Although researchers have documented gains from insider trading, the sources of private information leading to information asymmetry and insider gains have not been comprehensively investigated. We focus on research and development (R&D)—an increasingly important yet poorly disclosed productive input—as a potential source of insider gains. Our findings, for the period from 1985 to 1997 indicate that insider gains in R&D-intensive firms are substantially larger than insider gains in firms without R&D. Insiders also take advantage of information on planned changes in R&D budgets. R&D is thus a major contributor to information asymmetry and insider gains, raising issues concerning management compensation, incentives, and disclosure policies.

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Information Asymmetry, R&D, and Insider Gains

https://deepblue.lib.umich.edu/bitstream/handle/2027.42/26147/0000224.pdf

Insiders' profits, costs of trading, and market efficiency

Whether insider trading affects stock prices is central to both the current debate over whether insider trading is harmful or pervasive, and to the broader public policy issue of how best to regulate securities markets. Using previously unexplored data on illegal insider trading from the Securities and Exchange Commission, this paper finds that the stock market detects the possibility of informed trading and impounds this information into the stock price. Specifically, the abnormal return on an insider trading day averages 3%, and almost half of the pre-announcement stock price run-up observed before takeovers occurs on insider trading days. Both the amount traded by the insider and additional trade-specific characteristics lead to the market's recognition of the informed trading.

An Empirical Analysis of Illegal Insider Trading

THE STRONG-FORM of the efficient market hypothesis assumes all available public and private information is fully relected in a security's market price. The strongform, in terms of market participants, also assumes that no individual can have higher expected trading profits than others because of monopolistic access to information. One possible test of the strong-form is to determine whether insiders earn better than average profits from their market transactions. To ascertain if the market is truly efficient will involve determining how well insiders do relative to the market in general. To date, some work has already been done in evaluating rates of return earned by insiders trading for their own accounts. Jaffe [3,4], Pratt and DeVere [8], Rogoff [9], and Glass [2] have calculated rates of return earned by insiders trading for their own accounts and their work lends some support to the hypothesis that insiders do, in fact, earn above average profits. A major shortcoming of these studies centers on data availability, as no precise price per share or date of insider trades were reported to the S.E.C. prior to 1965. Further, except for Jaffe, the studies do not incorporate an explicit adjustment for risk. An additional problem with all of the studies is the skimming of the cream of the crop in their sample selection. That is the selection of samples based on "intensive" insider trading criteria, i.e., the samples are biased in favor of whose performance would more than likely be superior to the average insider. This bias, while not affecting their results relative to the semi-strong-form, invalidates the findings for a test of the strong-form. By testing the entire population of insiders, this study evaluates the performance of the "average" insider. Section II presents an explanation of the methodology used to evaluate insider performance, while Section III list and evaluates the results. The final section presents implications and conclusions.

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Insiders and market efficiency

The paper provides evidence that the signal contained in insiders' trading behavior is useful in making refined assessments of earnings quality, and informative about the valuation implications of accruals. We find that income-increasing accruals and unexpected accruals have lower (higher) persistence when managers engage in abnormal selling (buying) suggesting that insider trading information is useful in assessing the quality of the non-cash components of earnings. We show that the accrual mispricing phenomenon observed in previous work is largely due to the mispricing of positive accruals. We find that investors price all positive accruals as if they were informative and that a subset of positive accruals is correctly priced. That is, (1) investors correctly price positive accruals that are likely to be informative because concurrently insiders engage in abnormal buying, and (2) investors price all positive accruals the same independently of insider trading. We find that the extent of the mispricing is greater when positive accruals occur concurrently with abnormal selling relative to cases where there is no trading. The extent of the mispricing and the magnitude of the one-year ahead returns (14.7 to 22 percent) to a trading strategy based on positive accruals and abnormal selling suggests that these accruals arise from opportunistic earnings management that is successful in misleading investors. By contrast, the smaller positive accrual mispricing when there is no insider trading is more likely related to either the complexity of the firms' accrual generating process (Thomas and Zhang (2001) or to earnings fixation (Sloan 1996). Our evidence thus suggests that opportunistic earnings management is a partial explanation for the accrual mispricing phenomenon.

Insider Trading, Earnings Quality, and Accrual Mispricing

CI NSIDERS" are officers, directors, and owners of ten per cent or more of the common stock of the companies listed on the New York and American Stock Exchanges. The Securities and Exchange Commission (the SEC) requires that insiders keep the Commission informed regarding transactions in the common stock and convertible securities of the respective companies. The interest of the SEC in trading by insiders stems in part from the belief that insiders should not exploit their special opportunities to know about developments in their companies for personal profit through short-term trading. Further, the Commission feels that information on trading by insiders should be fully disclosed to the investing public because of light which such trading might cast upon the company's future prospects. There is also wide-spread interest in the investment community in trading by insiders because of the prevalent belief that insiders have valuable private information which bears upon their company's prospects and that knowledge of the trading by insiders will permit valid inferences regarding future movements in the prices of stocks. Because of the interest by the SEC and the investment community in insider trading, we have undertaken this study. The subject has been studied before in many ways, but none of the preceding studies has been definitive and the additional methods of analysis seemed promising. Opinions are somewhat polarized. Academic studies have found virtually no evidence of profitable exploitation by insiders of their special knowledge and no value to outsiders in data on trading by insiders. Others believe that insiders often make extraordinary profits and that knowledge of their trading is valuable. Both the SEC and investors should be interested in which opinion is correct. The methods and coverage of this study differ from those of earlier work, as do our conclusions. We show that proper and prompt analysis of data on insider trading can be profitable, although almost all earlier academic work has reached the contrary conclusion. The first

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Victor Niederhoffer

Papers

Predictive and Statistical Properties of Insider Trading