In brief 

Many investors take an active interest in the buying and selling of shares by company directors. While insider share dealing is governed by very strict rules related to how and when trades can be made, some evidence suggests that following these transactions can be an effective way to produce abnormal returns. After all, those individuals on the inside theoretically have the best knowledge of the future prospects of the stock. 

Background 

Every day, financial media outlets such as the Financial Times, publish details of quoted-company directors that have been trading their own stock. Both UK Listing Rules and AIM Rules restrict directors and persons discharging managerial responsibilities (PDMRs) from dealing in ‘close periods’ and at other times when there is undisclosed price-sensitive inside information. This means that directors can’t trade their stock less than 60 days ahead of annual results and annual reports (unless the results are published sub-60 days after the year-end). Neither can they trade in the period between the end of the half-year and the publication of the interim results. While the precise details vary slightly between exchanges, directors are generally required to seek authority for their share dealing and disclose their activity. In turn, the company must promptly disclose director dealings to the market. 

Investment strategies 

Because of the amount of interest in director dealings there has been a considerable amount of research into whether insiders can themselves produce abnormal returns from trading and whether outsiders can benefit by mimicking those trades. Early research by Jaffe (1974) and Finnerty (1976) found that using director dealings as a signal produced abnormal returns to varying degrees in subsequent months. In 1985 Givoly and Palman reached a similar conclusion but argued that insiders could make these abnormal returns because their actions were copied by investors, which consequently moved the share price. Later work by Jeng, Metric and Zeckhauser (2002) looked specifically at the gains made by insiders and found that insider purchases earn abnormal returns of more than 6% per year, while insider sales do not earn significant abnormal returns. 

Despite evidence that insiders are capable of predicting abnormal returns, academic research into whether outsiders can take advantage of tracking director dealings presents a mixed picture. In one of the largest studies of the subject, Seyhun (1986) explored the implications of firm size and liquidity related to…

Unlock the rest of this Article in 15 seconds

or Unlock with your email

Already have an account?
Login here