A Theory of Insider Purchases

60 Pages Posted: 11 Nov 2019

See all articles by Messod D. Beneish

Messod D. Beneish

Indiana University - Kelley School of Business - Department of Accounting

Garen Markarian

HEC - University of Lausanne

Date Written: October 30, 2019


Although prior work indicates that insider purchases signal undervaluation, there is scant evidence about what specific information such purchases convey, or what determines the extent of the undervaluation. Our theory explains the nature of the information conveyed by insider purchases, their incidence, and their signaling value. We argue that, conditional on information asymmetry, open market purchases occur when they plausibly signal that risk averse, undiversified insiders are willing to bear incremental wealth risk. Our tests account for limits to the public observability of insiders’ wealth and show, consistent with our predictions, that insider purchases are more frequent and informative in higher-risk contexts which we define, alternatively, as firms with higher fundamental risk (e.g., small, high book-to-market, high volatility firms), firms experiencing riskier circumstances (e.g., poor financial and market performance, low reporting credibility), and firms where insiders’ are exposed to higher risk as a result of their compensation contracts and ownership (e.g., option and share holdings, employment horizon). Further, exploiting our prediction that the signaling value of purchases depends on the increase in the insider’s wealth risk that is inferred by investors, we show that strategies based on linear combinations of the high-risk facets of these factors magnify the abnormal returns to strategies mimicking insider purchases by a factor of two to three. Finally, our results are robust to considering opportunistic/routine partitions of the sample, suggesting that insider purchases are largely strategic.

Keywords: Insider purchases, Risk, Incidence, Signaling, Compensation Risk, Delta, Vega, Options, Return Performance

JEL Classification: G31; G32; G34; M40

Suggested Citation

Beneish, Messod Daniel and Markarian, Garen, A Theory of Insider Purchases (October 30, 2019). Available at SSRN: https://ssrn.com/abstract=3478344 or http://dx.doi.org/10.2139/ssrn.3478344

Messod Daniel Beneish (Contact Author)

Indiana University - Kelley School of Business - Department of Accounting ( email )

1309 E. 10th Street
Bloomington, IN 47405
United States
812-855-2628 (Phone)
812-855-4985 (Fax)

Garen Markarian

HEC - University of Lausanne ( email )

UNIL Dorigny
Lausanne, Lausanne 1015

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