation depend on the type of trade, i.e., purchases vs. sales? (iv) Is the sequential performance of an insider’s trades more related to external factors, such as market liquidity, or more related to personal attributes, such as trade experience or net worth?
Our starting sample includes over 450,000 insider transactions in their own company shares between 2003 and 2020. This includes all sales, open market purchases, and option-related share acquisitions. We apply appropriate filters such as dropping companies for which there is no price data in the Center for Research in Security Prices (CRSP) database and keeping only transactions for officers and directors. We also aggregate sequential transactions for each insider to consolidate their trades of the same kind (for example, purchases) that occur over multiple days. When we aggregate all transactions that preceded (or followed) a 30-day inactivity period, our final sample includes 242,466 transactions for 37,655 insiders at 3,867 companies. Within this final sample, there are 119,946 (49%) acquisitions and 122,520 (51%) sales. As a robustness check, we used alternate inactivity windows, such as 182 days.
In the first stage of our analysis, we use both univariate and multivariate tests to provide robust evidence that insiders realize the most gain on their initial purchase whereas the performance of their subsequent purchases drops off steadily and markedly over time. In contrast, the performance of an insider’s sales generally increases over the sequence of trades. For example, there are 2,231 insiders who make a sequence of four open-market or option-related purchases during our sample period. For this group of insiders, the average active one-year return measure relative to the Fama-French 48 industry benchmark indices on each of their four trades is 6.9%, 5.5%, 2.4%, 1.4%, respectively. In contrast, for the group of 2,157 insiders who make a sequence of four sales in our sample period, the average active return on each of these transactions are -0.4%, 1.1%, 2.0% and 3.5%, respectively. These patterns hold for other sequences of buys and sells. Furthermore, by comparing the rate of deterioration of the performance of buy versus sell trades, we find that buyer performance falls off at a significantly faster rate than seller performance. While these findings are novel in and of themselves, in the second stage of our analysis, we will provide answers to our other research questions, primarily centered around the main cause and consequence of the patterns we document in the first stage of our analysis.
Ann Marie Hibbert is an Associate Professor and Finance Ph.D. Program Coordinator at West Virginia University
Josh Schein is the CEO of Global Key Advisors
Keonhi Lee holds a Masters in Financial Engineering from UC Berkeley and is currently an equity derivatives trader
This post is adapted from their paper, “Patterns in Insider Trading: Buyers Worsen, Sellers Improve” available on SSRN.
The views expressed in this post are those of the authors and do not represent the views of the Global Financial Markets Center or Duke Law.