The trading activity of corporate insiders has attracted the attention of financial economists for more than 30 years. Most of the research devoted to the issue (e.g. the classical papers by Jaffee 1974, Finnerty 1976, Seyhun 1986 and Lakonishok and Lee 2001) has been motivated by the efficient markets paradigm. Analyzing the profitability of insider trades allows a test for strong form efficiency. By considering the profitability of mimicking strategies (i.e., trading strategies that buy [sell] shares after publication of the fact that insiders bought [sold]), a test for semi-strong form efficiency can be performed. The by-now common methodology is an event study in which the day on which insider trading occurred, or the day on which the insider trade was announced, are the events under scrutiny.
The determinants of insider trading profits have also been an important subject of investigation. Researchers have related measures of profitability to variables that measure the intensity of insider trading, the position of the insider within the firm, firm size, and the size of the bid-ask spread. Recent studies (most notably Fidrmuc et al. 2006) have broadened the scope of analysis by considering variables related to corporate governance and other appropriate firm-specific factors. Investigating this relationship is important, because it allows conclusions to be drawn about both the degree and the determinants of informational asymmetries between corporate insiders and the capital market.
The present paper extends this line of research. Its contribution is twofold. Most importantly, we analyze whether a blackout period that prevents insiders from trading prior to specified corporate events, as is implemented in the UK, is warranted. In addition, we provide evidence from Germany, and thus from a bank-dominated financial system. This is in contrast to the vast majority of previous papers, which used data from either the US or the UK.1 In the UK, the LSE Model Code prevents corporate insiders from trading during a blackout period, which consists of the two months preceding final or interim earnings announcements and the month prior to quarterly earnings announcements. This rule imposes severe restrictions on the trading activity of corporate insiders, because it prohibits trading for six months of the year. It is thus an important question whether these trading restrictions are warranted. The rule is obviously based on the assumption that informational asymmetries are particularly large prior to earnings announcements.2 In Germany, no blackout period exists. We make use of this institutional difference by testing whether trades by corporate insiders prior to earnings announcements convey more information than trades at other times. The results of this test allow conclusions to be drawn as to whether or not a blackout period is warranted; hence, they have potentially important implications for policy.
The German financial system is characterized by a strong role for banks, a two-tier board structure (an executive board and a supervisory board, with the latter consisting partially of employee representatives, in accordance with codetermination laws), and a low degree of protection for minority shareholders.3 German standards for financial reporting are often considered to be intransparent.
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Insider Trading and Corporate Governance: The Case of Germany
