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Estimating the Returns to Insider Trading

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  • Leslie A. Jeng
  • Andrew Metrick
  • Richard Zeckhauser

Abstract

This paper estimates the returns to insiders when they trade their company’s stock. We first construct a rolling "purchase portfolio" that holds all shares purchased by insiders for a six-month period, and an analogous "sale portfolio" that holds all shares sold by insiders for six months. The six-month horizon is chosen to coincide with the "short-swing" rule of the Securities and Exchange Act of 1934; a rule that prohibits profit-taking by insiders for offsetting trades within six months. We then employ performance-evaluation methods to analyze the returns to the purchase and sale portfolios. This approach yields a proxy for the value-weighted returns to insider transactions beginning on the day after their execution and avoids the statistical difficulties that plague event studies on long-horizon returns. Our methods are designed to estimate the returns earned by insiders themselves and thereby differ from the previous insider-trading literature, which focuses on the "informativeness" of insider trades for other investors. Using a comprehensive sample of reported insider transactions from 1975-1996, we find that the purchase portfolio earns abnormal returns of more than 50 basis points per month. About one-quarter of these abnormal returns accrue within the first five days after the initial transaction, and one-half accrue within the first month. The sale portfolio does not earn abnormal returns. Our portfolio-based approach also allows for straightforward decompositions of performance by various characteristics; we find that the abnormal returns to insider trades in small firms are not significantly different from those in large firms, and that top executives do not earn higher abnormal returns than do other insiders.

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Bibliographic Info

Paper provided by Wharton School Rodney L. White Center for Financial Research in its series Rodney L. White Center for Financial Research Working Papers with number 19-99.

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Handle: RePEc:fth:pennfi:19-99

