Inferring Bad News from Insider Sales

Abstract

The vast majority of open market insider sales are motivated by the need for liquidity, which makes it difficult for researchers to establish a relationship between insider sales and future returns, i.e., identify information-based sales. We present and evaluate a new algorithm for identifying information-based insider sales. We hypothesize that when individuals who have insider-status with respect to multiple firms sell shares of one firm in which they are insiders and at the same time buy shares of other affiliated firms, the sale is more likely to be information-based, since the proceeds are reinvested. Insider sales of shares of two or more firms unaccompanied by insider purchases are more likely to be liquidity-motivated. We find that insider sales identified using this algorithm as information-based are followed by statistically and economically significant negative abnormal returns up to three years following the sale. Validation tests corroborate this evidence. Specifically, information-based sales are significantly more likely to be associated with delistings, earnings declines, downward analyst forecast revisions, analysts dropping coverage, and earnings restatements, in the year of and two years following the sale.

Keywords: insider trading, information asymmetry, information intermediaries, future returns, future performance, adverse events

JEL Classification: G12, G14, G18