Insider Investment Horizon

• Author: PAUL D. KOCH,CHAO JIANG,FERHAT AKBAS
• DOI: http://doi.org/10.1111/jofi.12878
• Published date: 01 June 2020
• Date: 01 June 2020

THE JOURNAL OF FINANCE •VOL. LXXV, NO. 3 •JUNE 2020

Insider Investment Horizon

FERHAT AKBAS, CHAO JIANG, and PAUL D. KOCH∗

ABSTRACT

We examine the relation between insiders’ investment horizon and the information

content of their trades with respect to future stock returns. We conjecture that an

insider’s investment horizon establishes a benchmark for expected patterns of contin-

ued trading behavior and thus helps identify unexpected insider trades, which should

be more informative in efficient markets. Consistent with this conjecture, the trades

of short-horizon insiders are both more unexpected and more informed, on average,

than those of long-horizon insiders. Short-horizon insiders and their firms also tend

to display characteristics that are associated with a greater focus on short-termism.

ALARGE LITERATURE EXPLORES HOW the investment horizon of certain groups

of investors, such as financial institutions, affects corporate policies and

stock prices.1One particular group of investors whose trades are under

scrutiny by regulators and other market participants is corporate insiders.

These individuals have privileged access to material private information and

can influence the firm’s policies, performance, and stock prices. Yet despite

their important role in financial markets, we know little about how insiders’

investment horizon affects the information content of their trades.

∗Farhat Akbas is with College of Business Administration, University of Illinois at Chicago.

Chao Jiang is with Darla Moore School of Business, University of South Carolina. Paul Koch is

with Ivy College of Business, Iowa State University. We acknowledge the helpful comments of

an anonymous referee; Christopher Anderson; Jim Barth; Henk Berkman; George Bittlingmayer;

James Brown; Yongqiang Chu; David Cicero; David Emanuel; Suzanna Emelio; Egemen Genc;

John Hackney; Jim Hilliard; Minjie Huang; Ozgur Ince; Namho Kang; Hugh Kim; David Lont;

Helen Lu; Dimitris Margaritis; Alastair Marsden; Felix Meschke; Stefan Nagel (the Editor); Scott

Schaput; Avanidhar Subrahmanyam; Eric Tan;Li Wang; Jide Wintoki; Jeffrey Wurgler; and semi-

nar participants at Auburn, Canterbury,Iowa State, Mississippi State, Ohio, Alabama, Alabama at

Birmingham, Auckland, Dayton, Kansas, New Hampshire, Otago, South Carolina, Wilfrid Laurier,

and the 2017 SFS Finance Cavalcade Conference. We also thank Minjie Huang for providing exec-

utive pay duration data and Rajendra Srivastava (SeekEdgar LLC) for support regarding the 10-K

data. None of the coauthors received any financial support for the particular research described

in this paper, and they have nothing further to disclose with regards to The Journal of Finance

Disclosure Policy.

Correspondence: Chao Jiang, Darla Moore School of Business, University of South Carolina, 1014

Greene Street, Columbia, SC 29208; telephone: (803) 777-6644; e-mail: chao.jiang@moore.sc.edu.

1For example, Yanand Zhang (2009) show that the well-known positive relation between insti-

tutional ownership and future stock returns is driven by asset managers with a short-investment

horizon (i.e., high portfolio turnover). See also Bushee (1998,2001), Cella, Ellul, and Giannetti

(2013), Chen, Harford, and Li (2007), Cremers and Pareek (2015), Derrien, Kecskes, and Thesmar

(2013), Gaspar, Massa, and Matos (2005), Gaspar et al. (2012), and Ke and Petroni (2004).

