Insider Trading and the Efficient Pricing of Loss Firms

Lyungmae Choi
Lucile Faurel
Stephen A. Hillegeist
(Preliminary and incomplete)
Abstract: Prior research suggests that investors find it especially difficult to value firms when
they are experiencing losses and inefficiently incorporate information related to the persistence
of losses into prices. Prior research shows that insider trading provides useful signals to the
market. Accordingly, we first investigate the incidence and profitability of insider purchases at
loss firms. We find that insiders at loss firms engage in relatively more net buying compared to
insiders at profit firms. Furthermore, these trades tend to generate large positive abnormal returns
(range) from the time of their trades through the loss reversal earnings announcement. Returns
are substantially higher at R&D intensive firms and Persistent Loss firms. We next examine
whether the market reactions to insider trading disclosures are consistent with their being
especially informative signals. The magnitudes of the average positive returns following insider
trading disclosures suggest that investors at least partially recognize their differential information
content depending on the type of loss firm the insider is at. Finally, we examine whether insider
trading at loss firms is associated with less mispricing of loss firms following negative earnings
announcements. Our results suggest that more intensive insider buying at loss firms is associated
with less negative returns during the earning announcement period and during the two
subsequent quarters. These results suggest that insider trading is positively associated with the
efficient pricing of loss firms.

W.P. Carey School of Business, Arizona State University

The Paul Merage School of Business, University of California Irvine

1. Introduction
This study examines whether trading by insiders at loss firms is associated with the stock
price efficiency. Prior literature provides evidence that loss firms are priced less efficiently
compared to profit firms. This inefficiency is attributed to investors inability to accurately assess
how likely losses will persist (Balakrishnan et al. (2010) , Dhaliwal et al. (2013), Li (2011)). As a
result, loss firms experience significant negative abnormal returns following negative earnings
announcements. This question is of interest because the incidence of losses reported by firms has
increased over time. More than 40 percent of the firms in Compustat database reported losses in
recent years (Hayn (1995), Joos and Plesko (2005)). Given the difficulty investors face when
pricing loss firms, insiders likely possess relatively large amounts of private information
compared to insiders at profit firms. Accordingly, more intense trading by insiders may their
private information to be more quickly and efficiently impounded into prices.
In this paper, we study insiders trading behavior at loss firms and its association with the
price efficiency of loss firms. Prior research consistently finds that insider trades, especially
purchases, earn positive abnormal profits. These results are consistent with insiders trading on
the basis of their private information. In addition, prior research finds that insider trades are more
profitable when information asymmetry between insiders and outside investors is expected to be
higher. In this paper, we examine cross-sectional differences across various partitions of the
sample based on two information asymmetry proxies: the intensity of research and development
(R&D) expenditures and the expected persistence of losses.
We focus on insiders net buying behavior during the periods leading up to the break in a
loss string. We first establish that breaks are important information events as they are associated
with economically and statistically significant abnormal returns. Thus, if insiders have private

information about an upcoming loss string break, it is reasonable that they have strong incentives
to trade based on that private information.
For the full sample, we find evidence that insiders at loss firms engage in significantly
more net buying compared to insiders at profit firms for up to 10 quarters prior to the break
quarter.1 In addition, we find considerable cross-sectional variation based on our information
asymmetry proxies in terms of which types of firms do insiders exhibit additional net buying
ahead of breaks. We find the increases in net buying are concentrated in High R&D firms; No
R&D firms exhibit only limited increases in net buying before the break quarter. We also find
that while insiders at Persistent Loss firms decrease their net buying somewhat before the break,
insiders at Transitory Loss firms significantly increase their net buying during at least 10 quarters
prior to the break.
We then analyze to what extent insider purchases at loss firms appear to be motivated by
private information by examining their profitability. We assume that insiders hold their
purchases until just after the announcement of the break earnings, or for a minimum of 120
trading days.2 For the full sample, the results indicate that insiders earn economically large
profits from their trades when they are made up to eight quarters before the break quarter. There
is also considerable cross-sectional variation in insider purchase profitability. Trades made by
insiders at High R&D firms and Persistent Loss firms are generally the most profitable.
Abnormal returns peak at 53.8% for purchases made three quarters before the break quarter at
High R&D firms and at 54.9% for purchases made five to six quarters before the break quarter at

We define the break quarter as the first quarter with positive profits following a string of one or more quarterly
losses.
2
120 trading days corresponds to the minimum holding period required for insiders to avoid roundtrip trading
restrictions imposed by the SEC.

Persistent Loss firms. In contrast, purchases made at No R&D firms and Transitory Loss firms
exhibit limited profitability.
Having analyzed insider trading behavior at loss firms, we next examine how the markets
respond to insider purchases at loss firms. We find evidence consistent with at least some
investors recognizing the differential pricing signals of disclosures of insider purchases at loss
firms. Insider purchase announcement returns are significantly larger at loss firms compared to
profit firms; at High R&D firms compared to No R&D firms; and at Persistent Loss firms
compared to Transitory Loss firms. These differences are consistent with differences in the
profitability of insider purchases that we document. These results suggest that purchases by
insiders at loss firms helps improve short-term price efficiency.
Finally, we examine whether the intensity of insider purchases is associated with
abnormal returns around the announcement of negative earnings and the subsequent two
quarters. Consistent with our predictions, we find that PEAD is significantly less negative among
High Buy firms compared to No Buy firms. This association also holds in the High R&D and
Persistent Loss partitions, but not in the No R&D and Transitory Loss partitions. Thus, the
partitions in which insider purchase intensity is associated with less negative abnormal returns
correspond to those partitions in which insider purchases are especially profitable. In summary,
our results suggest that when insider purchases at loss firms appear to be based on substantial
private information regarding the end of the loss string, prices are more efficient.
We contribute to the literature in at least two ways. First, we add to the insider trading
literature by identifying a new and important characteristic (accounting losses) that is strongly

associated with insider trading behavior and the profitability of insider trades.3 Second, we
provide evidence that more intense trading by insiders is associated with the more efficient
pricing of loss firms. As such, our findings suggest that insider trading prohibitions could lead to
less efficient stock prices, at least among loss firms.
The rest of the paper is organized as follows. Section 2 summarizes the related literature.
Section 3 describes the data and reports descriptive statistics. Section 4 present the main
empirical results, and Section 5 concludes.
2. Related Literature and Empirical Predictions
2.1 Insider trading at loss firms
The voluminous empirical literature on insider trading generally finds evidence indicating
that insiders earn abnormal profits when they trade in their firms shares (Seyhun (1986)). These
findings are driven primarily by insiders share purchases, given that average share sales are
more likely driven by managers portfolio diversification needs (Aboody and Lev (2000), Ravina
and Sapienza (2010)).4 This evidence is consistent with insiders trading on the basis of private
information that they obtain as a consequence of their insider positions.
The literature on insider trading before major corporate events presents somewhat mixed
findings. Less well understood is the specific types of private information that drive profitable
insider trades. For example, evidence in Givoly and Palmon (1985), Noe (1999), Sivakumar and
Waymire (1994), and Ke et al. (2003) indicate insiders generally do not trade on private

As Huddart and Ke (2007, p. 197) posit, [i]dentifying the characteristics of firms where insiders trades are most
profitable may prove useful to regulators who design enhanced disclosures or other remedies to limit insiders
trading advantage.
4
While there is evidence of insider sales driven by private information in certain cases (Cohen et al. (2012)),
analyses of general selling behavior by insiders typically only find limited evidence that they are based on private
information.

information regarding to upcoming earnings announcements.5, 6 Huddart et al. (2007) find that
insider transactions are clustered immediately after the earnings announcement but before the 10
K/Q filing dates. Other studies have found that insiders appear to trade profitably before a variety
of relatively infrequent corporate events such as Chapter 11 bankruptcy filings, stock
repurchases, seasoned equity offerings, earnings announcements, dividend initiations, and
earnings restatements. For example, Agrawal and Nasser (2012) find that insiders increase their
net purchases before takeover announcements by passively reducing their sales. Ravina and
Sapienza (2010)) find that insiders increase their selling prior to restatements.
We examine the incidence and profitability of insider trading made in the periods leading
up to an important information event that has received little attention in the literature: the
break in a string of quarterly losses when a firm reports positive earnings. We focus on insider
trading at loss reporting firms for several reasons. First, loss firms are likely more difficult to
value because the information content and valuation implications of losses are different from that
of profits (Darrough and Ye (2007), Joos and Plesko (2005)). Second, and likely related to the
first, prior literature suggests that loss firms are priced less efficiently compared to profit firms.
Balakrishnan et al. [2010] and Li [2011] suggest that the mispricing of loss firms is associated
with investors systematically under-estimating the likelihood of loss persistence, and hence, are
systematically surprised by the future announcement of losses.7 Third, Agrawal and Nasser

