Over the past few weeks I’ve spent some time digging into Insider Transactions and determining whether or not they are predictive of future returns.
I spent most of my time focusing on open-market purchases as this trade type represents a conscious decision on the Insider’s behalf to put more of their own money into their company’s stock.
Additionally, limiting the Insider transactions to C-Suite level insiders helps filter out noise. Finally, I limited my transactions to only those where the insider spent $100,000 or more on the transaction.
The resulting event study shows that there is some predictive power from corporate insiders. One feature I added to the analysis was the size of the trade relative to the Insider’s cumulative position. Trades where the insider doubled their position (or more) were far more informative of future Cumulative Average Abnormal Returns (CAARs) than trades that represented a small increase in the insider’s position.
To accomplish this analysis, I used FactSet Ownership: Float and Transaction Detail and People DataFeeds.
There’s been some really interesting research around the same topic. One of the papers I think would be a natural extension of this idea is Decoding Inside Information (Cohen et al., 2010) which offers a detailed look at the information signaled by Insiders buying and selling shares in their own company.
The paper does an excellent job showing how insider trades can be categorized in one of two ways. Trades are either routine or opportunistic. Routine trades are driven by a variety of motivations including liquidity, diversification, among others. The paper shows that these trades lack any signal the broader market can act on, and rarely lead to abnormal excess returns.
On the other hand, the opportunistic trades are shown to contain predictive information about the future direction of a company. Being able to identify and act on these informed trades gives an investor the chance to profit handsomely.
Cohen, Lauren and Malloy, Christopher J. and Pomorski, Lukasz, Decoding Inside Information (October 2010). NBER Working Paper No. w16454. Available at SSRN: https://ssrn.com/abstract=1692517