Why Do Corporate Insiders Trade? The UK Evidence

Abstract

Previous research shows that corporate insiders engage in profitable transactions by trading securities of their own firms around specific events. The objective of this study is to specifically analyse all the events that preceded insider trading transactions and their explicit trading gains. We contrast this hypothesis with the signalling of undervaluation. Using a large sample of UK companies, we test the proposition that corporate insiders time their trades and that the market impact of insiders' transactions varies based on the information on which they trade on. We find that (i) insiders buy (sell) shares prior to stock price decline (run up), (ii) the event date abnormal returns are positive for buy and negative for sell transactions, (iii) the post-event abnormal returns following [+1, +10] buy (sell) trades are positive (negative), suggesting that insiders convey information to the market and that other investors follow these trades, (iv) in the longer term [+2, +160] companies do not seem to regain their pre-trade valuation, (v) the pre- and post-event abnormal performance depends on the news that precedes the trades. Overall, our results suggest that insiders time their trades and they are capable to better assess the value of their firm. Outsiders, aware of that superior view, follow insiders' behaviour in the short-term and fortify the exceptional returns gained by directors. We also find evidence that insiders use this signalling effect to sometimes camouflage their trades and overcome regulators' monitoring.