Do Proprietary Costs Deter Insider Trading?

Author:

Choi Lyungmae1ORCID,Faurel Lucile2ORCID,Hillegeist Stephen2ORCID

Affiliation:

1. The University of Sydney Business School, University of Sydney, Darlington, New South Wales 2006, Australia;

2. W.P. Carey School of Business, Arizona State University, Tempe, Arizona 85287

Abstract

Insider trading conveys insiders’ private information to outsiders. This private information potentially benefits rival firms, which may reduce the competitive advantage of the insiders’ firms. Using a composite proprietary cost measure, we find proprietary costs are negatively associated with insiders’ purchases, especially when their trades are more likely to be informative to rivals. Consistent with proprietary costs increasing the costs of insider purchases and, hence, the expected benefits required to trade, insiders earn significantly higher abnormal profits when proprietary costs are higher. Exploiting settings with exogenous and event-driven variation in proprietary costs, we find insiders significantly reduce their purchases when noncompete agreement enforceability is high and before new product launches. Moreover, firms with higher proprietary costs are more likely to impose window-based insider trading restrictions and insiders with greater equity holdings reduce their purchases more strongly in the presence of proprietary costs. Finally, we provide evidence of real effects of insider trading on rivals’ investment decisions. We find that investments are associated with insiders’ purchases at rival firms, and these associations are stronger when proprietary costs at rivals are higher. Our findings indicate insiders and firms are aware of potential proprietary costs when insiders trade on private information and respond accordingly. This paper was accepted by Suraj Srinivasan, accounting. Supplemental Material: The online appendices and data files are available at https://doi.org/10.1287/mnsc.2021.02469 .

Publisher

Institute for Operations Research and the Management Sciences (INFORMS)

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