Some Insider Sales Are Positive Signals

Not all insider sales are the same. In the study reported here, a variable for shares traded as a percentage of insiders' holdings was used to separate information-driven sales from sales driven by liquidity or risk-reduction needs. In the insider trades from 1987 through 2002, only large sales that also accounted for large percentages of insiders' holdings predicted significantly negative future abnormal returns. Small sales that accounted for small percentages of shares owned not only did not predict poor performance but were correlated with significantly positive abnormal returns. The percentage of shares owned by insiders is also useful for predicting future returns following insider purchases. Most previous studies of insider trading have found that, although insider purchases are typically associated with positive future abnormal returns, insider sales tend to predict small, sometimes insignificant, negative abnormal returns. This asymmetry between the effects of insider purchases and sales may reflect differences in these transactions’ information content. When insiders purchase shares of their companies, the primary reason is to make money (i.e., they think the stock is undervalued). When insiders sell, however, the motivation may be either a perception that the stock is overvalued or simply a need for liquidity or portfolio diversification. The need-based insider sale does not contain negative information and, if all insider sales are considered together, reduces the strength of the signal about perceived valuation.We used information on insiders’ share holdings as well as their trades to measure the information content of insider sales. Specifically, we calculated the shares traded as a percentage of shares owned and used the ratio to separate informational sales from noninformational sales. We hypothesized that if insiders sell shares because they have a negative view about the company’s outlook, they will probably sell a larger percentage of their holdings than if they are selling only for liquidity or diversification. Thus, we hypothesized that insider sales that represented large percentages of shares owned should be associated with more negative future returns.The empirical results support this hypothesis. Using insider transaction data from 1987 through 2002, we found shares sold as a percentage of shares owned to be significantly correlated with future returns. Only insider sales of a large volume that also accounted for a large percentage of insider holdings predicted significantly negative future abnormal returns. Small sales that represented small percentages of shares owned not only did not predict poor performance but were correlated with significantly positive abnormal returns. Although this outcome may be specific to the time interval we studied (a period when option and stock compensation became common), we believe that comparing shares traded with shares held is useful for differentiating the signal of insider sales. We found that percentage of shares owned is also useful for predicting future returns following insider purchases. We found that insider purchases that were small relative to shares already owned predicted lower positive future returns than purchases that were large relative to shares already owned.