DOI: 10.1111/jofi.12878

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7/24/1998 12/6/1999 4/19/2001 9/1/2002 1/14/2004 5/28/2005 10/10/2006 2/22/2008 7/6/2009 11/18/2010

Trading Record of Mr. A

Stock Price Purchase Sale

Figure 1. Insider trading activity of an anonymous insider — Mr. A. (Color figure can be viewed

at wileyonlinelibrary.com)

This paper introduces the concept of an insider’s investment horizon

and examines its connection with the information content of insider trades

regarding future returns. We define an insider’s investment horizon as the

average annual net order flow in the insider’s own-company stock over the past

10 years. Specifically, annual net order flow is equal to inside shares purchased

minus shares sold, scaled by total shares traded. This measure ranges from

−1 for insiders who only engage in sells to +1 for insiders who only engage

in buys during a given year. A larger absolute value of net order flow (closer

to +1or−1) means that an insider is more persistent in either buying or

selling over time, which suggests less of an inclination to realize profits in a

timely fashion and thus a longer investment horizon. In contrast, net order

flow closer to 0 means that an insider switches between buying and selling

more frequently, which suggests the insider updates his or her position to

realize profits in a more timely manner and thus implies a shorter investment

horizon.

For example, William Clay Ford made multiple purchases of Ford stock

each year from 1988 to 2005, never selling a single share, while Bill Gates

made hundreds of sales and no purchases of Microsoft stock from 1996 to

2013. From their revealed insider trading patterns, we infer that both Mr.

Ford and Mr. Gates likely maintained a focus on long-term trading goals and

thus can be viewed as long-horizon (LH) insiders. In contrast, Figure 1,which

plots the insider trading activity of an anonymous insider in our sample who

switched between buying and selling his company’s shares frequently between

Insider Investment Horizon 1581

1998 and 2009, shows that this anonymous insider was more likely interested

in short-term objectives and therefore should be classified as a short-horizon

(SH) insider.

There are diverse theoretical incentives for insiders to trade, which could

lead to heterogeneity in both their investment horizons and the information

content of their trades. Similar to institutional investors, corporate insiders’

trading behavior and investment horizon may vary due to differences in in-

vestment style (e.g., a focus on short-term vs. long-term information), liquidity

needs, diversification motives, information access, concerns about restrictions

on insider trading, incentives to minimize taxable distributions or increase

corporate control, and various personal attributes, experiences, and behavioral

biases.

On the other hand, insiders are also subject to some trading incentives

that are not applicable to other groups of investors such as delegated asset

managers. For example, the trading behavior of insiders is likely to be

influenced by the horizon of their compensation contracts.2Many insiders

accumulate substantial shareholdings through their compensation package

or by founding the company and thus have strong incentives to repeatedly

sell shares in an ongoing effort to diversify or meet liquidity needs. Insiders

may also have incentives to use their privileged access to private information

to maximize trading profits by timing their purchases and sales (Cheng and

Lo (2006)). Finally, insider trading is subject to additional regulations, firm

level restrictions, and scrutiny. For example, the short swing rule prohibits

insiders from making profits through round-trip transactions within six

months and thus imposes a six-month lower bound on an insider’s investment

horizon.3

We conjecture that an insider’s investment horizon can shed light on the

information content of his or her own-firm trades by revealing the most

likely motivation(s) for the insider to trade and thus offering a benchmark for

establishing expected patterns of continued insider trading behavior. Consider

the trading motives for LH insiders like Bill Gates or William Clay Ford. These

insiders appear to focus more on long-term goals that are unlikely to change

in the short term. As a result, their persistent pattern of either buying or

selling leads to a stronger expectation for the next trade to continue the same

pattern. By continuing their persistent, expected pattern of either buying or

selling, the LH insider reveals that their motivation to trade has not changed

and hence is unlikely to be related to material information.

Next, consider the trading motives of SH insiders. These individuals appear

to focus more on dynamic short-term information flows that induce them to

2See Cadman and Sunder (2014), Gopalan et al. (2014), Cziraki and Groen-Xu (2017), Edmans,

Fang, and Lewellen (2017), and Gonzalez-Uribe and Groen-Xu (2017).

3See Huddart, Ke, and Shi (2007) and Jeng, Metrick, and Zeckhauser (2003). In addition,

corporate insiders must report changes in ownership to the SEC within two business days

(https://www.sec.gov/fast-answers/answersform345htm.html)and firms routinely impose their own

restrictions on insider trading activity (see, e.g., Bettis, Coles, and Lemmon (2000) and Jagolinzer,

Larcker, and Taylor(2011)).