Investment intelligence from insider trading

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Investment Intelligence from Insider Trading Investment Intelligence from Insider Trading H Nejat Seyhun The MIT Press Cambridge, Massachusetts London, England  1998 Massachusetts Institute of Technology All rights reserved No part of this book may be reproduced in any form by any electronic or mechanical means (including photocopying, recording, or information storage and retrieval) without permission in writing from the publisher This book was set in Stone Sans and Stone Serif by Achorn Graphic Services, Inc Printed and bound in the United States of America Seyhun, Hasan Nejat, 1954– Investment intelligence from insider trading / H Nejat Seyhun p cm Includes bibliographical references and index ISBN 0-262-19411-2 (hc : alk paper) Insider trading in securities—United States HG4910.S416 I Title 1998 364.16′8—dc21 98-24347 CIP To the loving memory of my parents Contents Preface xiii Acknowledgments Introduction xvii xix Insider-trading patterns Some preliminaries 1 Conflicting transactions Frequency of insider trading Insider-trading cycles Probability of trading against insiders Normal insider-trading patterns Seasonal patterns in insider trading Do insiders manipulate stock prices? Insider-trading regulations 14 17 18 23 Should insider trading be regulated? 28 Conclusions and investment implications 32 Does insider trading predict future stock returns? Background 35 Stock price movements following insiders’ transactions Relative performance 41 35 37 Contents viii Year-to-year profitability of insider trading 43 Duration of the stock price reaction to insider trading Prior stock price movements 49 Profitability of active and passive transactions Strengthening insider-trading signals 58 Do insiders manipulate stock prices? 61 Conclusions and investment implications A stock-picking strategy 54 63 67 Additional indicators of profitability 67 Identity of insiders 68 Volume and profitability of insider trading 74 Interaction between volume and identity of insiders Volume and officers and directors Volume and top executives Sales versus purchases 46 80 83 84 86 Firm size and profitability of insider trading 89 Interaction among identity of insiders, firm size, and volume of trade 92 Consensus among insiders 98 Insiders’ option exercises and other transactions Conclusions and investment implications 104 Predicting future market returns Market timing 107 107 Aggregate insider trading 109 Aggregate insider trading and future real activity 50%–50% rule 100 111 114 Implications for the mutual fund investor 124 Other cutoff rules 125 Other market-timing strategies based on aggregate insider trading 128 Contents ix Predicting industry returns 131 Conclusions and investment implications 134 Crash of October 1987 and insider trading 137 Why did the stock market crash in October 1987? Anatomy of the crash 137 140 Insider trading around the crash of October 1987 Conclusions and investment implications Dividend yields and insider trading 143 149 151 Dividend yields and future stock returns 151 Predictive ability of the market dividend yield 153 Forecasting characteristics of dividend yields 155 Market dividend yields and aggregate insider trading Intensive insider trading and dividend yields Changes in dividend yields Firm-specific dividend yields 166 170 Conclusions and investment implications Dividend initiations 159 164 172 175 Why firms pay dividends? 