Trades by Insiders and the Informativeness of Earnings Announcements

Abstract

Do insiders trade on private information about earnings? We address this question exploiting the discontinuity in the term structure of option prices around the announcement date, to obtain a daily and forward-looking measure of the informativeness of the next earnings announcement. This measure reveals two distinct trading motives related to the next earnings announcement. On the one hand, purchases by insiders decrease the informativeness of the subsequent earning announcement, suggesting that they trade on the earnings realization. On the other hand, sales increase the informativeness of earnings announcements. This result implies that insiders respond to an increase of earnings uncertainty, thereby using information about the variance when trading. The typical underdiversification of insiders drives this finding, as the positive relation is unique to officers and directors, and stronger in firms facing higher idiosyncratic uncertainty. The positive effect of sales is absent in signals by analysts or large outside shareholders, who possess private information but are better diversified.

Keywords: Insider Trading, Informed Trading, Public Information, Earnings Announcements

JEL Classification: G14, G30, M41