Directors’ trades in UK rights issues: do firms sell overvalued new equity?

Abstract

PurposeThis paper aims to examine the behavioral timing hypothesis in the context of UK rights issues by seeking to establish and investigate inter-relationships between directors’ trading around rights issues as a proxy for stock mis-valuation and post-issue stock price performance.Design/methodology/approachThe cumulative average abnormal returns, the buy and hold abnormal returns, the standardized residual cross-sectionalt-test and the generalized sign test techniques.FindingsThe directors do possess short-term timing ability as they can identify profitable trading situations by buying more often before stock outperformance and by selling more often before stock underperformance. In addition, directors trading prior to the rights offering is found to exert an influence on the long-run abnormal returns of the rights-issuing firm, which supports the story that mis-valuation and behavioral timing are empirical.Research limitations/implicationsOther types of seasoned equity offerings rather than rights issues should be included.Practical implicationsThe research provides a direct testing for the strong form of market efficiency hypothesis, which enables policymakers to take into account market reaction to directors’ trades and how it is affected by corporate events (e.g. rights issues) when addressing insider trading regulations.Originality/valueThis study extends available literature in the context of both developed and emerging equity markets to testing the behavioral timing hypothesis by testing the inter-relationships between directors’ trading around rights issues and post-issue short- and long-run performance. To the best of the author’s knowledge, this is the first study that examines these inter-relationships in the UK context.