Insider Trading and Share Repurchases: Do Insiders and Firms Trade in the Same Direction?

Abstract

Signaling undervaluation is often considered a primary motive for repurchasing stock, but insider trading activity by repurchasing firms is not always consistent with undervaluation. Net insider buying and selling are both more frequent in quarters when firms are repurchasing non-trivial amounts of stock, with the odds of observing a repurchase the highest in quarters with net insider selling. In multinomial logit models, shares repurchases associated with net insider selling are positively related to illiquidity, option exercises by insiders, and pre-repurchase returns and negatively correlated with industry-adjusted book to market ratios when compared to other repurchases. Hence, repurchases when insiders are selling stock are more likely done to support share prices or avoid dilution and are less likely undervaluation signals. We find that insider trades either validate or mitigate the undervaluation signal of the repurchase. Abnormal returns of repurchasing firms with net insider buying versus net insider selling in a given quarter are significantly higher for the quarter immediately after the repurchase and the three subsequent years. For repurchases accompanied by net insider selling, abnormal returns are negligible after only one year.

Keywords: Repurchases, buybacks, insider trading, long-run returns, signalling

JEL Classification: G35, G30, G14