175 Dividend initiation process 178 Stock price effects of dividend initiations Dividend initiations and insider trading 179 180 Conclusions and investment implications Earnings announcements 189 191 Information content of earnings announcements Prior literature on earnings announcements 191 193 Stock price reaction around earnings announcements Insider trading and earnings announcements 199 Insider trading, earnings surprise, and the stock price drift 201 194 References 388 Watson, eds Mid-America Institute for Public Policy Research Inc Homewood, IL: Irwin Rosenberg, B., K Reid, and R Lanstein 1985 Persuasive evidence of market inefficiency Journal of Portfolio Management 11:9–17 Rozeff, M S 1987 Insider trading: What we know and what we don’t know In The Effects of Organizational Transformation New York: Quorum Books Rozeff, M., and M Zaman 1988 Market efficiency and insider trading: New Evidence Journal of Business 61:25–44 Ryngaert, M., and J Netter 1988 Shareholder wealth effects of the Ohio antitakeover law Journal of Law, Economics and Organizations 6:253–62 Sanders, R W., and J S Zhanowicz 1992 Target firm abnormal returns and trading volume around the initiation of change-in-control transactions Journal of Financial and Quantitative Analysis 27:109–29 Scott, K E 1980 Insider trading, rule 10b-5, disclosure and corporate privacy Journal of Legal Studies 9:801–18 Seyhun, H N 1986 Insiders’ profits, costs of trading, and market efficiency Journal of Financial Economics 16:189–212 Seyhun, H N 1988a The January effect and aggregate insider trading Journal of Finance 43:129–41 Seyhun, H N 1988b The information content of aggregate insider trading Journal of Business 61:1–24 Seyhun, H N 1990a Do bidder managers knowingly pay too much for target firms? Journal of Business 63:439–64 Seyhun, H N 1990b Overreaction or fundamentals: Some lessons from insiders’ responses to the market crash of 1987 Journal of Finance 45:1363–88 Seyhun, H N 1992a The effectiveness of the insider trading sanctions Journal of Law and Economics 35:149–82 Seyhun, H N 1992b Why does aggregate insider trading predict future stock returns Quarterly Journal of Economics 107:1303–31 Seyhun, H N., and M Bradley 1997 Corporate bankruptcy and insider trading Journal of Business 70:189–216 Schwert, W 1990 Stock volatility and the crash of ’87 Review of Financial Studies 3: 77–102 References 389 Schwert, W 1996 Mark-up pricing in mergers and acquisitions Journal of Financial Economics 41:153–92 Shalen, C 1993 Volume, volatility, and dispersion of beliefs Review of Financial Studies 6:405–34 Shiller, R J 1989 Comovements in stock prices and comovements in dividends Journal of Finance 44:719–29 Shiller, R 1981 ‘‘Do Stock Prices Move Too Much to be Justified by Subsequent Changes in Dividends?’’ American Economic Review 71:421 –36 Shleifer, A., and L Summers 1988 Breach of trust in hostile takeovers In Corporate Takeovers: Causes and Consequences, A Auerbach, ed Chicago: University of Chicago Press, pp 33–56 Shleifer, A., and R Vishny 1986 Large shareholders and corporate control Journal of Political Economy 94:461–88 Silver, C B 1985 Penalizing insider trading: A critical assessment of the insider trading sanctions act of 1984 Duke Law Journal 1985:960–1025 Simon, C 1989 The effect of the 1933 securities markets Journal of Business 37: 117–42 Smiley, R 1981 The effects of state securities statutes on tender offer activity Economic Inquiry 19:426–35 Sobel, R 1965 The Big Board: A History of the New York Stock Exchange New York: Free Press Stattman, D 1980 Book values and stock returns Chicago MBA: A Journal of Selected Papers 4:25–45 Stewart, J 1991 Den of Thieves New York: Simon and Schuster Summers, L H 1986 Does the Stock Market Rationally Reflect Fundamental Values? Journal of Finance 41:591–600 Travlos, N G 1987 Corporate takeover bids, methods of payment, and bidding firms’ stock returns Journal of Finance 42:943–63 Trivoli, G W 1980 How to profit from insider trading information Journal of Portfolio Management 6:51–56 Vila, J L 1989 Simple games of market manipulation Economic Letters 29:21–26 Wang, J 1993 A model of intertemporal asset prices under asymmetric information Review of Economic Studies 60:249–82 References 390 Wansley, J W., W R Lane, and H C Yang 1987 Gains to bidder firms in cash and securities transactions Financial Review 22:403–14 Weinberger, A M 1990 Preventing insider trading violations: