Does stardom affect the informativeness of a CEO's insider trades?

• Published date: 01 October 2019
• Author: Sanjiv Sabherwal,Mohammad Riaz Uddin
• Date: 01 October 2019
• DOI: http://doi.org/10.1111/jbfa.12412

DOI: 10.1111/jbfa.12412

Does stardom affect the informativeness of a

CEO’s insider trades?

Sanjiv Sabherwal1Mohammad Riaz Uddin2

1Department of Finance and Real Estate,

University of Texasat Arlington

2Department of Finance, Accounting &

Managerial Economics, American University of

Beirut

Correspondence

SanjivSabherwal, Department of Finance and

RealEstate, University of Texasat Arlington,

Arlington,TX 76019, USA.

Email:sabherwal@uta.edu

Abstract

This study examines whether the celebrity or star status of a chief

executive officer (CEO) affects the informativeness of his insider

trades.Using three different measures to identify star CEOs in a sam-

ple of S&P 1500 firms, we find that trades of non-star CEOs predict

future abnormal returns and earnings innovations and that trades

of star CEOs do not. The predictive power of non-star CEO trades

is mostly attributable to opportunistic trades, not routine trades.

We also find evidence suggesting that the abnormal returns associ-

ated with non-star CEO insider trades are due to the lower visibility

and consequently less scrutiny of non-star CEOs compared with star

CEOs.

KEYWORDS

chief executive officer, insider trading, opportunistic trade, routine

trade, star

JEL CLASSIFICATION

G14, G23, G29

1INTRODUCTION

Does the celebrity or star status of a chief executive officer (CEO) matter for the informational content and predic-

tive power of his trades? The informational role of insider trading is not without debate. Cohen, Malloy,and Pomorski

(2012) find that trades by non-senior insiders [insiders other than CEOs or chief financial officers (CFOs)] can predict

future firm events better than trades by senior insiders. Wang,Shin, and Francis (2012) show that CFOs earn higher

abnormal returns following their purchases of company shares than CEOs. Knewtson and Nofsinger (2014) find that

because CEOs face more scrutiny than CFOs, CEOs limit their trading aggressiveness and their trades are less infor-

mative than tradesof CFOs. Meanwhile, Ozkan and Trzeciakiewicz (2014) show that CEOs tend to purchase their own

company shares more than CFOs do and that CEO purchases are more informative than those of CFOs. In this study,

we focus only on CEOs and investigate whether the celebrity or star status of a CEO reveals the information content

in his trading.

The public at large considers prominent CEOs in the United States to be celebrities or stars. Theyenjoy higher com-

pensation (Murphy, 1999) and attract more public attention (Malmendier & Tate, 2009) compared with low-profile

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2019 John Wiley & Sons Ltd 1171

1172 SABHERWALAND UDDIN

CEOs. Print and electronic media dedicate multiple issues to star CEOs, their success stories, and even their lifestyles.

While existing literature attempts to identify whether star CEOs create more value for their firms and consequently

for investors,no study has determined whether star CEOs offer superior information in trades that can be exploited by

investors to create value for themselves. Weattempt to do so by first arguing the opposite. Specifically, we first argue

that the trades of non-star CEOs are likely to have informational content, and then examine whether the empirical

evidence supports this argument.

Insider trading by a CEO may reflect his private information or his liquidity needs, or both. Therefore, not all CEO

trades are necessarily informed. Cohen et al. (2012) classify insider trades into two types: routine trades and oppor-

tunistic trades. Routine trades are usually motivated by liquidityneeds (when insiders sell shares to finance consump-

tion) or excessliquidity (when insiders receive a bonus and use it to buy shares), and opportunistic trades contain useful

private information. We predict that trades by star CEOs (CEOs receiving more public attention) are mostly routine

trades and therefore their tradesare not likely to be informative, in contrast to trades by non-star CEOs (CEOs receiv-

ing less public attention). Star or celebrity CEOs frequently appear in the media, are involved in more social activities,

and attract more attention from investors. Although both star and non-star CEOs possess useful private information

about their firms, star CEOs are less likely to exploit that information in their tradesdue to the greater scrutiny they

attract from the media and regulatory bodies. As a result, trades of star CEOs are less likely to be informative and to

have the power to predict future returns.

Non-star CEOs receive less coveragein the media, attract less attention from investors, and are under less scrutiny

by the regulatory bodies. Therefore, their trades are more likely to be opportunistic and to possess the power to pre-

dict returns. In addition, non-star CEOs usually do not receive a star premium in the form of extraordinarybonuses or

additional stock options. They thus are less likelyto purchase shares of their firms in a routine fashion.

Our investigation starts with the compilation of a sample of CEOs of S&P 1500 (including S&P 500, S&P MidCap

400, and S&P SmallCap 600) companies for the period 2004–2011. We classify these CEOs into two groups: stars and

non-stars. Weuse three different measures to identify star CEOs: an award-based measure, a web-based measure, and

a media-based measure. These measures identify star CEOs based on their award-winning,their Google search volume

index (SVI), and the quantity of media coveragethey receive in sources included in the Factiva database.

We employ panel regressions of future abnormal returns on indicators of star and non-star CEO trades. We find

that star buys and star sells are not good predictors of future abnormal returns and that non-star buys and non-star

sells are strong predictors of future abnormal returns. These findings support the argument that non-star CEO trades

possess useful information about firms’ future prospects. We also classify trades of both star and non-star CEOs as

either opportunistic or routine. Consistent with Cohen et al. (2012), most of the predictive power of non-star CEO

trades arises from opportunistic trades,not routine trades. Thus, while non-star CEOs execute both opportunistic and

routine trades, the opportunistic tradesare the ones that possess private information.

We also examine whether non-star CEO trades have future earnings-related information about firms. We run

regressions of future cumulative abnormal returns (CARs) over three- and five-day windows surrounding the first

two quarterly earnings announcements that take place after an insider trade on indicators of star versus non-star

CEO trades. Pre-earnings announcement trades of non-star CEOs predict CARs associated with quarterly earnings

announcements and trades of star CEOs do not. Furthermore, opportunistic insider purchases of a non-star CEO con-

tain information about the firm’s future earnings and routine purchases do not.

An alternative explanationfor the argument that star CEOs invite increased scrutiny is that star CEOs have inferior

information about their firms because stardom distracts them from managing the firm.1We investigate whether the

increased scrutiny or the inferior information argument explains our findings. We argue that because firms in highly

regulated industries face greater scrutiny by the Securities and Exchange Commission (SEC) and other regulators,

even the non-star CEOs of such firms are likely to be more cautious in their trading.Therefore, the increased scrutiny

argument suggests that the trades of both non-star and star CEOs are likely to be uninformative in highly regulated

1Wethank an anonymous reviewer for suggesting this alternative explanation.