While Ke et al. [2003] do not find evidence that insiders sell in the two quarters immediately preceding a break in a
string of consecutive increases in quarterly earnings, they do find that insider sales increase three to nine quarters
before the break of earnings increase. Also, Piotroski and Roulstone (2005) find that insider trades are positively
related to the firms future earnings performance.
6
More recent studies find that insiders increasingly engage in passive trading i.e. they postpone their selling
(buying) transactions until after good (bad) news announcements. For example McVay et al. (2006) show a
significant association between the likelihood of firms meeting or missing analyst forecasts and subsequent insider
sales. The results of these studies suggest that regulatory enforcement may affect the timing of insider trading but
not their ability to exploit inside information.
7
Similarly, Dhaliwal et al. [2013] find that investors pricing of the valuation allowance for deferred tax assets
varies with the saliency of the tax signal and the information environment of the firm.

(2012), Huddart et al. (2007), Ke et al. [2003] and others find that concerns about legal jeopardy
often inhibit insiders from actively trading on their private information ahead of bad news.
However, we expect that insiders at loss firms face relatively little legal jeopardy when they
increase their net buying based on private information regarding the break in a loss string.
In summary, loss firms provide a setting where insiders are expected to have relatively
high amounts of private information and reduced concerns about legal jeopardy. Thus, we expect
the insider trading signals in our setting to be especially strong indicators of insiders private
information. Accordingly, we make two empirical predictions. First, relative to profit firms, we
expect relatively more insider trading at loss firms during all of the periods leading up to and
including the break quarter. Second, given fewer legal jeopardy concerns, we expect the
profitability of insider purchases at loss firms to be greater than that at profit firms.
We expect the intensity and profitability of insider trading will vary across loss firms as a
function of cross-sectional differences in the amount of private information insiders possess. We
expect insiders to possess relatively more private information under two circumstances. First,
Aboody and Lev (2000) find that the presence of research and development expenses (R&D) is
an important source of private information for insiders. Thus, we expect R&D intensity to be
positively associated with both insider trading activity at loss firms and the profitability of
insider purchases. Second, Dhaliwal et al. [2013] find that insiders have private information
about the persistence of accounting losses over the following three years, and use this private
information when setting the valuation allowance for deferred tax assets. In addition, the
evidence in Balakrishnan et al. [2010] and Li [2011] indicates that investors have difficulty in
estimating the likelihood of loss persistence at loss firms. Accordingly, we expect that when
publicly available information predicts that losses are likely to persist, insiders will have

relatively greater or more precise information about the timing of the actual loss reversal (i.e., the
break quarter) compared to when publicly available information predicts that losses are likely to
be transitory.
2.2 Insider trading and market efficiency
While the consensus of the prior literature is that insiders trade and profit on their private
information, there are strong differences regarding the desirability of insider trading, and hence,
the desirability of insider trading regulations. Opponents argue that in addition to ethical and
fairness considerations, insider trading leads to higher information asymmetry, lower liquidity,
and a higher cost of capital (Manove (1989), Dye (1984), Leland (1992), Shin (1996)). In
contrast, proponents argue that by incorporating private information into prices, insider trading
reduces investor uncertainty, can improve liquidity under certain circumstances, and lead to more
efficient investment outcomes (Manne (1966), Ausubel (1990) Fishman and Hagerty (1992), ).
To the extent these latter arguments are correct, then insider trading will increase the
informational efficiency of the capital markets.
As discussed above, we expect that to the extent insider trades at loss firms reveal
insiders private information about the break in the loss string (timing, magnitude, and
persistence). To the extent that insider purchase signals are more informative at loss firms, and
markets react to these signals efficiently, we expect the market to react more strongly
(positively) when they become informed about such trades compared to similar trades at profit
firms. Similarly, we expect the market reactions to insider purchases will be stronger for insider
trades made at high R&D and high expected loss persistence firms.8 Consistent with this idea,

As Brochet (2010) discusses, the Sarbanes-Oxley Act (SOX) shortened the average time between the timing of an
insider trade and its disclosure from roughly 25 days to less than two. He finds that abnormal returns around insider
purchases disclosures are significantly greater after SOX than before. Accordingly, we expect market reactions to
insider purchases at loss firms will also increase in the post-SOX period.

Aboody and Lev (2000) find that market price and volume reactions are higher when insider
trades at high R&D firms are disclosed compared to such disclosures for non-R&D firms. To the
extent insider purchases at loss firms are more informative signals and the market reacts
accordingly, then more insider trading at loss firms will be associated with more informationally
efficient prices, at least in the short run.
Based on the above, we expect the disclosure of insider trades at loss firms will at least partially
reveal insiders private information about the break in the loss string. However, it is possible that
the increase in efficiency is only temporary if the contemporaneous stock price increases later
reverse and prices continue their downward drift. The results in Li (2011) suggest that investors
do not fully distinguish the differences in loss persistence among firms and instead appear to
assume that all losses are transitory. Balakrishnan et al. (2010) reach a similar conclusion.
Consequently, Li (2011) finds investors appear to be surprised by future announcements of
negative earnings for firms with predicted persistent losses (based on publicly available data),
and these firms experience significantly negative abnormal returns over the following four
quarters. Thus, if investors react to future negative earnings announcement without conditioning
on prior insider trading activity, then even loss firms with previous insider trading activity may
experience negative post-earnings announcement drift.
However, to the extent investors efficiently condition their reaction to future negative earnings
announcements on the extent of insider purchases, then we expect the trading activities of
insiders to improve price efficiency. In which case, we predict that stock price reactions to future
negative earnings announcements will be less negative when insiders have been more active
purchasers over recent prior periods compared to when no purchases have been made by
insiders.

As mentioned above, Li (2011) finds that loss firms, especially those with expected
persistent losses, experience negative post-earnings announcement drift (PEAD) for up to four
quarters following the earnings announcement. We expect that when insiders have been more
active purchasers, PEAD will be less negative following negative earnings announcements. We
also expect the reduction in negative PEAD will be greater for firms with expected loss
persistence compared to firms where losses are expected to be transitory.
3. Research design
We conduct two main sets of analyses. In the first set, we examine the incidence and
profitability of insider trading at loss firms during the periods leading up to the loss reversal. We
define a loss reversal as the first reported quarterly profit following a loss string of one or more
consecutive quarters with reported losses. In the second set, we examine how the market reacts
to disclosures of insider trading (short window reactions) and whether longer run abnormal
returns (through the announcement of the loss reversal) are negatively associated with the
intensity of insider trading.
Prior literature on the pricing of loss firms (Joos and Plesko (2005), Li (2011)) and the
profitability of insider trading (Aboody and Lev (2000)) identifies two important cross-sectional
factors: 1) research and development expenses (R&D), and 2) expected loss persistence. We
expect these factors to be associated with the degree of information asymmetry between insiders
and outside investors in the market. Accordingly, we examine how the results for all of our
analyses vary cross-sectionally across these two dimensions. We create three partitions of the
sample based on firms R&D intensity: 1) High R&D; 2) Low R&D; and 3) No R&D.
Observations in a single loss string (including the break quarter) are all placed in the same
partition. Observations with missing R&D values are assumed to have zero R&D expenses.

