Contract Features and the Informativeness of Insider Trades

Abstract

Economic theory predicts that insiders reveal private information when they trade equity in their firm. However, insider purchases to meet equity holding requirements or sales to satisfy liquidity needs do not reveal private information. We predict that contract terms stipulating CEO equity holdings and vesting conditions help market participants unravel the private information revealed by an insider trade. In support of our predictions, we document that the market reaction to a CEO equity trade is greater when the CEO holds a large portfolio of unconstrained equity in the firm. We also find that the one-year abnormal return following a CEO equity sale is significantly more negative when the CEO holds a large portfolio of unconstrained equity. Collectively, we show that publicly disclosed contract features provide context that help investors interpret the information revealed by insider trades and unravel private information.

Keywords: executive compensation, insider trading

JEL Classification: G30, G34, K22, M40, M46