Insider Trading and Option Grant Timing in Response to Fire Sales (and Purchases) of Stocks by Mutual Funds

Abstract

Mutual funds experiencing large outflows (inflows) tend to decrease (expand) their positions, creating downward (upward) price pressure in the stocks held in common by them (Coval and Stafford [2007]). This study shows that corporate insiders exploit the resulting mispricing by buying (selling) their company’s stock if it is subject to such fire sales (purchases) by funds. We also show that the likelihood of option grants is greater for stocks that are subject to mutual fund fire sales. Finally, we show that both the insider trading and the option granting activities help speed up the correction of the flow-driven mispricing. Overall, this study illustrates that insiders enhance personal benefits by trading on their personal account and influencing the timing of option grants in response to mispricing due to flow-driven fund trading. Moreover, these activities help improve the informational efficiency of stock price.