Firms with 0 R&D values in each quarter of the loss string are classified as No R&D firms. For
all remaining loss strings, we classify the firm based on its average R&D expenditures over the
loss period and during the break quarter relative the average R&D expenditures of the entire
sample with non-zero R&D over the same time period. If average R&D expenditures is above
the sample median, we classify the observations as High R&D, otherwise observations are
classified as Low R&D
To classify firm-quarter observations according to their expected loss persistence, we
estimate the probability of a loss in the following quarter. We use an augmented and quarterly
version of the Joos and Plesko (2005) model, where we additionally include R&D expense
scaled by total assets, firm age, and a special items indicator as additional predictor variables.
Details of the model are provided in the appendix. We use data for all firms from the previous 8
quarters (q-8 to q-1) to estimate the coefficients, and apply the coefficients to quarter q data to
predict q+1s loss probability. We then categorize the sample based on the expected loss
probability estimates. Firms in the top (bottom) tercile of the sample distribution are classified as
Persistent Loss (Transitory Loss) firms. Firms in the middle tercile are classified as Medium
Loss Persistence firms.
3.1. Insider trading and loss reversals
In our tests, we implicitly assume that insiders have private information regarding when
the loss string will end and that they expect the market will react positively to the announcement
of the break. Insiders can profit from their private information in two ways. First, insiders can
purchase their firms stock prior to the announcement of the break and sell it after the break is
announced. Second, insiders can postpone the sale of the firms stock until after the break is
announced. In both cases, insiders net buying activity would be higher during the periods

10

leading up the break. In order to analyze the pattern of insider trading before the announcement
of the break in a loss string, we estimate the following regression model for all firm-quarter
observations:

We measure intensity of insider trading, Net Buy, as the total number of net shares
purchased by active insiders (the number of shares purchased less the number of shares sold).9
Firms commonly institute blackout periods during which insiders are prohibited from trading in
their firms share (Jagolinzer et al. (2011)). Blackout periods typically prohibit trading during the
one month period leading up to and including the earnings announcement date. Accordingly, we
measure Net Buy during quarter q from one day after the earnings announcement of quarter q-1
to the end of quarter q. We divide Net Buy by 1,000 for ease of interpreting the coefficient
estimates.
Firm-quarter observations are arranged in event time according to when the break in the
loss string occurs. Break is an indicator variable equal to 1 if the loss string ends in that quarter,
i.e. earnings for the quarter are positive but earnings during the preceding quarter are negative.
String q is an indicator variable equal to 1 if observation quarter is part of a loss string at least q
quarters long and is q quarters before the break in a loss string, otherwise 0.10 The number of
observations naturally decreases as the number of quarters until the break quarter increases. In
order to ensure adequate sample size, we aggregate the certain of the String q indicator variables

We also consider an alternative measure of net buying that is based on the total number of net transactions (the
number of purchase transactions less the number of sales transactions). Untabulated results are similar to those
discussed in the paper.
10
For examine, String 3 equals 1 if the firm reports a loss for the quarter, reports a loss in the two subsequent
quarters, and reports a profit in the third subsequent quarter.

11

into a single combined indicator variable: Strings 5 & 6; Strings 7 & 8; Strings 9 & 10; and
Strings 11+. The coefficients on Break and String q capture whether insiders systematically
engage in more net buying activity during the quarters leading up to the announcement of a break
relative to the net buying activities of insiders at profit firms.
Size is the natural logarithm of the market value of the equity at the beginning of the
quarter. Seyhun [1986] reports that insider trading varies cross-sectionally with firm size.
Lakonishok and Lee [2001] find that insiders are more active traders in larger firms and insiders
sell more than they buy. BM is the book-to-market ratio measured at the beginning of the quarter
(Huddart et al. [2007], Piotroski and Roulstone [2005]). Loss Duration is the number of the
quarters since the loss string began, inclusive of observation quarter. Joos and Plesko [2005] find
the longer the string of prior losses, the less likely a loss firm will return to profitability during
the following period. Thus, Loss Duration controls for the effect of prior string length on
insiders trading decisions.
Lakonishok and Lee (2001), Piotroski and Roulstone [2005], and Rozeff and Zaman
(1998) find insiders are contrarian investors who buy stock with poor past performance. To
control for this behavior, we include two measures of past returns: 1) Prior Return is the raw
return over the 12 month period ending the month prior to the earnings announcement (i.e.
months -12 to -1) and 2) Event Return is the raw return for the period starting 2 days before to 1
day after the earnings announcement date (i.e. days -2 to 1). We also include two measures of
future performance: 1) Post Return 6 and 2) Post Return 12, which are defined as the raw return
for the first 6 months following the earnings announcement month (i.e. months 1 to 6), and for
the next 6 months after the earnings announcement month (i.e. months 7 to 12), respectively.
These variables are included because Seyhun [1998] finds a positive relation between insiders

12

net purchases and subsequent stock returns for at least 12 months following the trades. Thus,
including these variables helps control for other types of private information that drive insider
trading that is not specifically related to the timing of the break.11
We also include firm-fixed effects, oi, to control for systematic variation in insider
trading across firms (Huddart and Ke [2003]) and year fixed effects, 1t, to control for time fixed
effects to control for regulatory changes, the intensity of insider trading enforcement, or other
factors that may induce systematic variation in insider trading across time. All continuous
variables are winsorized at 1% and 99% and standard errors are clustered both at firm and
quarter level following Gow et al. (2010).
3.2. Profitability of insider trading at loss firms
Prior literature, including Aboody and Lev (2000), Jeng et al. (2003), and Ravina and
Sapienza (2010), finds that insider sales typically do not generate significant abnormal returns.
These findings suggest that most sells by insiders appear to be primarily motivated by
diversification or liquidity needs as opposed to negative private information. Accordingly, we
focus on analyzing the profitability of insider purchases.12
In order to measure the abnormal returns to insider purchases at the level of the
individual trade-day, where we treat multiple purchases by the same insider on the same day as a
single purchase. We examine all insider purchases during all loss strings and the subsequent
break quarter. We aggregate insider trades based on the number of quarters prior to and including
the break quarter. In order to have sufficient sample size in each category, we aggregate certain
loss string quarters using the same categories as in the insider trading analyses discussed above.

11

We obtain similar results when we exclude Post Return 6 and Post Return 12.
For the same reason, we exclusively analyze the markets reactions to disclosures of insider purchases and the
association between the intensity of insider purchases and longer-run abnormal returns.
12

13

For each insider purchase, we measure the buy-and-hold abnormal returns (BHAR) using
the Fama-French four-factor model starting the day of the insider purchase through two days
after the break earnings announcement or 120 trading days, whichever is later. While somewhat
arbitrary, we assume that insiders hold their purchases until at least the break earnings
announcement date in order to fully profit from any private information regarding the timing of
the loss break and/or the level of unexpected earnings for the break quarter. The finance
literature (Barber and Lyon (1997), Lyon et al. (1999), and others) notes an issue with using
BHAR over longer windows as the returns may be overstated. To mitigate this issue, we
implement rebalancing every 12 months during the assumed holding period.
We impose a minimum 120 trading day holding period because this corresponds to a six
month holding period. Insiders must hold a stock for at least six months while still retaining
profits from an offsetting transaction. Rule 16b of the Securities and Exchange Act of 1934, the
short-swing rule, states that profits made by insiders from transactions involving equity
securities of publicly held companies, when a purchase and a sale are made less than 6 months
apart, must be disgorged and paid over to the issuer. Thus, any profits realized for holding
periods less than 6 months would have to be returned to the company.
3.3. Market reactions to insider trading disclosures
In the analyses discussed above, we condition on the loss string coming to an end and the
firm reporting positive profits. Thus, firms that do not survive long enough to report a positive
profit are not included on our sample. We expect insiders have private information regarding
both the likelihood and timing of the break quarter. However, outside investors will not know
with certainty that the firm will eventually report a profit when it observes an insider purchase at

14

a loss firm. Accordingly, when we analyze the market reactions to insider purchase disclosures at
loss firms, we no longer impose the requirement that firms eventually report a profit.
While insiders are not required to notify investors about their intent to trade, they are
required to file disclosures (Form 4) of their trades with the SEC. Prior to the Sarbanes-Oxley
Act (SOX), they were required to file by the 10th day of the month following the month during
which the trade was made, which would result in an average delay of 25 days between the trade
date and the filing date. Beginning in August 2002, Section 403 required insiders to file within
two days of their trade.
To analyze the markets reaction to insider purchases, we cumulate abnormal returns
around both the purchase date and the filing date. While one might expect trades by insiders to
be relatively anonymous, Meulbroek (1992) and Aktas et al. (2008) find evidence consistent with
the market being aware of illegal insider purchases on the actual trade date. We measure
abnormal returns using the Fama-French four factor method and cumulate returns on the day of
and two days after (0,+2) the two event dates. During the post-SOX period, these windows
frequently overlap. In which case, we calculate abnormal returns from the date of insider
purchase to 2 days after SEC filling (typically (0,+3) or (0,+4)). If the same insider makes two or
more purchases on the same date but has different filing dates, we aggregate the multiple trades
into a single observation and use the earliest of the filing dates. Similarly, if two or more
purchases made on different dates have the same filing date, we aggregate these observations
into a single observation and use the earliest of the trade dates. To allow for the possibility that
the passage of SOX changed either insiders trading behavior or investors interpretation of
insider trading disclosures or both, we separately report our results for the pre- and post-SOX

