To Trade or Not to Trade: The Strategic Trading of Insiders around News Announcements

In this paper we analyze the strategic trading of insiders and the way insiders use short-lived private information. We argue that the decisions to trade or not to trade on foreknowledge of corporate news in short windows directly preceding the news announcements is likely to result from a trade-off between the incentives to capitalize on foreknowledge of the information content of the disclosure and the disincentives created by risk of the regulatory scrutiny. Using a large sample of directors ’ trades and regulatory news announcements in U.K. companies, we analyze the relationship between the price impact of news announcements and the likelihood of insider trading before the announcement. We expect the strategic trading to be reflected in a non-linear relationship. The more relevant the information released to the market, the larger is the profit that an insider can make by trading on this information and hence the higher the propensity to trade. However, the jeopardy of a potential regulatory action against the insider is expected to be higher if the forthcoming news release is highly price-sensitive and consequently this may prevent insiders from trading before news with a larger price impact. We find the results consistent with the strategic trading hypothesis in a sample of bad news. We show that insiders ’ propensity to trade profitably before ba