Flying below the radar? Insider trading by executives below the top

To enforce insider trading laws, financial regulators require top executives to disclose their own-company trades. A consequence of this focus is that executives below the top fly under the radar. In the study ‘Flying below the radar: Insider trading by executives below the top’ we use register data from Norway to examine whether executives below the top in listed companies earn abnormal returns on purchases in own-company stock. Our study finds evidence of positive abnormal returns using several alternative benchmarks. The estimates are economically large: about 100 basis points per month.

A centerpiece of the regulation of insider trading in financial markets around the world is that primary insiders, that is top executives and board members of listed firms, are required to publicly disclose their trading activity. Mandatory disclosure appears to be largely effective in deterring primary insiders from trading on material information, as evidenced by a large body of literature that finds modest or zero abnormal returns on such trades (Ali and Hirshleifer, 2017). Little is known, however, about whether the threshold for being a primary insider is set right, or whether other company insiders that fly below the radar have access to and trade on material information.

We use administrative register data from Norway to provide the first evidence on the return on insider trading by executives below the top, who are not required to publicly announce their trades. We compare these returns to several benchmarks, including publicly announced insider trades and trades made by executives below the top in other company stocks, and find strong evidence of executives below the top making abnormally high returns.

For each stock transaction (buy or sell) made at the Oslo Stock Exchange between 1997 and 2014, we identify the employer of the investor and which position inside the firm that individual occupies. The positional codes are designed in a way that demarcates below-the-top executives as a separate category. We use announcements of trades by primary insiders (ie, top executives and board members) to Oslo Stock Exchange to create one of several benchmark portfolios.

Our main finding is that below-the-top executives make substantial abnormal returns on purchases in own-company stock. For example, using sales in the own-company stock for comparison, the return difference is close to 100 basis points at the 1-month horizon. Using other benchmark portfolios and adjusting for risk factors, the results are very similar. In contrast, we find no evidence of abnormal returns on publicly announced trades by primary insiders (ie, top executives and directors).

It is possible that executives below the top have special stock-picking abilities and thus make abnormal returns on all their stock investments. However, we show that executives below the top do not earn abnormal returns on purchases of other company stocks. For example, the raw returns for purchases of other company stocks at the 1-month horizon are 44 basis points lower than for sales of other company stock. The finding that executives below the top only earn abnormal returns when they trade own-company stock effectively rules out that executives have abilities that allow them to earn abnormal returns on all investments.

To accommodate the possibility of intrinsic ability in predicting the movements of own-company stocks (due to, eg, industry experience or educational background), we supplement our analysis by testing for abnormal returns in two subsamples. The first subsample consists of executives who join a listed company during our sample period. For this subsample, we find negative or small positive abnormal returns to trades in the company stock in the year before joining the firm, and positive abnormal returns in the year after they joined. The second subsample consists of employees that are promoted to executive below the top. For this subsample, we find evidence of abnormal returns after promotion. As these two tests compare returns on the same stock in an event-window around the change of employer and around promotions, we conclude that abnormal returns to insider trading by executives below the top cannot be explained by some time-invariant, individual-specific ability to predict the movements of that stock.

The finding of large positive abnormal returns to insider trading by executives below the top in Norway brings up the question of external validity. We believe our estimates likely reflect a lower bound of the extent to which executives below the top benefit from insider trading around the world. Norway in 1985 was among the first developed countries to introduce insider trading laws. Also, Norway consistently ranks high on transparency and governance indices: Norway ranks 8th out of 190 on the World Bank ease-of-doing-business index and ranks among the ten least-corrupt countries in the world, according to the Corruption Perception Index published by Transparency International. Moreover, Eckbo and Smith (1998) and Eckbo and Ødegaard (2020) study the returns on publicly reported insider trading on the Oslo Stock Exchange. Neither study finds evidence of abnormal returns for such trades.

For market participants and regulators around the world, regulation of insider trading is an important question. Regulators have a number of levers in place to detect and deter insider trading, the most important perhaps being the mandatory reporting of trades by primary insiders. Our study provides evidence of the frequency and the returns on insider trading by individuals who are ‘just’ below the threshold to be considered primary insiders. These results are informative for regulators, market participants and the debate about whether a wider group of company employees should be considered primary insiders.

Hans K. Hvide is a Professor of Economics and Finance at the University of Bergen.

Kasper Meisner Nielsen is a Professor of Finance at Copenhagen Business School and Research Fellow at the Danish Finance Institute (DFI).