Do Proprietary Costs Deter Insider Trading?

Abstract

Insider trading conveys insiders’ private information to outsiders. A potential cost of insider trading relates to its potential benefit to rival firms, which may reduce the competitive advantage of the insiders’ firms. Following a variety of approaches to identify proprietary information risk, we find proprietary costs are negatively associated with insiders’ purchases, especially when insider trades are more likely to be informative to rivals. Consistent with proprietary information risk increasing the costs of insider purchases and, hence, the required benefits to trade, we find insiders earn significantly higher abnormal profits when proprietary costs are higher. In additional analyses, we find insiders significantly reduce their purchases prior to new product launches as well as following large reductions in import tariff rates, when stiffer competition increases proprietary costs. Finally, we find firms with higher proprietary costs are more likely to impose insider trading restrictions, and insiders’ purchase decisions are more sensitive to proprietary costs when they have higher firm ownership. Our findings indicate insiders and firms are aware of potential proprietary costs when insiders trade on private information, and insiders alter their purchase activities accordingly.