Corporate insiders who trade stocks based on the information they gain on the job earn a lot more if they work at multinational corporations than their peers at U.S. companies with no sales abroad. That’s the main finding of our new peer-reviewed research.
Insider trading happens when a director or employee trades their company’s public stock or other security based on important or “material” information about that business. Insider trading isn’t illegal as long as the person reports the trade to the Securities and Exchange Commission and the information is already in the public domain.
We wanted to know if multinational insiders stand to make more money because of the complexity of the information they could possess relative to outsiders.
So we examined returns from over 2.5 million trades reported to the SEC from 1987 to 2019 by insiders at over 10,000 companies. This is only a subset of all insider trades reported during the period because we focused on only those transactions most likely to be informed by the employee’s insight. We then compared monthly returns for insiders at multinational and domestic companies with those for a typical investor.
We found that all insiders beat the market, but those at multinationals did better—especially if they were on the highest rungs of the corporate ladder. While insiders at domestic companies typically obtained a return of 2.4% in the month following a stock purchase, those at multinational corporations reaped 2.8%. That may not sound like a lot, but assuming consistent returns, it could amount to earning $170,000 more if an insider traded $1 million over several months. And it’s triple the typical stock market monthly gain of 0.9%
The most in-the-know insiders—executives and others with the most intimate knowledge of the company and its operations—at multinationals got an even bigger advantage, earning 3.6% per month vs. 2.7% at domestic companies.
Why it matters
Insider trading is familiar to most people from movies that portray it in criminal terms, such as Gordon Gekko of Wall Street. In the film, he makes millions off others’ inside information.
But even when it is legal, insider trading is very profitable. That’s because insiders trading on public information are more knowledgeable about their industry and process information more effectively than outside investors.
With global companies, the advantage of being an insider increases. Since multinational companies generate earnings in foreign countries, with different currencies, cultures, economies, and operating environments, it can be hard for an outsider or analyst to accurately value the company and its stock price. This is especially true when the company does business in regions that are culturally and linguistically distinct from the U.S. This helps insiders trade more efficiently, by buying underpriced stocks at a bargain and selling them later for a windfall.
Companies often motivate their employees to work harder by offering them a stake in their success, but if insiders seem to be getting an unfair advantage over ordinary investors, it may undermine trust in financial markets. The size and profitability of such trades—particularly in light of our data—mean regulators and policymakers may want to consider whether new restrictions on insider trading are needed, such as placing additional limits on the timing or frequency of trades.
What other research is being done
Scholars, including us, are pursuing many avenues of research on insider trading, such as how insider trading restrictions are determined and how insider trades inform markets when news is limited. We’ve recently conducted research on how insider trades by colleagues at the same company tend to cluster together, and we are currently looking at how innovation affects insider trading.
Another recently published project relates to how information is incorporated into stock market prices and how investors underreact to news that may affect insiders’ ability to trade profitably. Similarly, ongoing research uses a GPT language model to assess the complexity of business regulatory filings and financial statements by analyzing technical jargon that can confuse investors, which could also affect how outside investors understand stock prices compared with insiders.
The Research Brief is a short take about interesting academic work.
D. Brian Blank is assistant professor of finance, Mississippi State University and Dallin Alldredge is assistant professor of finance, Florida International University.
This article is republished from The Conversation under a Creative Commons license. Read the original article.
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FAQs
Yes. Insider trading can be considered legal if corporate insiders (such as directors, executives, and employees) trade company stock without exploiting confidential material information. To do so, corporate insiders must file certain regulatory reports to the SEC and receive approval.
Does insider trading beat the market? ›
Stock prices rise more after insiders' net purchases than after net sales. On the whole, insiders do earn profits from their legal trading activities, and their returns are greater than those of the overall market.
Can CEO do insider trading? ›
What Can Outsides Learn from Legal Insider Trading Activities of CEOs. But it's not always illegal for CEOs to buy or sell their company shares. In fact, founders and CEOs are often expected by investors to have skin in the game. An executive buying shares of his company is often seen as a positive sign.
Why is this type of insider trading considered unethical as well as illegal? ›
The main argument against insider trading is that it is unfair and discourages ordinary people from participating in markets, making it more difficult for companies to raise capital. Insider trading based on material nonpublic information is illegal.
How do you prove insider trading? ›
Prosecutors must prove that the defendant actually received information, that the information was both “material” and “nonpublic,” and that the information directly influenced the defendant's trade.
How long do you go to jail for insider trading? ›
If you are convicted in a criminal insider trading prosecution, you are subject to a maximum of $5 million in fines as an individual (up to $25 million for a business entity), up to 20 years imprisonment, or both fine and imprisonment.
What does Paul Pelosi invest in? ›
Reports suggest that Paul Pelosi's stock portfolio yielded a 65% return on investment in 2023, with investments in companies like Palo Alto Networks, Inc. (PANW) and NVIDIA Corporation (NVDA) contributing to his impressive gains.
How accurate is insider trading? ›
In general, very little market movement is observed when insiders trade and when they report their trades to the SEC. Insiders in aggregate are contrarian investors. However, they predict market movements better than simple contrarian strategies. Insiders also seem to be able to predict cross-sectional stock returns.
Why is insider trading unfair? ›
Insider trading, as opposed to other forms of informed trading, can harm the integrity of the markets and lead to serious legal implications for the individuals involved. It also victimizes everyday investors who don't have access to the same information as the insiders.
What is the 10 am rule in stock trading? ›
Some traders follow something called the "10 a.m. rule." The stock market opens for trading at 9:30 a.m., and the time between 9:30 a.m. and 10 a.m. often has significant trading volume. Traders that follow the 10 a.m. rule think a stock's price trajectory is relatively set for the day by the end of that half-hour.
For example, a lawyer working on a corporate merger who trades on the information can be charged with insider trading. Hedge Fund Insider Trading: Hedge fund managers who receive nonpublic information and trade on it without disclosing their actions can also be involved in illegal insider trading.
Who controls insider trading? ›
It is illegal to engage in insider trading, but it is legal to trade your company shares as long as you follow the guidelines set by the SEC. U.S. Securities and Exchange Commission. "Insider Trading."
What is manipulative trading? ›
Market manipulation is a deliberate attempt to interfere with the free and fair operation of a market, typically for personal gain. It can take many forms, such as spreading false or misleading information, manipulating prices or trading volumes, or using unfair or fraudulent tactics to manipulate market conditions.
How do people who insider trade get caught? ›
The Securities and Exchange Commission plays a pivotal role in detecting and prosecuting insider trading. The agency monitors trading activities and investigates unusual spikes in trading volume or price changes that precede significant corporate events, such as mergers or earnings reports.
What is the difference between legal and illegal insider trading? ›
Legal insider trading happens often, such as when a CEO buys back company shares, or when employees buy stock in the company where they work. Illegal use of non-public material information is generally used for profit.
What are the different types of insider trading? ›
Classic Insider Trading: Buying or selling assets based on important non-public information. Tipper-Tippee Trading: An insider gives others access to confidential information so they can trade using it. Trading During Blackout Periods: Insider trading during times when particular people are barred from trading.
What is the common law insider trading? ›
Insider trading is the trading of a company's securities by individuals with access to confidential or material non-public information about the company. Taking advantage of this privileged access is considered a breach of the individual's fiduciary duty.
Which of the following is illegal insider trading? ›
Answer. C. Illegal insider trading is correctly described by the buying or selling of stocks, bonds, or other investments on the basis of nonpublic information. Illegal insider trading is the buying or selling of stocks, bonds, or other investments based on nonpublic information.
