Abstract
We examine whether managers’ trading decisions (both at a firm and personal level) are correlated with trading strategies suggested by the operating accruals and the post-earnings announcement drift (SUE) anomalies. We discuss advantages and disadvantages of the use of managerial trading activity to infer managers’ private valuation about their own securities. Our results provide corroborative evidence for the accruals anomaly, i.e., managers’ repurchase and insider trading behavior varies consistently with the information underlying the operating accruals trading strategy. On the other hand, we do not find corroborative evidence for the SUE anomaly.
Similar content being viewed by others
Notes
For example, suppose that a firm with very low accruals is identified by the accruals trading strategy as being undervalued and that executives of this firm use their inside knowledge of expected future cash flows to estimate the true equity value. If the executives believe the stock is undervalued, at the margin, they will buy shares on personal and firm accounts more heavily, thereby corroborating the accruals trading strategy.
All data items refer to the Compustat quarterly files.
As we discuss in more detail below, we measure the 6-month period to end 2 months after a quarter t. Accordingly, financial variables relevant to the repurchase decision are measured at quarter t−2, which ends 2 months prior to the computation of repurchase (and insider trading) data.
We delete firms in two-digit SIC codes that have an average of less than two observations per quarter.
Our inferences are unaffected if we do not control for lagged repurchases.
Specifically, for the five size quintiles (LOW to HIGH), the “no information” insider trading value is .60, .52, .45, .38 and .28, respectively.
Our choice to begin compounding 6-month returns 2 months after the quarter-end is consistent with that of Collins and Hribar, who compound starting 18 trading days after the earnings announcement. Our compounding strategy will start about 42 trading days after the quarter-end, where theirs will typically start roughly 48 trading days after the quarter-end (assuming that earnings announcements are usually made about 30 trading days after the quarter (Easton and Zmijewski, 1993)).
As discussed in Section 3.1, our repurchase measure is censored at −3.85% to avoid the influence of secondary equity issuances. We note however that we obtain similar results if we use an uncensored measure of repurchases or if we censor the value of repurchase to zero to retain only decreases in shares outstanding (i.e., net repurchases only).
If we censor negative values of repurchase to zero as an alternative computation of repurchases, then we find that cash is positively related to repurchase consistent with previous literature such as Dittmar (2000).
We use data from 1989 to 2001, so we have 52 overlapping 6-month periods (ending every fiscal quarter) for each firm.
Our inference is unaffected if we instead run separate regressions for each anomaly.
In unreported tests we change our PRE- and POST-intervals to match the fiscal quarter. Specifically, the PRE-period ends at the end of the fiscal quarter and the POST-period starts in the beginning of the following quarter. Using these alternate windows we find consistent results with the accruals anomaly for both share repurchases and insider trading in both periods. For the SUE anomaly, the results are similar to the ones presented in the paper and inconsistent with the mispricing explanation.
Firms without share repurchase programs may find it too costly to start a repurchase program simply to take advantage of transient mispricing. Therefore, we repeat our analysis using 43,391 firms with some history of repurchasing shares. For this reduced sample we find results very similar to those reported in the paper.
References
Ang, J. S., and Cheng, Y. (2003). Direct evidence on the market-driven acquisitions theory. Working paper, Florida State University
Baker, M., and Wurgler, J. (2002). Market timing and capital structure. Journal of Finance, 57(1), 1–32
Ball, R. (1992). The earnings–price anomaly. Journal of Accounting and Economics, 15, 319–345
Ball, R., & Bartov, E. (1996). How naive is the stock market’s use of earnings information? Journal of Accounting and Economics, 21, 319–337
Ball, R., & Brown, P. (1968). An empirical evaluation of accounting income numbers. Journal of Accounting Research, 6, 159–177
Beneish, M., & Vargus, M. (2002). Insider trading, earnings quality, and accruals mispricing. The Accounting Review, 77(4), 755–791
Bernard, V., & Thomas, J. (1989). Post-earnings-announcement drift: Delayed price response or risk premium? Journal of Accounting Research, 27, 1–48
Bernard, V., & Thomas, J. (1990). Evidence that stock prices do not fully reflect the implications of current earnings for future earnings. Journal of Accounting and Economics, 13, 305–340
Brav, A., Graham, J., Harvey, C., & Michaely, R. (2005). Payout policy in the 21st century. Journal of Financial Economics, 77(3), 483–527
