DO INSIDERS CLUSTER TRADES WITH COLLEAGUES? EVIDENCE FROM DAILY INSIDER TRADING

• Published date: 01 July 2019
• Author: Dallin M. Alldredge,Brian Blank
• Date: 01 July 2019
• DOI: http://doi.org/10.1111/jfir.12172

DO INSIDERS CLUSTER TRADES WITH COLLEAGUES? EVIDENCE FROM

DAILY INSIDER TRADING

Dallin M. Alldredge

Florida International University

Brian Blank

Mississippi State University

Abstract

We explore similarities in insider trading as a proxy for information flows. We observe

that corporate insiders cluster trades around those of other insiders at their firm,

especially around trades of insiders with whom they work closely. Clustering is greater

when informational advantages are larger: during periods of low investor attention, high

uncertainty, and high information asymmetry. We also document that clustered insider

purchases are followed by abnormal returns in excess of 2% during the subsequent

month. Our results are consistent with informed trading, which could result from

information sharing among corporate insiders.

JEL Classification: G14, G30, K22

I. Introduction

Do corporate insiders cluster together when they trade? Answering this question may

provide information about the relation between corporate insiders’information sets and

the resulting flow of information between corporate insiders, as evidenced by trades and

subsequent performance. Studies document that corporate insider trades exhibit superior

stock performance (Jaffe 1974; Seyhun 1986, 1998; Lin and Howe 1990; Lakonishok

and Lee 2001). Although aggregating all insider trades often masks the extent to which

insiders are informed, Lorie and Niederhoffer (1968), Cohen, Malloy, and Pomorski

(2012), and Biggerstaff et al. (2015) use patterns of insider trading to identify

abnormalities in trading behavior and uncover informed trading within time-series

patterns. In this study, we explore similarities in insiders’trading behavior at the daily

level to learn about the profitable information insiders hold and the subsequent transfer of

that information.

We offer evidence of daily trade clustering by investors with information pertaining

to a firm’s internal operations: corporate insiders (Lakonishok and Lee 2001; Cohen,

Malloy, and Pomorski 2012). We also offer both informed and uninformed explanations for

We are grateful for comments and suggestions from David Whidbee, Brandon Cline, David Cicero, Eric

Kelley, and Lee Biggerstaff, as well as seminar participants at Washington State University and Mississippi State

University. Errors are our own.

The Journal of Financial Research Vol. 0, No. 0 Pages 1–30 2019

DOI: 10.1111/jfir.12172

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© 2019 The Southern Finance Association and the Southwestern Finance Association

Vol. XLII, No. 2 Pages 331–360 Summer 2019

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why insiders could exhibit behavior similar to herding. If insiders’trades are completely

independent from one another, we expect that they do not bunch together any more than

expected by chance, with an average day containing a similar number of insider trades.

However, if informed insiders do trade in clusters, they may do so either intentionally or

unintentionally. As Holden and Subrahmanyam (1992) suggest, herd behavior can result

unintentionally because related information sets are revealed to individual traders at varying

rates, depending on information flow and trader networks. Although this could induce

informed investigative herding (Lakonishok, Shleifer, and Vishny 1992), insiders might also

cluster their trades because of other private information channels.

Specifically, relatively more informed insiders privately share information by

tipping other less informed insiders, and both sets of insiders coordinate trading to

mutually benefit from the shared information. Economic theory suggests that agents

behave rationally and incorporate relevant information into decision-making processes.

Scharfstein and Stein (1990) show that this results in herding when agents consider the

decisions of others. Furthermore, when managers are asked where they get information,

nearly universally people are cited as the source, especially those they perceive as

informed and to whom they can gain access in a timely fashion (Cross et al. 2003).

Similar behaviors and decision making could lead to herding behavior among an array of

manager decisions, including trading of the firm’s stock. Some early theoretical models

suggest that insiders with shared private information should not cooperate to mutually

benefit from shared information but rather should compete aggressively to profit from

their tradable information without benefiting other insiders (Holden and Subrahmanyam

1992; Back, Cao, and Willard 2000). However, Indjejikian, Lu, and Yang (2014) and

Ahern (2017) find rational explanations for why insiders share tradable information (i.e.,

rational information leakage to other informed participants) to jointly profit from private

information. These factors could result in informed trade clustering among insiders,

either through coordinated information sharing or independently obtained information.

Alternatively, insider trade clustering could result from uninformed trading

related to restrictions in trading or information. For example, firm trading restrictions in

the form of blackout dates or restrictions around earnings announcements could limit

insider trading opportunities and lead to the clustering of trades. Similarly, insiders

selling stock might trade in groups to avoid costly litigation risk, especially where media

and regulatory scrutiny is higher (Alldredge and Cicero 2015; Chen, Martin, Wang 2012;

Brochet 2010). Finally, limitations and differences between insiders’information sets

could result in information cascades, which are settings in which traders follow other

trades because they perceive those trades to be informed (Bikhchandani, Hirshleifer, and

Welch 1992). In particular, uninformed clustering could be the result of insiders viewing

the Form 4 insider trade disclosures of insider peers and following their trades. In a

related setting, Scharfstein and Stein (1990) show that managers sometimes mimic the

decisions of other managers when considering investment opportunities. Likewise,

Keynes (1936) suggests that investors will herd if they are concerned about how others

assess their abilities to make sound judgments. In the same way, insiders may disregard

their own noisy information sets and trade in groups based on information deduced from

the public disclosure of other insider trades. With these explanations in mind, we seek to

determine if and how corporate insiders cluster their trades.

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