Institutional Investors and Insider Trading Profitability

Abstract

This paper addresses the relationship between institutional ownership level and the profitability of insider trades. Like insiders, institutions have been shown to possess private information predictive of future returns. Classes of institutional investors are also known to be active in corporate monitoring for their own interests and for the interests of shareholders more broadly, including limiting insider trading profitability. We therefore hypothesize an inverse relationship between institutional ownership level and insider trading profits. Using a panel of approximately 46,000 firm-years, and utilizing a variety of univariate and multivariate tests, we find results that are strongly consistent with our hypothesis. Insider trades are related to one year ahead S&P500 adjusted returns, and this relationship is weakened by institutional ownership level. We also explore whether any explicit monitoring element of this effect can be observed. The results provide preliminary evidence suggesting an incremental negative relationship between proxies for institutional monitoring and insider trading profitability.

Keywords: insider trading, corporate governance, institutional ownership, institutional monitoring

JEL Classification: D82, G14, G23, P43, M41