Insider Trading and Long-Run Return Performance

Abstract

This paper investigates the relation between security performance and the propensity for trading by manager insiders. The primary empirical model focuses on whether individual firms' abnormal standardized levels of insider purchases and sales are related to past, current, and future security performance. To overcome the inherent problem of identifying insider activity in proximity to material events, when insiders may face significant costs of detection on some types of transactions, our study considers firm performance over long-run (3-year) intervals. Moreover, by analyzing all NYSE and AMEX firms, we are able to characterize the propensity, probability, and profitability of insider trading in equity markets in general. Our results show a strong tendency for insider net purchases to be significantly above and below normal between one and two years in advance of long horizon returns (both market-related and firm-specific) that are above and below normal, respectively. Subsequent to abnormal returns, insiders tend to reverse their trades. Thus, insider transactions have both a long-term anticipatory and a reactive components to them. Virtually all of our results are driven by the timing of the insider sales, rather than purchases.

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