Empirical evidence shows that investors respond to corporate insiders’ open market purchases by increasing the company’s stock price, reflecting that insiders possess private information indicating that the firm is undervalued. Consistent with that evidence, in a new paper we find that the market reaction to insider purchases over a 5-day window starting at the Form 4 filing is significantly positive and approximately 2%. Moreover, prior studies find that when investors have far less information than corporate insiders do, their market reaction to insider purchases is even more positive as it resolves investors’ uncertainty.
In the period after acquisitions, investors face high uncertainty about how the integration of the target into the acquirer is progressing and whether the acquirer is realizing synergies. This creates information asymmetry because insiders know more about how the integration is going. Therefore, on the one hand, investors can potentially put greater value on insider purchases in post-acquisition periods, interpreting them as a signal that the integration is going better than expected.
On the other hand, insiders face strong incentives for the acquisition not to be perceived as a failure, and prior research suggests that insiders are more likely to be overconfident when making acquisitions. These factors may make investors perceive post-acquisition insider purchases as a less credible signal that the integration is going better than expected. Therefore, investors face mixed signals about how to interpret the information from insider purchases after acquisitions.
If investors view insider purchases in the post-acquisition period as a more informative signal compared with non-acquisition periods, then we expect a more positive market reaction. But if investors view post-acquisition insider purchases as a less credible signal, then we expect a weaker market reaction.
In our paper, we find that insider purchases become less credible signals of favorable private information after acquisitions. Using more than 97,000 insider-purchase filings by executives and directors between 2003 and 2022, we empirically show that the market reaction to post-acquisition insider purchases is less than in non-acquisition periods. Specifically, the market reaction is 23% less relative to the average market reaction to insider purchases. Moreover, we find that the average 60-day abnormal stock return for post-acquisition insider purchases is 0.3% and is not significantly different from zero, compared with non-acquisition insider purchases, where the average 60-day abnormal stock return is 3.4%. We also find the market reaction to insider sales is significantly more negative in the post-acquisition period than in non-acquisition periods, consistent with investors having a dim view of insiders selling shares after an important transaction where they are expected to be overconfident.
Acquisitions are major corporate events, and insiders may have substantial personal stakes in their outcomes. Negative outcomes can reduce managers’ wealth or threaten future employment opportunities. Thus, insiders have incentives to use insider purchases to persuade market participants that an acquisition will have positive outcomes. In other words, if the acquirer overpaid for the target based on inaccurate or overoptimistic expectations, then insiders have an incentive to send favorable signals.
Consistent with this argument, we find that, the more likely a company has overpaid for an acquisition, the more likely its insiders will purchase its stock. For example, insiders are more likely to purchase when the acquirer’s announcement return is negative, more goodwill is acquired, stock consideration is used to buy public targets (empirically, the most value-decreasing acquisitions), and before goodwill impairments are reported. The mean long-run abnormal stock returns for acquisitions without insider purchases is 3.6%, while it is -6.3% for acquisitions with insider purchases.
The evidence suggests that, rather than trying to profit from private information, insiders make post-acquisition purchases to guide the market at their own cost. Based on the average insider purchase size of $302,000, our results imply that insiders earn $6,464 less in abnormal returns from post-acquisition insider purchases.
Finally, we examine how the signal from post-acquisition insider purchases affects investors’ assessment of post-acquisition management guidance. Management guidance of future performance is another important source of information about post-acquisition performance. When investors have an additional signal from insider purchases after good news from management guidance, they can interpret the signal as a confirmation that the good news is credible. Similarly, investors can interpret insider purchases after bad news in management guidance as a contradicting signal that the bad news is not as bad as expected.
We find a completely different impact of insider purchases in the post-acquisition period. After acquisitions, we find that investors appear to discount the earlier favorable news from managerial guidance when followed by subsequent insider purchases. Similarly, the market reaction to insider purchases after management guidance containing bad news is consistent with investors perceiving the bad news as worse than expected.
Overall, our findings suggest that the informational value of insider purchases does not always increase with higher information demand from investors. This finding does not mean that insider purchases are uninformative. Rather, our study suggests that the credibility of insider purchases depends on the settings in which the insider is making the decision. Investors appear to take this factor into account when interpreting insider purchases.
More broadly, our findings highlight an important limitation of viewing insider purchases simply as a useful source of insiders’ private information. The same insider purchase can mean different things depending on the circumstances. In the post-acquisition setting, where managers have both substantial private information about the acquisition and strong incentives to shape market expectations, investors appear to recognize that an insider purchase may reflect not only what insiders know, but also why they want the market to believe it.
Todd D. Kravet is an associate professor, and Minah Lee is a PhD student, at the University of Connecticut. This post is based on their recent paper, “When are Insider Purchases Credible Signals of Private Information? Evidence from Acquisitions,” available here.