15

periods. Insider purchases made on and after 08/29/2002 are classified as post-SOX, before that
are classified as pre-SOX.
3.4. Insider trading and market efficiency w.r.t. earnings announcements
Prior studies on insider trading have been debated on whether insider trading brings
useful private information into the stock price, thus increases efficiency of prices. (Manne (1966),
Manove (1989), Leland (1992), Fishman and Hagerty (1992) ). However, whether insider trading
improves pricing efficiency has not been established w.r.t. loss firms, where information
asymmetry between insiders and outside investor is likely to be especially high.
To provide evidence on this issue, we conduct two sets of test based on how the prior
presence or absence of insider purchases is associated with how efficiently the market reacts to
negative earnings announcements. Unlike the insider trading tests described above, we do not
restrict our sample to loss firms that eventually experience a loss reversal. Instead, we include all
loss firms that meet our data requirements.
Our basic approach is compute average abnormal returns measured around (-1, +1) and
following [(+2, +61) and (+2, +121) quarterly loss announcements. We then compare the
average abnormal returns among various partitions of the data. Specifically, we examine
abnormal returns among five partitions: the entire sample, High R&D vs. No R&D firms, and
Persistent Loss vs. Transitory Loss firms. In our first set of analyses, we do not condition on
prior insider purchase activity. Second, we condition on prior insider purchase activity and
analyze how abnormal returns vary across each of the five partitions depending on whether there
was high buying activity prior to the earnings announcement or no previous buying activity.
We classify firm-quarter observations into one of three groups based on their intensity of
insider trading over the prior four quarters. For each four quarter window, we sum the total

16

number of shares purchased by all insiders for all of our sample firms. For firms with no insider
purchases over the prior four quarters, we classify the observation as No Buy. For the
remaining observations with non-zero purchases, we classify an observation as High Buy if the
number of shares purchased is above the median and as Low Buy if the number of shares
purchased is below the median level. In our analyses, we focus on the differences between the
High Buy and No Buy partitions.
4. Sample selection and descriptive statistics
The data in this study come from several sources. Our primary data on insider trades are
come from the Thomson Reuters insider filings database. Section 16(a) of the Securities and
Exchange Act of 1934 requires that open market trades by corporate insiders be reported to the
SEC within 10 days after the end of month in which they took place. This deadline was later
changed to 2 days in 2002. Thomson Reuters insider filings database provide insider transactions
by corporate insiders, which include directors and officers (including CEOs, CFOs, and board
chairs) and others, such as beneficial owner of more than 10% of a company's stock. In our
analysis, we only include trades made by directors or officers during the period 1988 to 2010.
Our analysis focuses on open market stock purchases and sales by insiders, hence exclude
options exercise and private transactions.
We merge our insider transaction data with firm-level data from CRSP/Compustat,
including earnings, stock returns, and market capitalization. The sample include all firm-quarters
that had available at least two consecutive quarterly earnings data during the period 1988 to 2010
to measure the shortest loss string of one quarter. To measure the length of loss string, we use
quarterly earnings data as needed from the period extending back to 1976.

17

Our first set of tests examine the trading behavior and profitability of insider trades
during loss strings and the break quarter, which is the first positive profit quarter following a
string of one or more consecutive loss quarters. The sample selection procedures are shown in
Table 1. We include all firm-quarters with following exceptions. First, we exclude ongoing loss
strings as of December 2012. That is, firm-quarters that are part of a loss string that ends after
2012 are excluded because we need to identify when the loss string ends to determine where the
firm-quarter lie within the string. Second, to avoid complications related to delayed earnings
announcement, we only include firm-quarters in which the earnings announcement is made
within 60 days after the end of the fiscal quarter. Third, in order to eliminate thinly traded stocks,
we exclude all firm-quarters with stock prices at the end of quarter below $1 per share. Fourth,
we exclude firm-quarters with negative book value of equity at the end of the quarter. The final
sample for primary set of insider trading analyses includes 329,804firm-quarters. Of these,
89,402 firm-quarters are part of loss strings (including the break quarter). These firm-quarter
observations correspond to 11,575 and 8,075 distinct firms respectively (untabulated).
Descriptive statistics are presented in Table 2. The mean value of Net Buy is -25.61. This
means that insiders reduce their net holding by an average of 25,610 shares each quarter. This
finding is consistent with prior literature that open market transactions by insiders are
predominantly sales as insiders seek to diversify their portfolios and liquidate their holdings. The
median value of Net Buy is zero. This finding is also consistent with the prior literature and
indicates that insider transactions occur in fewer than half of all quarters. Panel B presents the
results for the loss quarter observations. During loss quarters, the mean value of Net Buy is 13.8, which is almost half the value for the entire sample. Thus, insiders at loss firms
substantially increase their net buying compared to insiders at profit firms.

18

Panel C of Table 2 provide descriptive statistics for the break firm-quarters; that is, for
firms that break a string of losses. There are a total of 26,024 loss strings. Loss String is defined
as the number of consecutive loss quarters before the break quarter. The shortest loss string has a
length of one. The mean value of Loss String is 2.42 while the median is 1. Thus, on average the
loss strings last between 2 to 3 loss quarters, with the majority of strings lasting only one quarter.
Thus, most losses are transitory.
5. Results
In this section, we present our empirical method and main results. Before proceeding to
our main tests, we first examine the market reaction around the announcement of loss reversal.
Next, we investigate insider trading intensity in each quarter prior to the announcement. Last, we
examine whether there is different insider trading patterns between opportunistic trading and
routine trading.
5.1. Preliminary Analyses Stock Returns around Loss Reversals
Our underlying assumption is that loss reversals are significant events for loss firms, and
thus, are a natural event that insiders would focus their trading activities on.13 Therefore, before
proceeding to our main analyses, we examine the returns that firms experience during the period
surrounding the break in the loss string. Confirming a substantial positive returns around the
announcement of the first profit following a loss string is important because our hypothesis
development depends, in part, on such returns being present. To the best of our knowledge, the
returns behavior around the break in a loss string has not been documented previously.
We measure abnormal returns using the Fama-French four-factor model over three time
periods: 1) the pre-announcement period from 45 days until 2 days before the break earnings

13

Ke et al. (2003) utilize a similar approach and focus on the break in a string a consecutive quarterly earnings
increases.

19

announcement [FFAR(-45,-2)]; 2) the announcement period from one day before until one day
after the earnings announcement [FFAR(-1,+1)]; and 3) the post-announcement period from two
days through 45 days after the earnings announcement [FFAR(+2,+45)].14 We include a broader
window in order to more fully capture the returns surrounding the release of the break earnings.
The results for the full panel are reported in Table 3, Panel A. Our sample includes
26,014 break firm-quarter observations. The results show that break firms experience positive
and significant returns over the roughly ninety trading day period surrounding the announcement
of the first positive earnings following a loss string. Summing the coefficients over the entire
period yields an economically significant abnormal return of 5.43%, with most the return (84%)
occurring during the pre-announcement and announcement periods.
Next, we examine the abnormal returns for firms grouped according to their R&D
intensity or expected loss persistence, respectively. The results w.r.t. R&D intensity are reported
in Panel B and show a clear pattern between R&D intensity and abnormal returns during the
break quarter. High R&D firms experience the largest average abnormal returns over the 90 day
window (9.68%), followed by Low R&D firms (6.90%), and with No R&D firms having the
lowest, but still significantly positive, abnormal returns (3.74%). Similarly, the results in Panel C
indicate a clear pattern between expected loss persistence and abnormal returns during the break
quarter. Firms with high expected loss persistence but who nonetheless reported positive
earnings experience positive abnormal returns of 12.97%, on average, over the 90 day trading
window. In contrast, transitory loss firms that had a relatively high likelihood of reporting a
profit experience much smaller, but still significant, positive returns surrounding the break
announcement (2.52%). Firms in the middle group of expected loss persistence experience
positive abnormal returns (6.63%) that are between the two extreme groups. Overall, the results
14

Results are qualitatively similar if we use size-adjusted abnormal returns (SAR) instead.

