Abstract

Co-written with Lyungmae Choi (City University of Hong Kong) and Lucile Faurel (Arizona State University).

Stock markets infer insiders’ private information from their trades as prices react to insider trade disclosures. In a similar fashion, we expect insider trading potentially reveals proprietary information to the firm’s rivals, which allows them to compete more effectively against the firm.

Using a variety of approaches to identify proprietary information risk, we find proprietary costs are negatively associated with insiders’ trading activities. The association is stronger when insider trading is more likely to be more informative to rivals; that is, when trades are made by top executives and before new product launches, when trades are made by insiders at low complexity firms, and at smaller firms.

We posit concerns about proprietary information risk increase the costs associated with insider trades, and hence, increase the required benefits before insiders are willing to trade. Consistent with this conjecture, we find that when insiders trade in the face of higher proprietary costs, they earn significantly higher profits. Examining the underlying mechanisms, we find firms with higher proprietary costs are more likely to impose and/or more strictly enforce existing insider trading restrictions, and insiders’ trading decisions are more sensitive to proprietary costs when they have higher ownership of the company.

Overall, our results indicate insiders and firms are aware of the potential proprietary costs that occur when they trade on private information, and they alter their trading activities accordingly.