Informed Traders: Linking Legal Insider Trading and Share Repurchases

Konan Chan, David L. Ikenberry, Inmoo Lee and Yanzhi (Andrew) Wang

Financial Analysts Journal, 2012, vol. 68, issue 1, 60-73

Abstract: Logic suggests that a link might exist between insider trades and share repurchases because of their potential to signal mispricing when market prices deviate from fair value; both events emanate from essentially the same set of decision makers. Using the overall repurchase sample, adding insider-trading information is generally not helpful. For “value” buyback companies, however, where perceived mispricing may be a more important factor, insider trading provides a strong complement to the repurchase signal.Logic suggests that a link might exist between insider trades and share repurchases because of their potential to signal mispricing when market prices deviate from fair value; both events emanate from essentially the same set of decision makers. A rich set of literature suggests that executives have timing ability with respect to both events. Long-horizon equity return drifts are evident subsequent to both classes of announcements. Several researchers, however, view this collective evidence with suspicion. Certainly, repurchases occur for a wide array of economic motivations, some not specifically related to mispricing. Moreover, insiders trade their stock for various reasons that are not directly related to private information about their companies. Some researchers are suspicious of the evidence supporting mispricing given the difficulty in measuring long-term abnormal stock returns. We addressed this debate by considering these two transactions jointly. We used publicly available information to form portfolios and evaluated their performance by using performance metrics common to the asset management industry as well as those commonly used in academic studies. For “value” buyback companies, where the likelihood of undervaluation is seemingly a more plausible economic motivation for repurchases, insider trading provided a strong complement to the repurchase signal. The same was not true for other buyback cases, where factors aside from mispricing may be motivating repurchase decisions. Our evidence is consistent with that of prior studies that concluded that some managers do exhibit timing ability. The results suggest that investors can combine these two independent corporate events made by essentially the same set of decision makers to better identify mispriced companies.

Date: 2012
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DOI: 10.2469/faj.v68.n1.3

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