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  1. Kothari, S. P. & Warner, Jerold B., 1997. "Measuring long-horizon security price performance," Journal of Financial Economics, Elsevier, vol. 43(3), pages 301-339, March.
  2. Meulbroek, Lisa K, 1992. " An Empirical Analysis of Illegal Insider Trading," Journal of Finance, American Finance Association, vol. 47(5), pages 1661-99, December.
  3. Josef Lakonishok & Robert W. Vishny & Andrei Shleifer, 1993. "Contrarian Investment, Extrapolation, and Risk," NBER Working Papers 4360, National Bureau of Economic Research, Inc.
  4. Chakravarty, Sugato & McConnell, John J., 1998. "Does Insider Trading Really Move Stock Prices?," Purdue University Economics Working Papers 1114, Purdue University, Department of Economics.
  5. Carhart, Mark M, 1997. " On Persistence in Mutual Fund Performance," Journal of Finance, American Finance Association, vol. 52(1), pages 57-82, March.
  6. Seyhun, H Nejat, 1988. "The Information Content of Aggregate Insider Trading," The Journal of Business, University of Chicago Press, vol. 61(1), pages 1-24, January.
  7. Barber, Brad M. & Lyon, John D., 1997. "Detecting long-run abnormal stock returns: The empirical power and specification of test statistics," Journal of Financial Economics, Elsevier, vol. 43(3), pages 341-372, March.
  8. Michael S. Rozeff & Mir A. Zaman, 1998. "Overreaction and Insider Trading: Evidence from Growth and Value Portfolios," Journal of Finance, American Finance Association, vol. 53(2), pages 701-716, 04.
  9. Finnerty, Joseph E, 1976. "Insiders and Market Efficiency," Journal of Finance, American Finance Association, vol. 31(4), pages 1141-48, September.
  10. Loughran, Tim & Ritter, Jay R, 1995. " The New Issues Puzzle," Journal of Finance, American Finance Association, vol. 50(1), pages 23-51, March.
  11. Andrew Metrick, 1998. "Performance Evaluation with Transactions Data: The Stock Selection of Investment Newsletters," NBER Working Papers 6648, National Bureau of Economic Research, Inc.
  12. Paul Gompers & Josh Lerner, 1998. "Venture Capital Distributions: Short-Run and Long-Run Reactions," Journal of Finance, American Finance Association, vol. 53(6), pages 2161-2183, December.
  13. Josef Lakonishok & Inmoo Lee, 1998. "Are Insiders' Trades Informative?," NBER Working Papers 6656, National Bureau of Economic Research, Inc.
  14. Chan, Louis K. C. & Jegadeesh, Narasimhan & Lakonishok, Josef, 1995. "Evaluating the performance of value versus glamour stocks The impact of selection bias," Journal of Financial Economics, Elsevier, vol. 38(3), pages 269-296, July.
  15. Rozeff, Michael S & Zaman, Mir A, 1988. "Market Efficiency and Insider Trading: New Evidence," The Journal of Business, University of Chicago Press, vol. 61(1), pages 25-44, January.
  16. Lin, Ji-Chai & Howe, John S, 1990. " Insider Trading in the OTC Market," Journal of Finance, American Finance Association, vol. 45(4), pages 1273-84, September.
  17. Brian J. Hall & Jeffrey B. Liebman, 1998. "Are CEOs Really Paid Like Bureaucrats?," The Quarterly Journal of Economics, MIT Press, vol. 113(3), pages 653-691, August.
  18. Brav, Alon & Gompers, Paul A, 1997. " Myth or Reality? The Long-Run Underperformance of Initial Public Offerings: Evidence from Venture and Nonventure Capital-Backed Companies," Journal of Finance, American Finance Association, vol. 52(5), pages 1791-1821, December.
  19. Cornell, Bradford & Sirri, Erik R, 1992. " The Reaction of Investors and Stock Prices to Insider Trading," Journal of Finance, American Finance Association, vol. 47(3), pages 1031-59, July.
  20. Seyhun, H Nejat, 1992. "Why Does Aggregate Insider Trading Predict Future Stock Returns?," The Quarterly Journal of Economics, MIT Press, vol. 107(4), pages 1303-31, November.
  21. John D. Lyon & Brad M. Barber & Chih-Ling Tsai, 1999. "Improved Methods for Tests of Long-Run Abnormal Stock Returns," Journal of Finance, American Finance Association, vol. 54(1), pages 165-201, 02.
  22. Jegadeesh, Narasimhan & Titman, Sheridan, 1993. " Returns to Buying Winners and Selling Losers: Implications for Stock Market Efficiency," Journal of Finance, American Finance Association, vol. 48(1), pages 65-91, March.
  23. Jaffe, Jeffrey F, 1974. "Special Information and Insider Trading," The Journal of Business, University of Chicago Press, vol. 47(3), pages 410-28, July.
  24. Barclay, Michael J. & Warner, Jerold B., 1993. "Stealth trading and volatility : Which trades move prices?," Journal of Financial Economics, Elsevier, vol. 34(3), pages 281-305, December.
  25. Sugato Chakravarty & John J. McConnell, 1997. "An Analysis of Prices, Bid/Ask Spreads, and Bid and Ask Depths Surrounding Ivan Boesky's Illegal Trading in Carnation's Stock," Financial Management, Financial Management Association, vol. 26(2), Summer.
  26. B. Espen Eckbo & David C. Smith, 1998. "The Conditional Performance of Insider Trades," Journal of Finance, American Finance Association, vol. 53(2), pages 467-498, 04.
  27. Conrad, Jennifer S & Hameed, Allaudeen & Niden, Cathy, 1994. " Volume and Autocovariances in Short-Horizon Individual Security Returns," Journal of Finance, American Finance Association, vol. 49(4), pages 1305-29, September.
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Cited by:
  1. Enrichetta Ravina & Paola Sapienza, 2006. "What Do Independent Directors Know? Evidence from Their Trading," NBER Working Papers 12765, National Bureau of Economic Research, Inc.
  2. Dlugos, Jennifer & Fahlenbrach, Rudiger & Gompers, Paul & Metrick, Andrew, 2005. "Large Blocks of Stock: Prevalence, Size, and Measurement," Working Paper Series 2005-9, Ohio State University, Charles A. Dice Center for Research in Financial Economics.
  3. Degryse, H.A. & Jong, F.C.J.M. de & Lefebvre, J.J.G., 2009. "An Empirical Analysis of Legal Insider Trading in the Netherlands," Discussion Paper 2009-48, Tilburg University, Center for Economic Research.
  4. Robert McGee, 2010. "Analyzing Insider Trading from the Perspectives of Utilitarian Ethics and Rights Theory," Journal of Business Ethics, Springer, vol. 91(1), pages 65-82, January.
  5. Lisa Hotson & Navjot Kaur & Harminder Singh, 2007. "The Information Content of Directors’ Trades: Empirical Analysis of the Australian Market," Accounting, Finance, Financial Planning and Insurance Series 2007_19, Deakin University, Faculty of Business and Law, School of Accounting, Economics and Finance.
  6. Kyriacos Kyriacou & Bryan Mase, 2006. "The Adverse Consequences of Share-Based Pay in Risky Companies," Journal of Management and Governance, Springer, vol. 10(3), pages 307-323, September.

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