20

in Table 3 support our assumption that breaks in loss strings represent important information
events and the associated abnormal returns provide strong incentives for insiders to trade based
on private information regarding an upcoming break quarter. In addition, Table 3 indicates that
the abnormal returns vary considerably across the two partitions we use. Accordingly, we expect
both the strength of the insider trading incentives and the insider trading signal to the market will
likewise vary across the two partitions.
5.2. Insider Trading at Loss Firms prior to Loss Reversals
In this section, we examine whether and to what extent to insiders at loss firms trade
during the loss string and during the break quarter. Table 4 reports the results of estimating
equation (1) for the Full Sample as well as the partitions based on R&D intensity and expected
loss persistence. For each regression, we report the number of firm-quarter observations that
have loss strings as least as long as in the corresponding row. For example, for the Full Sample,
there are 6,238 firm-quarter observations that have values of String 3 equal to 1 (that is, have
losses that occur in the third quarter preceding the break quarter). As expected, the number of
observations declines as the length of the loss string increases.
The results for the control variables are generally consistent with those in prior research.
The coefficient on Size is significantly negative, indicating insiders are more likely to buy in
small firms (Lakonishok and Lee [2001], Seyhun [1986]). The Prior Return coefficient is
significantly negative. This result is consistent with prior literature that finds insiders are
contrarian investors (Rozeff and Zaman [1998], Lakonishok and Lee [2001], and Piotroski et al.
[2005]). Consistent with the prior literature (Seyhun [1988], Ke et al. (2003)), the coefficients on
Event Return, Post Return 6, and Post Return12 are all significantly positive. Contrary to
expectations (Rozeff and Zaman [1998]), the BM coefficient is significantly negative, indicating

21

that insiders have higher net purchases at growth firms. Finally, the coefficient on Duration is
not significantly different from zero.15 Thus, insiders do not appear to condition their trading
decisions on the number of prior loss quarters.
The results for the Full Sample indicate that insiders increase their net purchases in the
loss quarters leading up to the break quarter. All of the coefficients on String 1 through Strings 9
& 10 are positive and significant (t-statistics range from 6.154 to 1.89, with an average of 3.74).
The coefficient estimates on the String q (and Break) coefficients represents the mean change in
the net number of shares (in thousands) traded by insiders during the corresponding loss string
quarter relative to normal profit quarters (i.e., all profit quarters excluding the loss string break
quarters). Accordingly, the coefficient on String 1 (4.52) indicates that insiders increase their net
buying by 4,520 shares during the last quarter of a loss string relative to the average level net
buying at during non-break profit quarters. Given that the average net number of shares sold by
insiders in our sample is 25,610 shares per quarter, 4,520 additional shares traded represents a
17.7% increase in insider net buys. The mean value (untabulated) of the significant String q
coefficients is 4.415. In addition, considering 53% of firm-quarters have zero values of Net Buy,
this result is even more economically significant. Finally, the String 11+ coefficient is not
statistically significant (t-statistic = 1.157) despite a relatively large number of observations
(7,038) that fall into this category. This result suggests that insiders generally do not change their
trading behavior during loss string when the break is more than 11 quarters away. One
interpretation is that insiders are highly uncertain about the timing of the break quarter when it is
so far in the future. Another is that insiders choose not to trade so far in advance of the break

15

However, in some of the partitions examined in Table 4, the Duration coefficient is sometimes significantly
negative and sometimes significantly positive. Accordingly, the role played by the duration of prior losses appears to
be context specific.

22

because the expected returns over these periods are negative. We examine this issue in the next
section.
Surprisingly, the Break coefficient is positive (2.211) and significant (t-statistic = 3.11).
This result indicates that insiders increase their net buying even during the fiscal quarter of the
break that is, just ahead of the announcement of a profit that breaks the loss string. The
magnitude of the coefficient is roughly half the size of the String 1 coefficient. This indicates
that insiders are cutting back their increases in net sales just prior to announcement of the break
earnings. However, the fact that insiders are increasing their net buying all of the way up to the
break earnings announcement is notable given that prior research generally finds that insiders
avoid trading just prior to significant information events to reduce legal jeopardy and external
scrutiny. For example, Ke et al. [2003] find that while insiders increase their sales from between
3 to 9 quarters before the break of consecutive earnings increases, they observe no additional net
selling during the two quarters immediately preceding the break quarter. The differences in
findings may indicate that insiders perceive their legal jeopardy to be lower from buying before
good news than it is for selling before bad news.
To ascertain whether the tendency to increase net buys during a loss string varies with
our proxies for the level of firm-investor information asymmetry, we next examine insider
trading in subsets of the data. We first examine trading behavior during the High R&D and No
R&D partitions and report the results in Panel B of Table 4.16 The results show considerable
differences across the two partitions. The results show that for High R&D firms, insiders have
significantly higher levels of net buying in all periods preceding the announcement of the break
(t-statistics range from 6.67 to 2.55). In addition, the magnitude of the String q and Break

16

For the sake of brevity, we do not report the results for the either of the two middle partitions (Low R&D and
Medium Loss Persistence) in either Table 4 or Table 5.

23

coefficients are generally more than twice the size of the corresponding coefficients estimated
using the full sample. The average coefficient is 10.152, which represents an average increase in
net buying of over 10,000 shares per quarter by insiders at High R&D firms.
The results for the No R&D partition provides only limited evidence that insiders at those
firms increase their net buying based on information regarding the upcoming loss string break.
Panel B shows that only the String 1, String 2, and String 3 coefficients are significant (at the 5%
level of better). In addition, their magnitudes are relatively small (2.48, 2.32, and 2.78,
respectively). Note that unlike for the High R&D firms, there is no evidence of additional net
buying during the break quarter. In summary, the results indicate the additional net buying ahead
of break announcements is largely limited to insiders at High R&D firms, who heavily increase
their net purchases even during loss strings of more than 11 quarters.
Next, we examine how insider trading during loss quarters varies across the Persistent
Loss and Transitory Loss partitions. In Section 2, we argued that firm-investor information
asymmetry will be increasing with expected loss persistence. Accordingly, we expect that
insiders at High Expected Loss firms will trade more intensively before breaks compared to
Transitory Loss firms. However, the results in Panel C of Table 4 are not consistent with our
predictions. Instead, the results show that insiders at firms where the losses are expected to be
transitory exhibit significantly more net buying during loss strings relative to profit firms. Each
of the String q coefficients in the Transitory Loss partition are positive and significant (tstatistics range from 5.610 to 1.813 and average 3.285).17 Note that the number of observations
where the actual loss string is greater than three quarters is relatively small. In addition, the

17

Note that we do not include Break in the Loss Persistence regressions because it does not make sense to calculate
expected (future) loss persistence when the firm actually reports a profit.

