Insider trading and future stock returns in firms with concentrated ownership levels

ABSTRACT

We investigate the relationship between insider trading and stock returns in firms with concentrated ownership. To this end, we employ data from East Asian countries which span the period January 2003 to May 2012. Consistent with the previous literature, we find a significantly negative relation between the selling activity of insiders and stock returns. However, contrary to studies which focus on highly developed markets, we find that the buying activity of insiders is also inversely related to future stock returns. Our analysis shows that top directors with higher ownership levels drive this result, suggesting that the trading activity of insiders is not always associated with profit-making motives and can be explained by their level of ownership. Furthermore, we demonstrate that a trading strategy which focuses solely on purchases made by top directors with high ownership levels yields negative returns. The paper has important implications for outside investors who mimic the trading activity of insiders with the aim to realise profits.

KEYWORDS:

• Insider trading
• stock returns
• economic value
• trading strategies

JEL CLASSIFICATIONS:

• G12
• G14
• C53

Disclosure statement

No potential conflict of interest was reported by the authors.

Notes

1. Returns for months t and t − 1 are set to missing if (1 + R_t)(1 + R_t−1) − 1 < 50%, where R_t is the return for month t, and at least one of the two returns is greater than 300% (see also Lee 2010).

2. Our results are robust to the use of dollar weighted insiders’ buying (selling) activity.

3. A number of studies in the return predictability literature focus on the spurious evidence of predictability which can arise as a result of highly persistent predictive variables (see, inter alia, Nelson and Kim 1993; Stambaugh 1999; Amihud and Hurvich 2004; Philips and Lee 2013). However, our inferences are not affected by such concerns given that the predictive variables employed in our paper are far from being persistent.

4. As is evident from Table 1, Hong Kong comprises a large fraction of our sample. The context here is relevant to the study of Brochet (2017) which involves a similar issue. Following Brochet (2017), we conduct an empirical analysis excluding Hong Kong from our sample and we find that the negative relationship between the buying activity of top directors and stock returns remains robust to this exclusion. Therefore, our main inferences are not driven by Hong Kong.

5. Results are similar if the trading volume of the previous month is used instead.

6. We have also run our tests based on equally weighted portfolio returns and our results are qualitatively similar.

7. We thank an anonymous reviewer for suggesting these robustness checks.

8. In our sample, the average percentage of trades in the month before earnings announcements is 11.6%.