Marc Goergen is a Professor of Finance at IE Business School, Luc Renneboog is a Professor of Corporate Finance at Tilburg University, and Yang Zhao is a Senior Lecturer in Financial Data Analysis at University of Liverpool. This post is based on their recent paper.
There is an extensive body of studies that documents that corporate insiders with access to insider information are able to earn abnormal returns by trading their firms’ shares. Insiders’ sales and purchases are considered by the market to be important signals about a firm’s prospects such that those trades are often followed by other market participants.
A less extensive literature has demonstrated that illegal insider trading, whereby insiders trade on price-sensitive information not yet disclosed to the market, can generate substantially higher abnormal returns. Still, regulation intends to create a level-playing field for all investors. This is why, prior to information releases by companies, there may be trading bans to prevent insiders from exploiting their informational advantage. For example, in the UK, there are trading bans – so-called “close periods” – in place during the 30 days before an earnings announcement.
Insiders violating insider trading regulations can face severe consequences. For instance, in 2016, two investment bankers were convicted of insider trading in the UK and sentenced to 3.5 and 4.5 years of imprisonment, respectively, along with the seizing of their assets (valued at £1.7 million), as part of Operation Tabernula led by the Financial Conduct Authority (FCA).
