Corporate Governance and Insider Trading*

This paper examines the role of corporate governance in limiting insiders ’ ability to profit from their information advantage. Using the governance score compiled by Institutional Shareholder Services as a measure of the effectiveness of a firm’s governance, we find that compared to insiders of poorer-governed firms, those of better-governed firms earn significantly smaller abnormal profits from their sales trades, but not from their purchase trades. Among various governance attributes, board effectiveness and audit quality play the most important role in reducing the profitability of insider sales. We also find that these asymmetric effects of governance on the profitability of insider trading come from two possible channels: better monitoring and more effective compensation structure. Furthermore, good governance restricts insiders ’ use of private information, but not of public information, and the market interprets insider sales in better-governed firms as containing less private information than those in poorer-governed firms