Why does shareholder protection matter for abnormal returns after reported insider purchases and sales?

• Published in: Journal of banking & finance Vol. 37; no. 6; pp. 1915 - 1935
• Main Authors: Fidrmuc, Jana P., Korczak, Adriana, Korczak, Piotr
• Format: Journal Article
• Language: English
• Published: Amsterdam Elsevier B.V 01.06.2013; Elsevier Sequoia S.A
• Subjects: Abnormal returns; Economic rent; Economic theory; Hypotheses; Information content; Insider dealing; Insider trading; Rent extraction; Sales management; Shareholder protection; Stock prices; Stockholders; Studies; Transaction costs; U.S.A; Western Europe; United States > US; Europe; Information content; Rent extraction; Insider trading; G34; G14; Shareholder protection
• ISSN: 0378-4266; 1872-6372
• DOI: 10.1016/j.jbankfin.2012.06.019

► We analyze the effect of shareholder protection on CARs after insider trades. ► We cover reported insider transactions across 15 European countries and the US. ► Higher ASD index is associated with higher abnormal returns for purchases and sales. ► For purchases, CARs are higher when insider’s actions are more trustworthy. ► For sales, selling for liquidity reasons is trusted more in high ASD countries. We use a unique data set of more than 240,000 reported insider transactions across 15 European countries and the USA to analyze the link between country-level shareholder protection and abnormal returns following insider trades. We show that abnormal returns after insider transactions are positively correlated with country-level shareholder protection against expropriation by corporate insiders, which supports the information-content hypothesis. Market reaction to insider purchases increases with shareholder protection because shareholder protection enhances the transparency and trustworthiness of insiders’ actions, and limits possibilities for direct profit diversion, so that more information is eventually reflected in stock prices. For insider sales, shareholder protection decreases their negative information content. We conjecture that this is due to the effect of greater transparency and trustworthiness strengthening the diversification and liquidity reasons for selling in better shareholder protection countries. We find limited support for the rent-extraction hypothesis that conjectures that shareholder protection is associated with insider trading dollar profits.