A survey of corporate compliance programs Securities Regulation Law Journal 18:180–93 Wier, P 1983 The costs of antimerger lawsuits: Evidence from the stock market Journal of Financial Economics 11:207–24 Winans, R F 1986 Trading Secrets New York: St Martin’s Press Wycoff, R D 1968 Wall Street Ventures and Adventures New York: Greenwood Index Absolute book-to-market ratio (B/M) defined, 243–44 Active trading defined, 51, 64 formation, 244 future stock returns and, 51–52 future market returns and, 246–47 mutual fund investors and, 108 future stock return predictions, 248, 258–59 future stock return prices and, 250 insider trading and, 248–51 outsiders and, 58 profitability, 54–58 Aggregate insider trading computing, 114–24 market returns predictions, 259 cutoff rules, 114–24, 125–28 net stock returns and, 247–48 defined, 42–43 overall portfolio performance and, 246 predictive power, 242–47 dividend changes and, 168–70 dividend yields and, 159–63, 172 raw returns and, 246 55%–45% rule, 126–28, 135 variations, insider view of, 260 50%–50% rule, 114–24, 125, 135 Absolute price/earning ratio (P/E) defined, 216–17 future net stock returns and, 223–24 future raw stock return predictions, 218–20, 234–35 insider trading, future raw stock returns and, 220–21 insider trading and, 235 low, 222 predictive power, 217, 218–25 forecasting power, 173 future market return predictions, 109– 11 future real activity and, 111–14 intensive, dividend yields and, 164– 66 joint predictive ability with P/E ratios, 214–15 market-timing strategies based on, 128–31 risk capturing, 222 mutual fund investor and, 124–25 vs relative P/E ratios, 225 predictive power, 119–24, 134 Index American Stock Exchange, Anonymity, Auto industry, insider trading in, 132– 34 392 Buying activity, insider, 38 aggregate insider, 152, 164 consensus, 99 Buy proportion, aggregate, 117–18 Bid-ask spread, 36, 92, 321–22 Bidder firm Buy signals, aggregate insider, market returns and, 119–24 defined, 261, 262 identity, 291 Cady Roberts & Co., 25 insider buying, 286–87 Call options, 101, 102–103 insider trading, 285–90 Capital markets, public confidence in, pre-announcement period, 285–86, 292 29–30 Chrysler Corporation, insider trading pre-announcement trading, insider, 283 in, 132–34 Commission fees, 25, 36, 321 stock price effects, 279, 281–85, 291 Consensus successful, 281–82, 291–92 among insiders, 98–100, 105 synergy with target firm, 266 buying, 99 takeover effects, 279–81 defined, 98 welfare effects, 285 B/M ratio See Book-to-market ratio Board of directors See Directors Book-to-market ratio (B/M) absolute (see Absolute book-to-market ratio) Contrarian investing (mean-reversion), 294, 308–14 Corporate takeover, 261–62 bidders (see Bidder firm) defenses, 281 disclosure requirements, 271 future raw stock returns, insider trading and, 249 failure, 264 hostile, 280 future stock return prediction, 240– long-term horizon predictability, 308– 41 15 future stock return prices, 250–51 payment forms, 287–88 growth-based investment, 237–42 pre-announcement stock price drifts, high, 237 predictive ability, insider trading for future stock returns and, 249–50 relative (see Relative book-to-market ratio) systematic differences in, 237–38 value-based investment, 237–42 variation, 258 267–71, 278 price effects, 263–67 probability of success, 271, 272, 274–75 profitability, 275–76 short-term horizon predictability, 297–308 successful, 282–83 synergy in, 266, 280 Broker, targets (see Target firm) Business cycles, sensitivity to, 116 unsuccessful, 266, 282–83 Index Corporations governance, interference in, 31 size (see Firm size) Cycles, insider-trading, 6–8, 32 393 intensive insider trading and, 164– 66 measuring, 153–54 net stock returns and, 170–72 past, future market returns and, 158 Directors defined, 70 information possessed by, 69, 72 predictive ability, 151–55, 159–60, 172–73 Dow Jones Industrial Average, 137 profitability of transactions, 71, 84 volume of