Buy or Sell: What Did the CEO Do?

It doesn’t always mean stock is going down when the CEO sells.

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 benchmark index.

"The Information Content of Realized Losses" appears in the July 2018 issue of The Review of Financial Studies.