Actual insider trading returns and determinants of short term returns
MetadataShow full item record
This dissertation provides an in-depth analysis of insider transactions to enhance our understanding of insiders' decision making process regarding the purchase or sale of their companies' shares. We calculated insiders' actual holding periods and introduced other methodological improvements to determine the magnitude of abnormal returns to insider trading more accurately. Our calculations indicate that insiders have an average holding period of 8 years and they do not have any abnormal returns. There is a start contrast between our results and the results from previous studies that characteristically used holding periods of 12 months or less. We also test four hypotheses to explain the buying, holding, and selling patterns of insiders. Superior information effect assumes insiders trade in order to take advantage of their privileged/private information. This predicts abnormal returns after insider sale and purchase transactions. Motivation effect assumes that insiders' effort level is a function of their ownership in the company. This factor predicts abnormal returns after large sale and purchase transactions. Diversification effect hypothesizes that insiders prefer diversified portfolios over undiversified ones. Insiders need to be compensated to hold less diversified portfolio, hence this factor predicts abnormal returns after insider purchases but not after insider sales. The last hypothesis, tax effect, predicts that insiders will have longer holding periods in order to delay the payment of capital gains taxes, and only expectations of significant underperformance can induce insiders to dispose their holdings. It also predicts that insiders with very large capital gains will have abnormal returns after their sale transactions. Our analysis in the multivariate regression framework indicates that insiders take advantage of their superior information. We did not find a credible connection between overall insider returns and motivation effect. Zero abnormal returns to insider purchases also indicate that the diversification effect is also not valid for insider purchases. We attribute this to insiders' overconfidence in their information or their ability. The analysis of sale transactions did not support the superior information effect. Even though it is possible to find some subset of insider sales which could be motivated by insiders' possession of negative information, in general sales transactions are mostly driven by insiders' diversification needs. Motivation effect was also found to be behind the short term returns after insider sales. Overall, insiders do not have abnormal returns after their sales. One reason is that the stocks insiders sell after large capital gains keep their momentum and outperform the market even after insider sales. This is exactly the opposite of what is predicted by the tax effect. This indicates that insiders are bad market timers. In contrast to tax effect's prediction, we also found a negative relationship between the amount of capital gains and the length of an insider's holding period. Insiders with larger capital gains have shorter holding periods. We attribute this to the changes in insiders' expectation long after their purchases; diversification needs also play a role in their decision to sell after they experience some abnormal returns.