Essays on Insider Trading and Financial Reporting Discretion

Abstract

This thesis presents three empirical studies investigating the capital market effects of the interplay between financial reporting discretion and insider trading. The empirical studies contribute to the emerging accounting literature which considers managers’ private signal conveyed by means of their trading on their own firm’s shares.

The first study examines whether the disclosure of directors trading improves market efficiency and contributes to the long standing controversy in the literature with regards to the informational efficiency of insider trading. The findings indicate that insider trading assist market participants to assess the implications of current for future earnings during an earnings announcement and consequently lead to more efficient prices. However, the information in insider trading subsumes the information in financial reporting discretion in this setting.

The second empirical chapter investigates the interplay between financial reporting discretion and insider trading focusing on the setting of acquisitions financed with equity whereby managers have incentives to manipulate earnings and the opportunity to conceal the consequences from doing so. In this particular setting, it is shown that a combination of financial reporting discretion aiming to inflate earnings and insider purchases denoting overconfident managers is associated with acquirers’ long term underperformance.

The third empirical chapter employs a setting characterised by an exogenous constraint over financial reporting discretion over the capitalisation of R&D expenditures. It is shown that constraining financial reporting discretion comes at the expense of a loss of information about future earnings. Moreover, constraining financial reporting discretion reduces also the usefulness of the insider purchases disclosure as a means for assessing the motivation for capitalisation.