24

coefficient magnitudes are relatively large as the estimates range from 14.161 to 4.939, and
average 9.264.
In contrast, insiders at firms where losses are expected to be highly persistent exhibit no
additional net buying during the quarters leading up to the loss reversal. None of String q
coefficients are significantly positive. Indeed, the String 1, String 2, Strings 5 & 6, and Strings 7
& 8 coefficients are significantly negative (t-statistics range from -2.484 to -1.851). These results
are the opposite of what one would expect if insiders at these firms had private information about
the upcoming break in the loss string. One interpretation of the results is that when it comes to
public signals of expected loss persistence, insiders trading decisions are not consistent with
their having private information about the timing of the break quarter. Instead, they increase their
net buying when public signals indicate that the current quarters loss will likely reverse (even
when the actual loss reversal does not occur for two or more years) and they do not increase their
net buying when public signals suggest that the current loss is likely to be persistent (but the loss
actually reverses in a few quarters). This is the opposite pattern that we observe in the R&D
partitions. Of course, these (non-) trades could be highly profitable even if they do not appear to
be based on private information. We turn to the issue of insider trading profitability in the next
section.
5.3. Returns to Insider Trades
The evidence presented to this point suggests that insiders, especially at High R&D firms
high Transitory Loss firms, engage in significantly more net buying during loss quarters leading
up to the break in the loss string. These results are consistent with insiders trading on private
information related to the timing of the break of the loss string. If this interpretation is correct,
then insiders will earn positive abnormal returns to their stock purchases, on average, if they wait

25

to sell until the announcement of positive earnings at the break. In this section, we analyze the
returns associated with insider purchases during the periods leading up the break earnings
announcement. We focus on actual purchases as such transactions are the most likely to be based
on private information.
For each purchase during a loss string and including the break quarter, we calculate the
FFAR starting the day the insider trade is made until the day after the break earnings
announcements, with a minimum six month holding period. We then aggregate all of the returns
based on when they were made relative to the break quarter. Due to the presence of large
outliers, we winsorized the return data at the 5%/95% level. Naturally, the number of
transactions in each quarter decrease as one moves further away from the break quarter. The
results are presented in Table 5.
In Panel A, we report the FFAR results for the whole sample. Untabulated results using
size-adjusted returns are qualitatively similar and our inferences remain unchanged. The results
show that on average, trades made by insiders are highly profitable (and significantly different
from zero with t-statistics ranging from 37.20 to 6.23) with the exception of trades made during
more than 8 quarters prior to the break quarter. The quarterly average abnormal returns do not
exhibit a clear pattern. For trades made during the break quarter, the results indicate that insider
trades experience abnormal returns of 16.15%, on average. Average returns are somewhat
smaller for trades made during the first and second quarters preceding the break quarter (11.84%
and 13.69%, respectively). Average returns increase to roughly 23% over the next four quarters
(the String 3, String 4, and Strings 5 & 6 coefficients are 24.94%, 22.47%, and 23.66%,
respectively). Average holding period returns then decline to 16.36% for trades made either 7 or
8 quarters prior to the break quarter. For purchases made 9 or more quarters prior to the break

26

quarter, returns are not significantly different from zero. Thus, the results indicate that while they
are still profitable, shares purchased by insiders more than six quarters before the break quarter
were made prematurely as abnormal returns would have been higher on average had insiders
delayed their purchases one or more quarters.
Given the diversity of methodologies used to estimate insider trading profits and holding
period examined in prior studies, it is difficult to directly compare the magnitudes reported in
Table 5 the results presented in other studies. That said, the magnitudes of the abnormal returns
reported in Panel appear to be substantially larger than those reported in most prior studies of
insider trading. Most prior studies only examine relatively short holding periods. Given the
restrictions on insider swing sales, the minimum effective holding period is six months (or
roughly 120 trading days). Even at this minimum holding period, our results show that insiders
earn abnormal returns of between 12% and 16% if they trades during either the Break or String 1
quarters. These comparisons suggest that insiders at loss firms possess substantially more private
information, on average, compared to insiders at profit firms.18
Next, we examine how insider trading abnormal returns vary cross-sectionally between
High R&D and No R&D firms. The results are reported in Panel B. The general pattern of results
for trades made by insiders at High R&D firms is similar to that for the entire sample, except that
for trades made in each quarter preceding the announcement of the break, the average returns are
higher than their Panel A counterparts by anywhere between 15 and 29 percentage points. In
addition, all of the average returns are significantly different from zero (t-statistics range between
25.32 and 2.71), except for trades 11 or more quarters before the break quarter. The average
abnormal returns varies from a low a 13.79% (for purchases made between nine and ten quarters

18

Consistent with this idea that information asymmetry is larger at loss firms, Ertimur (2004) finds that bid-ask
spreads are significantly higher for loss firms.

27

before the break quarter) to a high of 53.84% (for purchases made 3 quarters before the break
quarter).
The results in Table 4 showed that insiders at High R&D firms exhibited the biggest
increase in net buying activity and this activity extended through all of the loss quarters we
examined. The results in Table 5 indicate that, on average, these trades were highly profitable if
held to the announcement of the break earnings as long as the break in the loss string occurred
within 10 quarters of the purchase. In this sense, the additional net buying by insiders at these
firms appears justified given their large average profitability. Together, these results provide
further evidence that when High R&D firms experience losses, purchase decisions by insiders
appear to be motivated by especially large amounts of private information. Aboody and Lev
(2000) document that during 6 months (12 months) following insider purchase in R&D firms,
mean market-adjusted return is 9.61% (8.56%).
We find a very different pattern of insider trading profitability when we examine
purchases made at No R&D firms. While the results show that the Break, String 1, String 2,
String 3, and Strings 5 & 6 are significantly positive (t-statistics range from 24.65 to 2.94), the
magnitudes of the coefficients are relatively modest. While insider purchases made during the
break quarter earn 12.05% on average, the average returns made during the loss quarters only
ranges from 7.24% to 2.94%. Furthermore, the String 4 and Strings 7 & 8 coefficients are not
significantly different from zero while the Strings 9 & 10 and Strings 11+ coefficients are
significantly negative (-21.79% and -14.63%, respectively). Therefore, at least for the quarters
nearer the break, the relatively modest magnitudes of the abnormal returns suggest that while

28

they are likely based on private information, on average, the amount of private information is
similar to the amounts possessed by insiders at profit firms.19
Lastly, we examine how abnormal returns to insider purchases vary cross-sectionally
between Persistent Loss and Transitory Loss firms. The results are reported in Panel C. The
pattern of returns and their magnitudes (and significance levels) are similar to those for High
R&D firms reported in Panel B. Insider trades made during the final loss quarter are highly
profitable (31.23% on average). Average returns peak at 54.86% in for trades made between five
and six quarters before the break quarter. Average returns then decline and are no longer
significantly profitable when made nine or more quarters before the break quarter.
Recall that the results in Table 4 indicated that insiders at Persistent Loss firms did not
display any tendency to increase their net buys during the periods leading up to the break
announcement, and if anything, had lower net buys during certain quarters. The results in Panel
C indicate that insider purchases at these firms tend to be highly profitable. Thus, the results
suggest that either most insiders at Persistent Loss firms do possess substantial private
information regarding the timing of the break or that for some reason, they are inhibited from
trading on this information.
The results for the Transitory Loss firms do not provide much support that purchases by
insiders at these firms are based on private information. Aside from purchases made during the
final loss quarter, which earn a modest abnormal return of 3.72%, average returns are never
positive for any of the other quarters during the loss string. Indeed, the String -3, Strings 9 &10,
and Strings 11+ coefficients are significantly negative. These results are in striking contrast to
the results reported in Table 4, which showed that insiders at Transitory Loss firms engaged in

19

In our discussion, we loosely equate the amount of private information with the magnitude of the abnormal returns
that insiders earn on their trades.

29

significantly higher net buys in all of the quarters during the loss string. The juxtaposition of
higher net buying and non-positive returns for all but the last loss string quarter suggests that
insiders at Transitory Loss firms do not actually possess private information about the upcoming
loss reversal although their trading behavior suggests that they believe they do.
5.4. Market reactions to insider purchases
In this section, we analyze the abnormal returns cumulated over the days of and
immediately after both the trade date and the filing date for insider purchases. Our sample
consists of all available firm-quarters for which we have sufficient data to run our tests. Note that
we do not require firms with losses to eventually report a profit in order to be included in the
sample (as was the case for the insider trading analyzes above). For ease of exposition, we refer
to both dates as the insider trading dates. In untabulated tests, our inferences are qualitatively
similar if we just use the filing dates in our tests, although the magnitudes of the abnormal
returns are smaller than the reported ones. Following Brochet (2010), we conduct the analyses
separately for both the pre- and post-SOX periods.
In our first analysis, we compare the mean FFARs on the insider trading dates for loss
firms and profit firms. The results are reported in Panel A of Table 6. Consistent with Brochet
(2010), the magnitudes of the abnormal returns are larger in the post-SOX periods compared to
their pre-SOX counterparts. Untabulated t-tests indicate that all of the differences are highly
significant. For ease of exposition, we focus our discussion on the post-SOX period.
Consistent with prior literature, abnormal returns are significantly positive on the insider
trading days for both profit and loss observations (t-statistics = 41.20 and 32.90, respectively).
The results show that the abnormal returns for loss observations is significantly larger than that
for profit firms (t-statistic = 22.68). The magnitude of the average FFAR for loss firms (2.63) is

