Sunday, June 19, 2005
Academic Paper: Do Managers Detect Mispricing? Evidence from Insider Trading and Post-Earnings Announcement Drift
Abstract:
We find that insiders trade in a manner that indicates they are aware of post-earnings-announcement drift: they are more likely to buy (sell) after the announcement of good (bad) earnings news when the initial price reaction to such news is small in absolute magnitude. This result stands in contrast to the results of other researchers who, without controlling for the initial price reaction to earnings news, find that insiders tend to sell (buy) in response to good (bad) news. It also has important implications for corporate finance. By demonstrating that managers can spot mispricing when trading on their own account, it suggests that recent theories that assume managers are bad at judging the rationality of stock prices have limited applicability. It also supports theories that assert managers time new issues and repurchases to exploit mispricing. In addition, we find that insider purchases made after earnings announcements help the market more quickly incorporate positive earnings news into prices. Insider sales, however, do not appear to have this effect for negative earnings news. Further, neither insider purchases nor sales made after earnings announcements appear to get information about future earnings better reflected in stock prices.
We find that insiders trade in a manner that indicates they are aware of post-earnings-announcement drift: they are more likely to buy (sell) after the announcement of good (bad) earnings news when the initial price reaction to such news is small in absolute magnitude. This result stands in contrast to the results of other researchers who, without controlling for the initial price reaction to earnings news, find that insiders tend to sell (buy) in response to good (bad) news. It also has important implications for corporate finance. By demonstrating that managers can spot mispricing when trading on their own account, it suggests that recent theories that assume managers are bad at judging the rationality of stock prices have limited applicability. It also supports theories that assert managers time new issues and repurchases to exploit mispricing. In addition, we find that insider purchases made after earnings announcements help the market more quickly incorporate positive earnings news into prices. Insider sales, however, do not appear to have this effect for negative earnings news. Further, neither insider purchases nor sales made after earnings announcements appear to get information about future earnings better reflected in stock prices.
# posted by Stockcoach @ 3:13 PM 
