To Trade or Not to Trade: The Strategic Trading of Insiders around News Announcements

We argue that insiders' decisions to trade in short windows before news announcements are likely to result from a trade-off between the incentives to capitalize on the foreknowledge of the disclosure and the risk of regulatory scrutiny and lost reputation. We provide evidence that insider buying is driven by the trade-off, while selling is primarily influenced by the deterring effect of the regulatory and reputation risks. We show that insiders strategically choose the amount of shares bought ahead of good news announcements. They increase their purchases as the price impact of the news goes up, but we find that the amount of shares purchased levels off as the news becomes extreme. In contrast, we find that the probability of insider selling significantly decreases with the price impact of the forthcoming bad news. To further support our arguments on the importance of incentives and disincentives to trade, we show that the strategic trading is mainly observed in the most price-sensitive groups of news announcements, it is clearly pronounced for best informed executives (CEOs), and that trading patterns change with changes in regulations, and insiders with higher reputation at risk limit their trading ahead of bad news.