30

more than twice the magnitude for profit firms (1.13). These findings indicate that the market
participants view insider purchase signals to be more informative when made by insiders at loss
firms compared to profit firms. Combined with the prior results that show insiders earn
substantial abnormal returns on their purchases at loss firms, these results suggest that trading by
insiders at loss firms help improve the price efficiency for these firms. However, given the
magnitude of the abnormal returns earned by insiders on their purchases at loss firms, the market
does not appear to be fully incorporating the information contained in the insider trading signal
during the short-window periods we examine. We investigate this issue further in section 5.5.
Next, we examine cross-sectional differences in the market reaction to insider purchases
at loss firms. In Panel B, we report mean FFARs for the High R&D and No R&D partitions. The
results show that R&D intensity and abnormal returns on the insider trading dates are positively
related. For High R&D firms, the mean FFAR is 3.87% and is highly significant (t-statistic =
21.77). For No R&D firms, the mean FFAR is drops to 2.12% (t-statistic = 20.12). The
difference between the High R&D and No R&D groups is economically large (1.75%) and
statistically significant (t-statistic = 8.53). These results support our prediction that market
participants will react more strongly to insider trading signals at more R&D intensive returns.
Our findings are consistent but the magnitudes are much larger than those reported in
Aboody and Lev (2000). They compare filing date returns (0, +1, +2) for firms with and without
R&D during the pre-SOX period, but they do not condition on whether the firm reports a loss.
The magnitudes of the abnormal returns they report (0.58% and 0.39% for R&D and No R&D
firms, respectively) are much smaller than the abnormal returns reported in Panel B for the preSox period. While not strictly comparable, the differences in magnitude suggest that by itself, the

31

presence or absence of R&D represents a much smaller source of information asymmetry

compared to the presence or absence of a loss.
Finally, we examine whether the market reaction to insider trading signals of loss firms
varies with the expected loss persistence. The results for the mean FFARs for the Persistent Loss
and Transitory Loss partitions are reported in Panel C. Similar to the results for the R&D
partitions, the results show a positive relation between expected loss persistence and abnormal
returns on the insider trading dates. Mean FFARs for Persistent Loss firms is 3.75% and highly
significant (t-statistic = 22.15). The mean falls to 1.16% (t-statistic = 10.48) for Transitory Loss
firms. The difference in means for the Persistent Loss and Transitory Loss groups is
economically and statistically significant (2.59%, t-statistic = 13.10). These results support our
prediction that market participants will react more strongly to insider trading signals with higher
expected loss persistence.
In summary, the results in Table 6 indicate that investors respond to the information
contained in the insider purchase signals. Furthermore, the strength of the reaction is consistent
with the strength of the insider trading signal, as measured by the average profitability of the
insider purchases that we documented in Table 5. To the extent that insider purchases at loss
firms signal undervaluation, our results indicate that insider trading helps improve price
efficiency of loss firms, at least in the short-term. We examine insider trading is associated with
improved price efficiency over longer periods in the next section.
5.5. Insider Trading and market efficiency around and after negative earnings
announcements
In this section, we examine to what extent insider purchases prior to a negative earnings
announcement is associated with the markets reaction to the earnings announcement as well any
post-earnings announcement drift. We examine three returns windows: 1) the announcement
32

period (-1, +1); 2) the one quarter post-announcement period (+2, +61); and 3) the first two
quarters after the announcement (+2, +121). For each return period, we calculate average FFARs
for five partitions of the data: the full sample, High R&D, No R&D, Persistent Loss, and
Transitory Loss. We predict that insider purchases lessens the underpricing of loss firms. The
results are presented in Table 7.
In Panel A, we present the average FFARs for each announcement period without
conditioning on the level of insider trading. Consistent with the conclusions in Balakrishnan et
al. (2010) and Li (2011), we find evidence consistent with investors being negatively surprised
when the loss is announced. Average abnormal returns for all loss firms around the earnings
announcement are -1.508% and the result is highly significant (t-statistic = 42.38). Furthermore,
returns continue to drift down during the post-announcement periods by about 1%. Thus, our
evidence indicates that loss firms, in general, are inefficiently priced.
We find that the pattern of returns varies significantly between the High R&D firms and
No R&D firms. While average announcement period returns are significantly negative for both
groups, the returns for the High R&D firms are significantly less negative (-1.354 vs. -1.561; tstatistic for the difference = 2.43). For High R&D firms, the negative returns are essentially
offset by positive PEAD over the first quarter (1.222%). The upwards drift continues in the
second period, where the total two quarter drift is 2.169%. In contrast, returns for the No R&D
firms continue to drift downwards by 3.204% over the next two quarters.
We also the pattern of returns varies between the Persistent Loss and Transitory Loss
firms during the post-announcement period. However, during the announcement period, both
partitions experience negative abnormal returns (-1.462 and -1.489, respectively). These returns
are not significantly different (t-statistic = 0.30). Persistent Loss firms do not experience any

33

systematic returns drift during the post-announcement quarters. In contrast, the Transitory Loss
firms continue to experience negative abnormal returns (although the magnitudes are relatively
modest compared to the drift experience by No R&D firms.
Having the unconditional results, we now examine how abnormal returns around and
following the negative earnings announcements vary across the High Buy and No Buy partitions
for each of the five partitions. The results for the Full Sample are presented in Panel B. They
show that abnormal returns for both the High Buy and No Buy groups are significantly negative
during the announcement period (-1.34% and -1.56%, respectively). Consistent with our
prediction, abnormal returns are significantly less negative (by 0.22%) among the High Buy
firms (t-statistic = 2.27).
Examining the post-announcement results for the Full Sample, we find no evidence of
PEAD over either time horizon (t-statistics = -0.90 and -0.30, respectively) for High Buy firms.
However, PEAD is negative and significant for the No Buy firms over both time horizons (tstatistics = -7.47 and -5.02, respectively). Furthermore, the differences in PEAD across the High
Buy and No Buy groups are significant for the first post-announcement quarter (t-statistic = 2.43)
and marginally significant for the first two post-announcement quarters (t-statistic = 1.91). Thus,
for the overall sample, the results indicate that prices during the first two post-announcement
quarters are more efficient when insiders have been relatively active purchases during the
periods leading up to the negative earnings announcement.
Next we examine how insider buying behavior is associated with returns for High R&D
firms. The results are presented in Panel C. They show that while both groups experience
negative abnormal returns around the earnings announcement, the difference between the High
Buy and No Buy firms is not significant (t-statistic = 0.56). However, PEAD varies significantly

34

between them. Firms in the High R&D and High Buy partition experience significant positive
PEAD: 3.29% over the first quarter and 6.33% over the first size months. Recall that this
follows that positive abnormal returns around the insider trading days. Among the High R&D
and No Buy firms, post-announcement returns are still significantly positive, but are relatively
small in magnitude (0.69% and 1.58%, respectively). In addition, the differences in PEAD are
statistically significant for both post-announcement horizons (t-statistics = 3.19 and 3.83,
respectively). Thus, among High R&D firms, prior insider purchasing behavior is significantly
associated with abnormal returns around the negative earnings announcement date as well as for
at least 6 months after the announcement.
The results in Panel C also show that No R&D firms experience economically and
statistically significant negative abnormal returns across all three time horizons (-1.52% and 1.60%, respectively, during the announcement period and -3.42% and -3.31%, respectively, over
the six month post-announcement period). In contrast to the High R&D firms, none of the
differences between the High Buy and No Buy groups is significant (t-statistics range from -0.15
to 0.33). Thus, while Tables 4 and 5 show that insiders at No R&D firms exhibit additional net
buying during at least some of the loss string quarters and that insiders earn modest but positive
abnormal returns on those trades, their relatively modest buying activity is not associated with
abnormal returns around and after negative earnings announcements. One explanation for the
differences is that while the Tables 4 and 5 analyses assumed perfect foresight of the break
quarter, the analyses in Table 8 do not.
With one exception, the patterns of returns in Panel D for both the Persistent Loss and
Transitory Loss firms are similar to each other. Across both the High Buy and No Buy partitions,
abnormal returns are significantly negative during the announcement period, but the differences

