Insider Trading, Informativeness, and Price Efficiency Around the World

• Author: Qinghai Wang,Lilian Ng,Xiaoqiong Wang,Donghyun Kim
• Date: 01 December 2019
• DOI: http://doi.org/10.1111/ajfs.12278
• Published date: 01 December 2019

Insider Trading, Informativeness, and Price

Efficiency Around the World*

Donghyun Kim

School of Business Administration, Chung-Ang University, Republic of Korea

Lilian Ng

Schulich School of Business, York University, Canada

Qinghai Wang

College of Business Administration, University of Central Florida, United States

Xiaoqiong Wang**

School of Business, Indiana University Kokomo, United States

Received 26 July 2018; Accepted 23 September 2019

Abstract

This paper provides the first direct evidence of the impact of enforcing insider regulations on

the informativeness of insider trades and stock price efficiency across 44 countries with vary-

ing levels of insider trading regulations. Results suggest that insider purchases earn abnormal

profits, especially in countries with active enforcement of insider trading regulations. We fur-

ther show that while insiders trade less before earnings announcements in countries with

active enforcement, their stock prices react more to earnings news than those in countries

without active enforcement. Overall, our results support the view that effective insider trading

regulation promotes price efficiency.

Keywords Insider trading; Market efficiency; Regulation enforcement; Earnings announce-

ments

JEL Classification: G11, G23, G32

*We thank Kee-Hong Bae, Melanie Cao, Doug Cumming, Peter Cziraki, Yunsung Eom, Vid-

ham Goyal, Mark Kamstra, Ambrus Krecskes, Yelena Larkin, Editor Kwangwoo Park, Gordon

Roberts, Andreanne Simard, Hongping Tan, Daniel Tut, Yinggang Zhou, and seminar partici-

pants at the Chinese University of Hong Kong, University of Wisconsin-Milwaukee, and

Schulich School of Business at York University, the Asia-Pacific Financial Markets Confer-

ence, and Financial Management Association Meetings for many helpful comments and sug-

gestions.

**Corresponding author: School of Business, Indiana University Kokomo, United States. Tel:

+1-765-455-9470, Fax: +1-765-455-9348, email: xw55@iu.edu.

Asia-Pacific Journal of Financial Studies (2019) 48, 727–776 doi:10.1111/ajfs.12278

©2019 Korean Securities Association 727

1. Introduction

Whether or not insider trading should be regulated has been the subject of a long-s-

tanding debate among researchers and policymakers. Opponents of insider trading

regulation contend that allowing insiders to benefit from their information advan-

tage in trading promotes more informationally efficient financial markets (Manne ,

1966; Carlton and Fischel, 1983; Leland, 1992; George and Seyhun, 2002). Propo-

nents of insider trading regulation, however, argue that unrestricted insider trading

can adversely affect the incentives of outside investors to acquire and produce infor-

mation, hence making stock prices less informationally efficient (Fishman and Hag-

erty, 1992; Khanna et al., 1994). Bhattacharya and Daouk (2002) make the first

attempt to look at varying enactments and first-time prosecution of insider trading

laws across 103 countries. They find that only first-time legal prosecution of insider

trading laws can reduce a country’s cost of equity, thereby lending support to insi-

der trading regulation.

1

However, their study provides no direct evidence on the

informativeness of insider trades across different regulation regimes, the potential

tradeoff between the informational benefit of insider trading and the cost of

reduced information acquisition, and the overall impact of insider trading regula-

tion on price efficiency. Thus, the purpose of our study is to address all these

important issues and provide evidence that helps settle the debate.

Our research represents the first to directly evaluate and compare the informa-

tion contents of insider trading activities across different regulation and enforce-

ment regimes. We exploit a newly available global dataset that contains information

of global insider transactions of senior corporate executives and corporate directors

from 44 countries over the period of 2007 to 2013. By examining insider trading

activities in this large number of countries with varying levels of insider trading

enforcement, we seek to provide the first comprehensive evidence on insider trading

activities and their informativeness across different markets, to understand the role

of insider trading regulation in determining insider trade informativeness, and to

assess the relation between insider trading regulation and stock price efficiency.

We start by examining insider trading activities and their informativeness across

different insider trading regulation regimes. All 44 countries in our sample have

insider trading laws, but enforcement of insider trading laws varies widely across

these countries. To measure the extent to which a country enforces its insider trad-

ing regulation consistently and rigorously, we construct an “Active Enforcement"

variable that is based on the prosecution of insider trading in a country during the

sample period of 2007–2013.

2

Active Enforcement is a binary variable that equals

1

Our unreported results show that first-time prosecution has no effect on the informativeness

of insider trading.

2

We have also constructed the same variable using information 5 years prior to 2007. Both

measures yield qualitatively similar results. Given varying start years of the availability of insi-

der transactions for the sample of countries, we choose to report the results based on the

construct for the sample period.

D. Kim et al.

728 ©2019 Korean Securities Association

one if the country is actively enforcing its insider trading regulation in that it has at

least one insider trading prosecution case during the sample period; otherwise, it is

zero. We measure the informativeness of insider trades based on abnormal stock

returns subsequent to insider transactions. For each country, we compute the aver-

age cumulative returns of stocks traded by insiders for buys and sells, separately, in

excess of the country index return for varying periods of 5–120 days following the

day of insider trades.

Several results emerge from the comparison of the large number of insider

trades across the countries. First, corporate insiders trade actively, and their trades,

particularly their buy transactions, are informative, and the effect is more pro-

nounced in countries with active enforcement of insider trading regulations than in

countries without.

3

Abnormal returns associated with insider buy transactions over

the different periods from 5 to 120 days subsequent to insider transaction dates are

positive and highly significant, while those associated with sell transactions show no

robust evidence. Furthermore, insider trading informativeness is related to various

country-level economic and legal characteristics, but the legal characteristic variables

such as the rule of law, the general effectiveness of law enforcement, investor pro-

tection, and the quality of government do not substitute for the effects of enforce-

ment of insider trading regulation. Second, insider trading regulations do not seem

to affect the level of insider trading activities. The results show no significant differ-

ence in overall insider trading activities (scaled by a country’s stock marke t capital-

ization) between countries with and without active enforcement of insider trading

regulations.

Why does active insider trading regulation result in more, not less, informative

insider trades? How does insider trading regulation affect stock price efficiency? To

answer these questions, we examine insider trading activities around an important

corporate event –corporate earnings announcements –and also investigate the rela-

tion between insider trading regulation, insider trading activity, and market reaction

to earnings news. In countries with active enforcement of insider trading regula-

tions, insiders trade less actively before corporate earnings announcements, but

market reactions to earnings news are stronger. These findings suggest that active

enforcement of insider trading regulation deters insiders from exploiting non -public

and material corporate information in their stock trading, but seems to facilitate

market efficiency. Furthermore, insiders trade actively before earnings announce-

ments in countries without active enforcement of insider trading but with lockout

period requirements, implying that active enforcement of insider trading reg ulation,

not insider trading regulation itself, determines insider trading activity around earn-

ings announcements. All these results are robust after controlling for various coun-

try, market, and institutional characteristics.

3

U.S. studies such as Ravina and Sapienza (2010) and Cohen et al. (2012) also find that

insiders still have the ability to trade on private information, in spite of the U.S.’s rigorous

enforcement of insider trading regulations.

Insider Trading and Price Efficiency

©2019 Korean Securities Association 729