trading and, 84 Disclosure, of insider transactions, 24 Earning announcements information content, 191–93 Dividend declaration date, 178 insider trading and, 199–201 Dividend initiation period for, 196 as bad news, 177 defined, 177 postannouncement window, 196 price-earnings ratios and, 233–34 as good news, 177, 189 prior literature, 193–94 insiders’ motivations and, 183–84 stock price reactions, 192, 193–99, insider trading and, 180–89 predicting, pre-announcement information for, 180–84, 189 211–12 Earnings drift, 198 Earnings surprise prior insider trading, 189–90 after large insider trading, 206 process, 178–79 computing, 195 stock price effects, 177–80, 185–87 future stock return predictions, 207 Dividends See also Dividend yield first (see Dividend initiation) reasons for, 175–78 start-up firms and, 176–77 Dividend yield aggregate insider trading and, 159–63, 172 changes in, 156, 166–70, 173 classification, 158–59 insider trading, stock price drift and, 201–204 negative, 207, 208 positive, 207, 208 Equally weighted index, 41 Ex-dividend date, 178–79 Executives lower-level (see Officers) top-level (see Top executives) defined, 153 Exercise price, 101 explanations for predictive ability, Expectations, 191–92, 195 154–55 firm-specific, 170–72, 173 55%–45% rule, 135, 164 forecasting characteristics, 155–59 50%–50% rule, 114–24, 125, 135 future stock returns and, 151–53, 172–73 Financial Times, xx Firm size insider trading, 3-month-ahead stock returns and, 160–63 aggressiveness of information exploitation and, 88 Index Firm size (cont.) buy-sell decisions, identity of insiders and, 95–96 394 dividend yield, predictions and, 172– 73 dividend yields and, 151–53 identity of insiders and, 92–98, 105 growth-based investing and, 209–10 insider-trading patterns and, 14–16, 33 holding relative P/E ratios constant, multiple mimicking transactions and, 336–39 officers’ transactions profitability and, 93 outsider profitability and, 325–26 passive trading and, 91 probability of trading against insiders and, 9–11 profitability and, 89–94, 105, 334 top executives’ profitability and, 93 – 94, 328–29 trading volume, information quality and, 76 volume of trade, identity of insiders and, 92–98 predictions and, 235 passive transactions and, 51–52 P/E ratio prediction of, 225–31 predictability, 35–36, 148, 172–73, 235, 297 prediction, book-to-market ratio and, 240–41 price-earning ratio and, 210–14 value-based investing and, 209–10 General Motors, insider trading in, 132–34 Gross national product (GNP), growth rates, 111, 112–13 Growth-based investing, xxiv Ford, insider trading in, 132–34 book-to-market ratio and, 237–42 Forecasting future stock returns and, 209–10 aggregate insider trading and, 129–31 dividend yields and, 155–59 industry-aggregate method, 132–33 using 55%–45% rule, 127–28 Future market returns dividend yields and, 158 predicting, 118–24 Future net stock returns, absolute P/E ratios and, 223–24 Future raw stock returns book-to-market ratios, insider trading and, 249 Future real activity, aggregate insider trading and, 111–14 Future stock prices direction of changes, 86 predicting, 64–65 Future stock returns active transactions and, 51–52 Holding periods, dividend yield predictive ability and, 158–59 Hostile takeovers, 280 Identity of insiders, 68–74 buy-sell decisions in small firms and, 95–96 firm size, volume of trade and, 92–98 volume of trading and, 80–83 IIP (index of industrial production), 111, 113 Imitation of insiders, xxii multiple transactions, 336–39 potential profits from, 322–25 publication delays and, 320 reporting delays and, 318–20 risks from, 331–34 transaction costs and, 321–22 Index 395 Index of industrial production (IIP), advantage, source of, 69–70 111, 113 Industry-aggregate method, 132–33 classes, 53, 68, 70–71 consensus among, 98–100 Industry returns, predicting, 131–34, identity.See Identity of insiders 135 Information, xx–xxi efficiency, insider trading and, 29 exploitation