Do Proprietary Costs Deter Insider Trading?
2019-05-20 09:19:25
by Lyungmae Choi, City University of Hong Kong

Wednesday, April 24, 2019 | 2:00pm-3:30pm | Room 335, HSBC Business School Building


Stock markets infer insiders’ private information from their trades as prices react to insider trade disclosures. In a similar fashion, we expect insider trading potentially reveals proprietary information to the firm’s rivals, which allows them to compete more effectively against the firm. Using a variety of approaches to identify proprietary information risk and focusing on insider purchases, we find proprietary costs are negatively associated with insiders’ trading activities. The association is stronger when insider trading is more likely to be informative to rivals; that is, when trades are made before new product launches, by top executives, and by insiders at low complexity firms. We posit concerns about proprietary information risk increase the costs associated with insider trades, and hence, increases the required benefits before insiders are willing to trade. Consistent with this conjecture, we find that when insiders trade despite higher proprietary costs, they earn significantly higher abnormal profits. Examining the underlying mechanisms, we find firms with higher proprietary costs are more likely to impose and/or more strictly enforce existing insider trading restrictions, and insiders’ trading decisions are more sensitive to proprietary costs when they have higher ownership of the company. Overall, our results indicate insiders and firms are aware of the potential proprietary costs that occur when insiders trade on private information, and they alter their trading activities accordingly.