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Posted 2/10/98
CLEVELAND -- Knowledge of insider trading activity provides investors with more potential for gain at small companies than at large ones, according to a recent study.
The study's authors, Inmoo Lee and Josef Lakonishok, state that insider trading "is a potentially strong indicator for small stocks." This is because stocks of larger companies, defined as those with market capitalizations over $300 million, usually reflect the company's value more accurately than do stocks of smaller companies.
Lee is assistant professor of banking and finance at the Weatherhead School of Management at Case Western Reserve University, while Lakonishok is William Karnes Professor of Finance at the College of Commerce and Business Administration of the University of Illinois at Urbana-Champaign. Their results are contained in a working paper, "Are Insiders' Trades Informative?", which they plan to submit to professional journals.
Lakonishok and Lee studied insider trading activity of all stocks listed on the New York, American, and NASDAQ exchanges in the 1975-95 period. They found that companies with extensive insider purchases over any six-month period had a return of about 22 percent the following year, compared with a return of 14 percent for companies with extensive insider sales. However, Lee and Lakonishok note that insider trading is a stronger indicator of the future performance of small stocks than large ones.
The authors also conclude that despite extensive media reporting on insider trading, such activity rarely results in major stock price changes immediately following such trading. However, overall insider activity seems to predict market movements. When insiders are optimistic, they say, stocks on average do well, and when they are pessimistic, markets usually perform poorly afterward.
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