The inside line on director trades

Summary: Crunching the data on insider trades – director purchases and sales – for the top 250 ASX-listed companies between 2002 and 2014.

Key take-out: Director trades in smaller listed companies are likely to slip under the radar screen moreso than trades in larger stocks.

If you’re hoping for a sign one way or another to capitalise on a director deed, this may be the missing piece of research in your repertoire.

Towards the end of last year, three researchers from University of Queensland, The University of Newcastle and the Queensland University of Technology asked the question whether or not stricter corporate governance constrains insider trading.

The topic of insider buying and selling is one that InvestSMART returns to on a fortnightly basis via the column Directors Deeds. Whether a chairman, non-executive director or CEO, these company insiders may have access to superior information when making buy and sell decisions.

Smaller investors sometimes hope to exploit this information asymmetry.

Insider sales may also raise questions of ethics. Insiders that trade securities during a blackout period, outside a trading window, or before a company releases sensitive information to the market, often attract attention from regulators.

Buying not selling

Crunching data from the top 250 companies in Australia from 2002 to 2014, the researchers used a complex methodology to decode corporate governance data. Companies were lumped into three groups, labelled as either highly restrictive, moderately restrictive or non-restrictive with respect to insider trading policies. It wasn't unusual for some of our top companies to move between the three over the years, from highly restrictive to moderately restrictive and ultimately back again.

And beyond that, there were other interesting findings. Among these, Australian companies were found to only embargo trading that negatively impacted shareholders.

The study authors couldn't determine that stricter corporate governance deterred all types of insider trading in the context of the ASX. These policies weren't putting a handbrake on purchases, but they were constraining sales to a degree. Insider sale activity reduces shareholder wealth, and it therefore attracts more attention than insider purchases.

The Australian way

Overall though, Allan Hodgson, Michael Seamer and Katherine Uylangco concluded that insider trading was less a 'thing' here in Australia. They drew on findings from two earlier studies in 2005 and 2013 where insider trading returns were found to be higher in countries with blanket country-wide governance. Conversely, internal corporate governance policies have been the default in Australia since the ASX introduced Listing Rule 12.9 on January 1, 2011. It goes with saying, firms with weaker corporate governance are more likely to experience fraud led by management.

The paper, published in the Accounting & Finance journal, referenced four earlier studies highlighting the merits of companies placing their own restraints on insider trading, including windows and periods, and the stipulation of seeking general counsel approval.

There is something else working in our favour in Australia too. When there is a separation between chairman and CEO, management is found to act less deceptively, so insider trading becomes less common. In the US, often the CEO will also be the company chairman.  

Personalities over policies 

Beyond that though, the findings confirmed what we believed to be true from the out-of-cycle transactions we sometimes observe when compiling Director Deeds. A company can place all the restrictions it likes on its people, but personalities will always overcome policies.

Hodgson, Seamer and Uylangco agreed with a central truth identified in a 2015 paper (The Impact of Personal Attributes on Corporate Insider Activity) that personality traits, and not regulation, were more likely to determine the degree of insider trading activity.

Unfortunately (for some) personality is largely fixed, according to behavioural economics, psychology and genetics literature. And, another unfortunate factor, this same 2015 paper deemed personality traits “unobservable to the econometrician”. The study was suitably vague, suggesting attributes as loose as the degree of attentiveness or financial sophistication, and could only conclude these attributes mattered more when profitable trading opportunities were restricted by regulations.

Bottom line

Stricter governance may deter insider trading, but it does not significantly translate into lower trading volumes, expenditure value or reduced profits from insider purchases, found the Australian researchers. 

For companies with non-restrictive share trading policies, the highest average value of a purchase is $2.355 million, followed by moderately restrictive share trading policies at $2.277m and highly restrictive share trading policies at $2.004m. 

That nugget isn’t of much use to the average investor. But something else might provide a hint to opportunistic investors.

As touched on above, size of a company, in relation to public information availability, is the most significant constraint of insider purchase profitability.

So, basically, a smaller company stands to gain more from insider trading because its movements don’t attract anywhere near as much attention from analysts and media. Out of sight, potentially outsized returns, perhaps? We will let you decide.