aggressiveness, firm size and, 88 information sources, 104 knowledge hierarchy, 72–73, 74, 104 large trades by, 104 (See also Large transactions, by top executives) number of shares traded by, 11–12 illegal insider, xxviii–xxix option exercises, 100–103 macroeconomic, market timing and, pre-announcement trading, 266–67, 109 269–70 nonpublic macroeconomic, 110 probability of trading against, 8–14, possession by insider classes, 68–69 pre-announcement, for dividend initi- 32–33 reporting delays by, 318–20 ation prediction, 180–84 quality See Information quality screening, for publications, 82–83 takeover, exploitation by top executives, 272–74, 276–77, 278 Information content aggregate insider-trading signal, 121 doubling, 58, 60, 79 earning announcements, 191–93 with large insider trading, dividend initiation and, 187–88 large transactions by top executives, 232–33 stock price manipulation and, 18–23, 61–63 in target firms, 278 top executives, 53 –54 total shares bought and sold, 13–14 Insider trading absolute B/M ratio predictive power and, 259 absolute book-to-market ratio and, 248–51 around crash of October 1987, 143– 49 in bidder firms, 285–90 outsider profitability and, 327–28 characteristics, 1–2, 21 P/E ratios, 215–18 during 1987 crash, predictions and, relative B/M signal, large transactions and, 257–58 takeover announcements, 261–63 Information quality determinants of, 100 (see also specific determinants of quality) dollar volume of trade and, 74–76 signal of, 78 volume of trade and, 104 Insiders See also specific classes of insiders 145–46 defined, 2, 3–4, xxv–xxxii dividend initiation and, 180–89 earning announcements and, 199– 201 earnings surprise, stock price drift and, 201–204 frequency, 5–6, 12–13, 32 future stock return predictions and, 148–49 illegal, 26, 27, 28 Index Insider trading (cont.) information efficiency and, 29 intensity, 11–12, 33 intensive, dividend yields and, 164–66 investment styles and, xxiii–xxv large, 204–206 (see also Large transactions, by top executives) learning from, xxxiii–xxxvii 396 recommendations for, 339–40 regulations and, 34 risk-averse, 332–33 ITSA (Insider Trading Sanctions Act of 1984), 26, 27, 273–74 ITSFEA (Insider Trading and Securities Fraud Enforcement Act of 1988), 26, 27, 274 long-term winner-loser status and, 310–15 January effect, 33 measuring, 3–4, 248–49 3-month-ahead stock returns, dividend yields and, 160–63 normal patterns, 14–17 past-future correlations, 22, 33–34 Large transactions, by top executives, 204–206, 208 in bidder firms, 288–89, 292, 304, 306–308 patterns, 1–2 dividend initiation and, 188–89 pre-announcement, 278 long-term horizon predictability and, predictive ability, 206, 145–46 prior to dividend initiations, 189–90 relative B/M ratios and, 253–58 seasonal patterns, 17–18 short-term winner-loser status and, 301–304 314–15 outsider profitability and, 329 reporting, 319–20 Legal issues See Regulations; specific laws Liability, for insider-trading, 26 –27 signals (see Signals) Liquidity, 19, 30 –31 in target firms, 271–76 Long-term horizon predictability, of time series properties of, 20 transactions See Transactions corporate takeovers, 308–15 Loss probability See Risk volume, profitability and, 74–80 Insider Trading and Securities Fraud Enforcement Act of 1988 (ITSFEA), 26, 27, 274 Insider trading predictive power, absolute P/E ratio and, 221–22 Insider Trading Sanctions Act of 1984 (ITSA), 26, 27, 273–74 Intensity of trading, 52–53 Macroeconomic developments, signals and, 110 Managers, dividends and, 176 Market dividend yield See Dividend yield Market performance, total vs relative, 41–43 Market returns Interest rates, short-term, 110 distribution following insider trading, Investors inside (see Insiders) 43–44 following aggregate insider trading sig- insider-trading regulations and, 31 outside (see Outsiders) nals, 119, 126–28, 135 future, 118–24, 158 Index future net stock, absolute P/E ratios 397 Officers and, 223–24 future raw