Do corporate insiders trade on future stock price crash risk?
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Do corporate insiders trade on future stock price crash risk? Guanming He1 · Helen Mengbing Ren2 · Richard Taffler3
© The Author(s) 2020
Abstract We explore whether firm managers trade on future stock price crash risk. This depends on managers’ ability to assess future crash risk, and on whether the expected payoff is greater than the expected costs associated with potential reputation loss and litigation risk. We find that insider sales are positively associated with future crash risk, which is consistent with managers’ trading on crash risk for personal gain. We also find that managers take advantage of high information opacity to pursue crash-risk-based insider sales more aggressively, but are less able to capitalize on this in the case of financial constraints or post-SOX. Keywords Insider selling · Managerial opportunism · Financial constraints · Information asymmetry · SOX JEL Classification G14 · G30 · M41
1 Introduction The literature documents that managers tend to trade on the basis of their advance knowledge of corporate bad news at the expense of uninformed outside investors (e.g., Ke et al. 2003; Dechow et al. 2016). Insiders’ motivation for such information-based sales is to avoid personal losses associated with the announcement of negative firm news which is information previously unknown by outsiders. In contrast, our paper examines whether corporate insiders trade on future stock price crash risk, rather than on specific bad news events that insiders know about exactly via their private information. It cannot be taken for granted that managers can recognize future stock price crash risk as well, which requires their ability to extrapolate from their inside knowledge and information. Thus, ex ante, it is unclear if insiders are able to anticipate stock price crash risk. Furthermore, whether insiders will actually trade on future crash risk also depends on how they perceive the likelihood of whether the payoff from such strategic trading will be greater than the costs associated with potential reputation loss and threat of * Guanming He [email protected] 1
Durham University Business School, Durham University, Durham, UK
2
University of Liverpool Management School, University of Liverpool, Liverpool, UK
3
Warwick Business School, University of Warwick, Coventry, UK
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litigation. Such perceived benefits vis-à-vis costs, due to the unique nature of crash risk, are distinct from those from trading on corporate events, especially when looking at crash-riskbased insider sales made based on a relatively long horizon. For these reasons, whether insider sales are associated with future stock price crash risk is an important, open question worthy of exploring. Extant studies (e.g., Jin and Myers 2006; Hutton et al. 2009) attribute stock price crash risk to managerial hoarding of bad news. In particular, managers have incentives to hide bad news for career and short-term compensation reasons (Jin and Myers 2006; Kothari et al. 2009; Baginski et al. 2
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