Estimating the Returns to Insider Trading

Leslie A. Jeng, Andrew Metrick and Richard Zeckhauser

Rodney L. White Center for Financial Research Working Papers from Wharton School Rodney L. White Center for Financial Research

Abstract: This paper estimates the returns to insiders when they trade their company’s stock. We first construct a rolling "purchase portfolio" that holds all shares purchased by insiders for a six-month period, and an analogous "sale portfolio" that holds all shares sold by insiders for six months. The six-month horizon is chosen to coincide with the "short-swing" rule of the Securities and Exchange Act of 1934; a rule that prohibits profit-taking by insiders for offsetting trades within six months. We then employ performance-evaluation methods to analyze the returns to the purchase and sale portfolios. This approach yields a proxy for the value-weighted returns to insider transactions beginning on the day after their execution and avoids the statistical difficulties that plague event studies on long-horizon returns.

Our methods are designed to estimate the returns earned by insiders themselves and thereby differ from the previous insider-trading literature, which focuses on the "informativeness" of insider trades for other investors. Using a comprehensive sample of reported insider transactions from 1975-1996, we find that the purchase portfolio earns abnormal returns of more than 50 basis points per month. About one-quarter of these abnormal returns accrue within the first five days after the initial transaction, and one-half accrue within the first month. The sale portfolio does not earn abnormal returns. Our portfolio-based approach also allows for straightforward decompositions of performance by various characteristics; we find that the abnormal returns to insider trades in small firms are not significantly different from those in large firms, and that top executives do not earn higher abnormal returns than do other insiders.

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