stock, 218–20, 249 defined, 70 firm size, profitability and, 93 year-by-year, 43–45 information possessed by, 68–69, 72 Market timing absolute P/E ratio, insider trading and, 236 aggregate insider trading-based, 128– 31 defined, 108 strategies, 107–109 Mean reversion profitability of transactions, 71, 83– 84, 93 volume of trading and, 83–84 On-line reporting services, xx Option exercises, 100–103 timing, 102, 105 types, 101 Outsiders defined, 294 active insider trading and, 58 of stock prices over long horizon, 308–14 imitating insider trading in large firms, 95 Mergers, 261 insider trading in small firms and, 92 Misappropriation theory, 29 profit determinants, 325–31 Mispricing of stock profits, 217–318 large transactions by top executives in bidder firms and, 307–308 vs risk, 212–13, 240–41 Momentum, 21–22 Momentum investing, 293–94 Mutual fund investors, 107–108 replication of most profitable trading, 97–98 reporting delays and, 318–20 signal of quality of insider information, 78 trading costs for, 36 active, 108 aggregate inside trading and, 124–25 choices, 108 passive, 108 Passive trading defined, 40, 50 elimination, 64 firm size and, 91 NASDAQ, Net stock returns absolute book-to-market ratio and, 247–48 after option exercises, 102–103 future stock prices and, 51 future stock returns and, 51–52 mutual fund investors and, 108 profitability, 54–58 purchases, 55 dividend yields and, 170–72 for risk-aversion, 53 preceeding insider sales, 55 strategies, 64 profitability and, 77 by top executives, 53–54 for purchases, 47–48 relative, 60–61 Payment date, in dividend initiation process, 179 for sales, 47–48 Payment forms, for corporate take- New York Stock Exchange, overs, 287–88 Index Predictive power absolute book-to-market ratio, 242–47 absolute P/E ratios, 217, 218–25 398 identity of insiders and, 68–74, 105 indicators, 67 –68 (see also specific indicators) aggregate insider trading, 119–24 of insider trading, 45, 63 dividend yield, 151–55, 159–60, 172– of large shareholders, 81–82 73 of officers’ transactions, 83–84 insider trading, 65, 250 of option exercises, 100–103 relative B/M ratios, 251–53, 260 of passive trading, 54–58 Price/earnings ratios (P/E), 209–10 absolute (see Absolute price/earning ratio) classifying, 216–18 of purchases vs sales, 104 of top executives’ transactions, 73–74 over time, 64 selling consensus and, 98–99 direction of insider trading and, 222 trade-off with risk, 334–36 earnings announcements and, 233–34 future stock returns and, 210–14 volume of insider trading and, 74–80 year-to-year, 43–46 high, 213, 220, 222 information content, 215–18 insider trading and, 213–14 joint predictive ability with aggregate insider trading, 214–15 large insider-trading volumes and, 231–33 low, 222 market vs firm-specific effect, 223– 25 Profits corporate, aggregate insider trading and, 111, 113–14 determinants, for outsiders, 325–31 insider, 26–27, 39 outsiders, 217–318 potential, from mimicking insiders, 322–25 Proxy contests/fights, 261, 262 Publication delays, 320 negative, 215 positive, 215 Publications, screening of insidertrading information, 82–83 predictive power, 214 Purchase month, 59 reasons for future stock returns predic- Purchases tions, 225–31 relative (see Relative price/earning ratio) active, 55–56 call option, 101 consensus, 99 Price impact, 322 insider, vs sales, 97 Profitability net returns, 47–48 of active trading, 54–58 passive, 55–56, 57–58 determinants, 104 passively traded, 50, 51 of directors’ transactions, 84 profitability, 104 estimate, narrowing of, 42 of extremely large transactions, 79– small, 33 in small firms, identity of insiders 80 firm size and, 89–92, 105, 334 and, 95–96 stock, 41 Index stock prices and, 63 399 Risk stock returns around, 57–58 vs sales, 86–89 capturing, absolute P/E ratio and, 222 defined, 332 Put options, 101, 102, 103, 105 from imitating insiders, 46, 64, 331–34 increased, book-to-market ratio and, Raiders, 264 Record date, in dividend