Executive Compensation, Individual-Level Tax Rates, and Insider Trading Profits

Abstract

We consider insider trading profitability as a means for executives to shift the impact of changes in individual-level tax rates to shareholders. Consistent with predictions from an analytical model, we document a positive association between abnormal insider trading profitability and changes in income tax rates at the federal and state level. We estimate that the changes in insider trading profitability offset between 12% and 16% of the effect of tax rate changes on net compensation for an average executive. We predict and find that several factors moderate this relation. We conclude that executives pass a portion of the tax effects onto shareholders through insider trading profits.

Keywords: insider trading; executive compensation; individual-level taxes

JEL Classification: H24; H31; J33; M12