Stock trading by corporate insiders has long drawn interest because of its implications for corporate governance, market integrity, and regulatory oversight. However, the question of whether and how CEOs’ non-routine insider trading influences the trading behavior of other insiders remains ambiguous and underexplored. In a new paper, we address that question by investigating the relationship between CEO’s and non-CEOs’ opportunistic insider trades.
A CEO’s insider trading could influence other insiders’ trading activities in two opposite directions. On one hand, it might encourage similar trading by non-CEO insiders, implicitly endorsing that behavior and reducing its perceived risks and the ethical concerns of engaging in it. Moreover, given their access to proprietary information, CEOs often signal market expectations through insider trading, motivating other insiders to follow their lead for potential financial gains. On the other hand, a CEO’s insider trading could deter similar behavior by others. Increased scrutiny from regulators and internal compliance mechanisms, triggered by the CEO’s insider trading, may discourage non-CEO insiders from engaging in insider trading due to heightened risks and visibility.
We empirically assess these two possibilities to determine which prevails by analyzing a comprehensive sample of firms. Our findings reveal that the CEO’s opportunistic insider trading encourages non-CEO’s to also engage in insider trading. Specifically, when the CEO engaged in insider trading in the previous year, the likelihood of non-CEO insiders doing so increased by 1.8 percent in the following year.
To find out why, we explore two channels: boldness channel and incentive channel. Through the boldness channel, we find that a CEO’s insider trading erodes a firm’s corporate culture of integrity, fostering permissiveness and reducing psychological barriers to unethical behavior. This erosion lowers the psychological barriers for non-CEO insiders, which creates an environment where unethical behavior is implicitly tolerated and even encouraged. Through the incentive channel, we document that non-CEO insider trades become more informative and profitable when a CEO has also engaged in insider trading. Given their special access to high-quality private information, CEOs convey valuable market insights through their trades, giving others an incentive engage in similar, potentially lucrative trades.
To further understand the dynamics of this phenomenon, we conduct heterogeneity analyses and find that the effects of CEO insider trades on non-CEO insider trades are more pronounced at firms that have independent audit committees and gender-diverse boards and are audited by Big Four accounting firms. This suggests that non-CEO insiders are more likely to follow the CEO’s lead to engage in misconduct such as opportunistic insider trading when corporate governance is strong. In contrast, in firms with weaker governance, non-CEO insiders are more likely to engage in misconduct independently, without relying on the CEO’s example.
To address endogeneity concerns, we adopt an instrumental variable approach and two-stage least squares regression estimations. Our instrumental variable analysis employs two instruments that are closely correlated with the CEO’s opportunistic trading behavior but are unlikely to directly influence the actions of other insiders: CEO overconfidence and the average extent of CEO insider trading in other firms within the same industry and year. The first stage estimations show that both instruments are positively associated with the CEO’s opportunistic insider trading. The second stage estimations demonstrate that the CEO’s opportunistic insider trading encourages the subsequent opportunistic trading of non-CEO insiders, lending further support to our main findings.
Finally, we conduct robustness checks to validate our results. First, we adopt an alternative insider trading metric: insider trading frequency. Second, we focus solely on insider sales, rather than analyzing both purchases and sales. Third, we re-run our baseline regressions at the firm rather than individual level. Fourth, we include additional CEO fixed effects in our empirical analysis. Fifth, we replicate our main results with a subsample of firms by excluding firms in the finance and utilities sectors and those headquartered in Delaware. Sixth, we perform our baseline regressions with a subsample of periods, by excluding the financial crisis and pandemic periods. The results of all these robustness checks are consistent with those of our main analysis, further confirming our findings.
This post comes to us from Thomas J. Chemmanur and Cheng Jiang at Boston College’s Carroll School of Management, Lukai Yang at Texas A&M International University’s Sanchez School of Business, and Jingyu Zhang at Queen’s University’s Smith School of Business. It is based on their recent article, “The Fish Rots from the Head Down: CEO and Non-CEO Opportunistic Insider Trading,” available here.