initiation process, 179 Regulations See also specific laws insider concern for, 16–17, 33, 78–79 investors and, 34 need/rationale for, 28–34 of option exercises, 101–103 types of, 23–28 Relative book-to-market ratio (B/M) computing, 244 239 with insider trading, 45–46 measuring, 333 multiple mimicking transactions and, 336–39 P/E ratios, future stock returns and, 212–13 premium, variation over time, 295 trade-off with profitability, 334–36 vs mispricing of stock, 212–13 Risk-aversion, passive trading for, 53 defined, 244 future stock return predictions, 259– 60 Sale month, 59 Sales, 33 insider trading and, 253–56 active, 55, 56 large transactions and, 256–58 consensus, profitability and, 98–99 predictive power, 251–53, 260 insider, vs purchases, 97 variations, insider view of, 260 net returns, 47–48 Relative market performance, 41–43 passive, 50–51, 55, 56–57 Relative price/earning ratio (P/E), 217 profitability, 104 future stock returns and, 232, 235 high, 235 insider trading and, 228–29, 235 low, 235 put option, 101 in small firms, identity of insiders and, 95–96 stock, 41 net stock returns and, 229–30 stock prices and, 63 predicting future stock return and, vs purchases, 86 –89 235 predictive power, 217, 225–27, 235– 36 risk capturing, 230–31 vs absolute P/E ratios, 225 Reversals probability of, 21, 23 short-term, 20 stock price reactions and, 62 Right-skewness, 299 Seasonal patterns, in insider trading, 17–18, 33 SEC See Securities and Exchange Commission Sector investing, 131 Securities and Exchange Act, 24, 25– 26, 101 Securities and Exchange Commission (SEC), 271 detection of illegal trading, 274 Index Securities and Exchange Commission 400 Small firm stocks, index of, 129 (SEC) (cont.) option exercise rules, 102 Standardized unexpected earnings (SUE), 195–98, 200, 204, 233 reporting delays, 318–20 Stock market reporting failures, xxviii short-term losers, 298–308 surveillance programs and, 75 short-term winners, 298–308 10-Q and 10-K reports, 191 13-D statements, 280 unusual trading volume and, 16 Selling, aggregate, 152 Sell signals, aggregate insider, market returns and, 119–24 Sentiment, insider, Shareholders, large corporate decision-making and, 82 defined, 70 information possessed by, 69, 72 as information source, 70, 82 insider trading benefits, 30 large trades by, 104 profitability of, 71, 81–82 volume of trading and, 81–83 Shares, net number traded, 3, valuation mistakes, 211 Stock market crash of October 1987, 149–50 anatomy of, 140–43 insider buying and, 7, 118 insider trading patterns and, 143–49 reason for, 137–40 Stock market data, survival bias of, 296–97 Stock-picking strategy, relative B/M ratios and, 252–53 Stock price after stock market crash of 1987, 141– 43 announcement period reactions, 198– 99 bidder firm, 279–81, 281–85 Short sale, 38–39, 63 in corporate takeovers, 263–67 Short-swing profits rule, 266–67 dividend initiation effects on, 179–80, Short-term horizon predictability, of corporate takeovers, 297–308 185–87 dividend initiation reactions, 177–78 Signals, xx duration of reactions, 46–49 aggregate insider trading, 114–15, 118–19 earnings announcement reactions, 192, 193–99 buy, 323 following insider transactions, 37–41 conflicting, elimination of, 59–60, 65 insider purchases and, 63 interpreting, 1–2 insider sales and, 63 macroeconomic developments and, January effect, 33 110 market and firm-specific, 130–31 long-term horizon predictability, 297, 308–15 market returns and, 119–24 manipulation See Stock price manipu- quality, consensus and, 105 relative P/E ratios and, 231–33 lation mean reversion over long horizons, sell, 323 strong, 58–61, 134, 231–33 308–14, 316 mispricing, 211, 212–13 Index 401 net movements, following option exer- insiders in, 278 cises for top executives, 103 overreaction, 154–55 insider trading in, 271–76 probability of success, 274–75 pre-announcement drift, 267–71 shareholders, 262, 264, 265 prior to insider transactions, 49–54 stock price