Bushee, B., & Raedy, J. (2003). Factors affecting the implementability of stock market trading strategies. Working paper, University of Pennsylvania
Chan, K., Jegadeesh, N., & Lakonishok, J. (1996). Momentum strategies. Journal of Finance, 51, 1681–1713
Collins, D., & Hribar, P. (2000). Earnings-based and accrual-based market anomalies: One effect or two?. Journal of Accounting and Economics 29, 101–123
D’Mello, R., & Shroff, P. (2000). Equity undervaluation and decisions related to repurchase tender offers: An empirical investigation. Journal of Finance, 55(5), 2399–2424
Dittmar, A. (2000). Why do firms repurchase stock? Journal of Business, 73(3), 331–355
Dong, M., Hirshleifer, D., Richardson, S., & Teoh, S. (2006). Does investor misvaluation drive the takeover market? Journal of Finance, 61(2), 725–762
Easton, P., & Zmijewski, M. (1993). SEC form 10K/10Q reports and annual reports to shareholders: Reporting lag and squared market model prediction errors. Journal of Accounting Research, 31(1), 113–129
Fama, E. (1998). Market efficiency, long-term returns, and behavioral finance. Journal of Financial Economics, 49, 283–306
Foster, G., Olsen, C., & Shevlin, T. (1984). Earnings releases, anomalies and the behavior of security returns. The Accounting Review, 59, 574–603
Grullon, G., & Michaely, R. (2002). Dividends, share repurchases, and the substitution hypothesis. Journal of Finance, 57(4), 1649–1684
Ikenberry, D., Lakonishok, J., & Vermaelen, T. (1995). Market underreaction to open market share repurchases. Journal of Financial Economics, 39, 181–208
Ikenberry, D., Lakonishok, J., & Vermaelen, T. (2000). Stock repurchases in Canada: Performance and strategic trading. Journal of Finance, 55(5), 2373–2397
Jones C., & Litzenberger, R. (1970). Quarterly earnings reports and intermediate stock price trends. Journal of Finance, 25, 143–148
Kothari, S. P. (2001). Capital markets research in accounting. Journal of Accounting and Economics, 31,105–231
Lee, C. (2001). Market efficiency and accounting research: A discussion of ‘capital markets research in accounting’ by S. P. Kothari. Journal of Accounting and Economics, 31, 233–253
Pincus, M., Rajgopal, S., & Venkatachalam, M. (2003). The accrual anomaly: International evidence. Working paper, University of Iowa
Piotroski, J., & Roulstone, D. (2005). Do insider trades reflect superior knowledge about future cash flow realizations? Journal of Accounting and Economics, 39(1), 55–81
Polk, C., & Sapienza, P. (2004). The real effects of investor sentiment. Working paper, Northwestern University
Rhodes-Kropf, M., Robinson, D., & Viswanathan, S. (2003). Valuation waves and merger activity: The empirical evidence.’ Working paper, Columbia University
Richardson, S., Sloan, R., Soliman, M., & Tuna, I. (2005). Accrual reliability, earnings persistence and stock prices. Journal of Accounting and Economics, 39(3), 437–485
Richardson, S., & Sloan, R. (2003). External financing, capital investment and future stock returns. Working paper, University of Pennsylvania
Rogers, W. (1993). Regression standard errors in clustered samples. Stata technical bulletin reprints, (Volume 3, pp. 83–94). College Station, Texas: Stata Press
Rozeff, M., & Zaman, M. (1988). Market efficiency and insider trading: New evidence. Journal of Business, 61(1), 25–44
Rozeff, M., & Zaman, M. (1998). Overreaction and insider trading: Evidence from growth and value portfolios. Journal of Finance, 53(2), 701–716
Schwert, G. (2003). Anomalies and market efficiency, Chapter 15. In George Constantinides, Milton Harris, and René Stulz (Eds.) Handbook of the economics of finance (pp. 937–972). North-Holland
Seyhun, H. (1986). Insider profits, costs of trading, and market efficiency. Journal of Financial Economics, 16(6), 189–212
Seyhun, H. (1992). Why does aggregate insider trading predict future stock returns. The Quarterly Journal of Economics, 107(4), 1303–1331
Sloan, R. (1996). Do stock prices fully reflect information in accruals and cash flows about future earnings? The Accounting Review, 71, 289–316
Stephens, C., & Weisbach, M. (1998). Actual share reacquisitions in open market repurchase programs. Journal of Finance, 53, 313–334
White, H. (1980). A heteroskedasticity-consistent covariance matrix estimator and a direct test for heteroskedasticity. Econometrica, 48, 817–838
Acknowledgements
We appreciate the comments and suggestions of Peter Easton (editor), Joseph Gerakos, Theodore Goodman, Jeffrey Ng, Jonathan Rogers, Tjomme Rusticus, Sarah Zechman, two anonymous referees, and seminar participants at the University of Pennsylvania and 2004 European Accounting Association Meeting. We appreciate financial support from The Wharton School. Rodrigo Verdi is also grateful for financial support from the Deloitte and Touche Foundation.
Author information
Authors and Affiliations
Corresponding author
Rights and permissions
About this article
Cite this article
Core, J.E., Guay, W.R., Richardson, S.A. et al. Stock Market Anomalies: What Can We Learn from Repurchases and Insider Trading?. Rev Acc Stud 11, 49–70 (2006). https://doi.org/10.1007/s11142-006-6395-y
Issue Date:
DOI: https://doi.org/10.1007/s11142-006-6395-y