When considering whether to buy stock in
a company, investors often look to the trading
activity of its top executives. If CEOs or
CFOs make large purchases of company
stock, investors tend to assume the stock
price is about to go up. But what does it
mean when executives sell?
A new paper by Peter Kelly, an assistant
professor of finance at the Mendoza College
of Business at the University of Notre
Dame in Indiana, looks at the predictive
power of corporate executives' trading
activities-the legal type of insider trading.
Generally, insider purchases have strong
return predictability, but insider sales do
not. That's because executives buy stock
because they expect it to rise, but they sell
stock for many reasons-to diversify their
portfolios or to get cash to finance a house.
Kelly found that when insiders sell
company stock for a loss, the stock's subsequent
six-month return is lower by lBB
basis points-the measure of a stock's percentage
change in value-than in all other
firm-months. When insiders sell their stock
for a gain, there is no return predictability.
Investors need a stronger negative signal
to sell at a loss than to sell at a gain, Kelly
explains. "Since selling a stock at a loss is
painful, an investor who sells at a loss must
have particularly negative information."
If managers purchase stocks recently
sold at a gain by company insiders and
sell stocks sold at a loss, Kelly says, they
would earn 67 basis points
per month higher than the
"The Information Content
of Realized Losses" appears
in the July 2018 issue of The
Review of Financial Studies.