behavior of, 263–67 put options and, 101 stock price drift, 277–78 reactions, 46 –49, 64, 65 successful, 264, 269, 270–71, 277 reporting month, 323–25 synergy with bidder firm, 266 seasonal pattern in, 18 underevaluation, 266 short-term horizon predictability, unsuccessful, 264, 277 297–308 stock market crash of 1987 and, 137– 43 trends, alternative explanations for, 295–98 Stock price drift, earnings surprise, insider trading and, 201–204 Stock price manipulation Tender offers, 261, 262 10-K, 191 10-Q, 191 Texas Sulfur case, 25 13-D statements, 280 Top executives bidder firm, large transactions by, 288–89, 292 incentives, 29 during 1987 crash, 147–48 insider, 18–23 defined, 70 insiders and, 34, 61–63 firm size, profitability and, 93–95 regulations, 24–25 information possessed by, 68, 72 volume of trading and, 63 Stock returns around insider purchases, 57–58 dividend yield changes, predictions from, 167–68 3-month-ahead, dividend yields and, 160–63 predictability, 167–68, 220, 296–97 relative, 60–61 SUE (standardized unexpected earnings), 195–98, 200, 204, 233 Survival bias, of stock market data, 296–97 Synergy, in corporate takeovers, 266, 280 in large firms, 88 large trading (see Large transactions, by top executives) option exercises, net stock price movements after, 102 outsider profitability and, 328–29 profitability of transactions, 71, 84– 88, 94–95, 328–29 risk vs profitability, 335–36 in small firms, 88, 96–97 takeover information exploitation, 269–270, 272–74, 276–77, 278 transactions following reporting month, 329–30 volume of trading and, 84–86, 94– Takeover announcements, information content, 261–63 95 Trade size, buy-sell activity and, 16–17 Target firm Trading costs, 36, 92 defined, 261, 262 Trading volume See Volume of trade Index Transaction costs bid-ask spreads, 321–22 commission fees, 321 price impact, 322 Transactions active, 40, 55 (see also Active trading) backward-looking, 57, 64 (see also Passive trading) 402 Value Line Investment Survey, xx Volume of trade defined, 76 directors and, 83 –84 doubling, information content and, 79 firm size, identity of insiders and, 92– 98 conflicting, 3–4 identity of insiders and, 80–83, 92–98 costs of (see Transaction costs) information quality and, 97, 104 disclosure, 24 large shareholders and, 81–83 extremely large, profitability of, 79– officers and, 83–84 80, 88 for information exploitation, 39–40 large (see Large transactions, by top executives) outsider profitability and, 326–27 P/E ratios and, 231–33 profitability and, 74–80, 94–95 purchases and, 86–89 multiple, mimicking of, 336–39 sales and, 86–89 option exercises, 100–103 stock manipulation and, 63 passive (see Passive trading) stock price manipulation and, 63 profitability (see Profitability) top executives and, 84–86, 94–95 profit realization based on past trad- unusual, SEC and, 16 ing, 39–40 publication lag, 36 Wall Street Journal, xx, 82, 88–89 reporting, xx, 39 Williams Act of 1968, 280 stale, 330–31 stock price movements and, 37–41 Trend-based investing alternative explanations for trends, 295–98 defined, 293 mean-reversion or contrarian approach, 294 Underperformance, 45–46 Value-based investment, xxiii–xxv See also Price/earnings ratios basis for, 239–40 book-to-market ratio and, 237–42 (see also specific types of B/M ratios) future stock returns and, 209–10 Year-by-year returns, 43–45 .. .Investment Intelligence from Insider Trading Investment Intelligence from Insider Trading H Nejat Seyhun The MIT Press Cambridge, Massachusetts... xvii xix Insider- trading patterns Some preliminaries 1 Conflicting transactions Frequency of insider trading Insider- trading cycles Probability of trading against insiders Normal insider- trading. .. in insider trading Do insiders manipulate stock prices? Insider- trading regulations 14 17 18 23 Should insider trading be regulated? 28 Conclusions and investment implications 32 Does insider trading
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