Does Insider Trading Activity Separate Winners and Losers when a Peer Firm Restates?

Abstract

Peer restatements are an ambiguous signal for investors following non-restating firms in the same industry. The literature, however, consistently documents that non-restating firms experience negative returns when a peer restates, on average. Based on a simple single agent model, we predict that prior insider trading activity provides information that investors use to condition their response to a peer-firm restatement. Consistent with our prediction, we find that the negative returns for non-restating firms are mitigated when insiders have been buying and amplified when insiders have been selling. The effect varies cross-sectionally with more weight being placed on prior insider trading activities when non-restating firms have higher information uncertainty, lower costs of biased reporting, or operate in less-concentrated industries. Finally, we report evidence that recent insider trades prior to a peer restatement help investors correctly interpret implications of the peer restatement for future outcomes of the non-restating firm.