35

are not significant. For Persistent Loss-High Buy firms, PEAD is positive but insignificant in
both time horizons (t-statistics = 1.26 and 1.60, respectively) while PEAD is negative but not
significant for Persistent Loss-No Buy firms (t-statistics = -1.81 and -1.60, respectively). The
differences between the two groups is positive and significant across both time horizons (1.96
and 2.20, respectively). In contrast, the differences in drift between High Buy and No Buy firms
in the Transitory Loss partitions are not significant. Thus, the buying activity of insiders is
associated with announcement and post-announcement returns at Persistent Loss firms but not
Transitory Loss firms. These findings are consistent with insider purchases at Persistent Loss
firms being based on private information (as Table 5 shows they are very profitable, on average)
while those at Transitory Loss firms do not appear to be based on private information.
6. Conclusion
In summary, our evidence suggests that 1) insider purchases prior to loss reversals are
highly profitable to insiders when information asymmetry between insiders and outsiders is
expected to be high: 2) market reactions to such insider trades suggests that investors at least
partially recognize their differential information content; and 3) more intensive insider trading at
loss firms is associated with the more efficient pricing of loss firms.
In this paper, we study the insiders trading behavior at loss firms and its association with
the price efficiency of loss firms. Our results suggest that insiders at loss firms engage in
significantly more net buying compared to insiders at profit firms for up to 10 quarters prior to
the break quarter. We find the increases in net buying are concentrated in High R&D firms and
Transitory Loss firms; No R&D firms exhibit only limited increases in net buying before the
break quarter while Persistent Loss firms experience somewhat lower net buying by insiders
before the break.

36

We then examine the profitability of insider purchases at loss firms. We find that insiders
earn economically large profits from their trades when they are made up to eight quarters before
the break quarter. In addition, trades made by insiders at High R&D firms and Persistent Loss
firms are generally the most profitable. Abnormal returns peak at 53.8% for purchases made
three quarters before the break quarter at High R&D firms and at 54.9% for purchases made five
to six quarters before the break quarter at Persistent Loss firms. In contrast, purchases made at
No R&D firms and Transitory Loss firms exhibit limited profitability.
We find evidence consistent with at least some investors recognizing the differential
pricing signals of disclosures of insider purchases at loss firms. The differences in returns are
consistent with differences in the profitability of insider purchases that we document across the
various partitions. We also examine whether the intensity of insider purchases is associated with
abnormal returns around the announcement of negative earnings and the subsequent two
quarters. Consistent with our predictions, we find that PEAD is significantly less negative among
High Buy firms compared to No Buy firms. This association also holds in the High R&D and
Persistent Loss partitions, but not in the No R&D and Transitory Loss partitions. Thus, the
partitions in which insider purchase intensity is associated with less negative abnormal returns
correspond to those partitions in which insider purchases are especially profitable. In summary,
our results suggest that when insider purchases at loss firms appear to be based on substantial
private information regarding the end of the loss string, prices are more efficient.

37

Appendix A
Loss Persistence Prediction Model
Joos and Plesko (2005) develop a loss-reversal model to classify observations based on the
predicted future persistence of losses, specifically whether losses are predicted to be persistent or
transitory. Their model estimates investors ex ante assessment of whether a reported loss in year
t will persist in year t+1 or turn into a profit, using data from year t-5 to year t. They then use the
estimated coefficients from the model to compute predicted probabilities of loss reversal in the
following year. Finally, they rank predicted probabilities of loss reversals from low to high, and
define persistent (transitory) losses those with low (high) predicted probabilities of reversals.
We estimate a similar loss-reversal model at the quarterly level to classify quarterly
losses into predicted persistent or transitory losses. Following Joos and Plesko (2005), we
include profitability variables (ROA and past ROA), firm characteristics (size and sales growth),
the incidence and frequency of past losses, and dividend information. We expect high current
profitability, high past profitability, large firm size, and high sales growth to be associated with
high probability of a loss turning into a profit. We also conjecture that if the loss is the first loss
reported in a string, and if the firm continues to pay dividends while incurring a loss, the
probability of a loss reversal is high. Conversely, if the loss string is long and if the firm stops
paying dividends while incurring a loss, the probability of a loss reversal is low.
We augment the model with three additional variables: the R&D activity of the firm in the recent
past (Joos and Plesko 2005, Darrough and Ye 2007, Dhaliwal et al. 2013), the age of the firm
(Dhaliwal et al. 2013), and whether special items are negative (i.e., reducing earnings) (Darrough
and Ye 2007, Li 2011). We expect firms engaged in R&D to have low probabilities of loss
reversals, whereas we predict older firms and reported losses with negative special items to be
associated with high probabilities of loss reversals. Accordingly, we estimate the following
quarterly loss reversal logistic regression model:

Reversalq 1 1ROAq 2 ROA[ q 4;q 1] 3 Sizeq 1 4 SalesGrowthq

5 FirstLossq 6 LossDurationq 7 DivDumq 8 DivStopq

(A.1)

9 R&DA[ q 4;q 1] 10 Ageq 11 NegSPI q q 1

where Reversalq+1 is an indicator variable equal to one if the loss in quarter q turns into a profit
in quarter q+1, zero otherwise. Other variables are defined in the notes to Table A.1 below. We
estimate Equation A.1 using eight previous quarters to obtain coefficient estimates to apply to a
current quarter to predict the probability that the loss in the following quarter will reverse. We
then rank the quarterly loss reversal probabilities from low to high, and assign quarterly
observations in the lowest (highest) tercile in the predicted transitory (persistent) loss
subsamples.
Table A.1 reports the results of the estimation of Equation A.1 computed using the Fama and
MacBeth (1973) procedure (i.e., averages of coefficients based on quarterly estimations of the
model). Table A.1 reports results without (Model I) and with (Model II) the variables added to
the Joos and Plesko (2005) model. For our analyses, we use the results from the estimation of
Model II to classify observations into predicted transitory or persistent losses.
38

Table A.1: Loss Reversal Logistic Regression Model

Reversalq 1 1 ROAq 2 ROA[ q 4;q 1] 3 Sizeq 1 4 SalesGrowthq 5 FirstLossq 6 LossDurationq

7 DivDumq 8 DivStopq 9 R&D[ q 4; q 1] 10 Ageq 11 NegSPI q q 1
Variable

Expected
Sign

ROAq

ROA[q-4;q-1]

Sizeq-1

SalesGrowthq

FirstLossq

LossDurationq

DivDumq

DivStopq

R&D[q-3;q]

Ageq

NegSPIq

Average Nb. of Firm-Quarters

Average Likelihood Ratio p-value
Average Pseudo R2 (%)

Coefficient
(t-statistics)
Model I
Model II
3.895
4.542
(18.43)
(19.94)
1.401
1.418
(25.03)
(25.64)
0.045
0.014
(6.72)
(2.22)
0.104
0.114
(9.70)
(9.83)
0.222
0.197
(8.63)
(7.34)
-0.106
-0.099
(-19.52)
(-18.52)
0.494
0.426
(13.85)
(12.22)
0.044
0.100
(0.78)
(1.75)
-1.463
(-2.89)
0.009
(8.53)
0.446
(14.26)
1,232
0.0000
15.56

1,232
0.0000
16.70

Notes:
This table presents the results from the logistic regression model presented above. Reported coefficients are the
average coefficients over the sample period 1988-2010 and associated t-statistics (in parenthesis) derived using the
Fama and MacBeth (1973) procedure. Bolded coefficients and t-statistics are statistically significant (two-tailed pvalues < 0.10). The dependent variable Reversal is an indicator variable equal to one if the loss in quarter q turns
into a profit in quarter q+1, zero otherwise. ROA is the rank of return on assets in quarter q (measured as income
before extraordinary items scaled by lagged total assets), scaled to range between zero and one. ROA[q-4;q-1] is the
rank of the average return on assets over quarters q-4 to q-1, scaled to range between zero and one. Size is the
natural logarithm of market value of equity at the end of quarter q-1. SalesGrowth is the percentage growth in sales
in quarter q relative to quarter q-4. FirstLoss is an indicator variable equal to one if the loss in quarter q is the first in
a string, zero otherwise. LossDuration is the number of consecutive quarters since the firm first reported a loss in the
current loss string, including quarter q loss. DivDum is an indicator variable equal to one if the firm is paying
dividends in quarter q, zero otherwise. DivStop is an indicator variable equal to one if the firm stops paying
dividends in quarter q, zero otherwise. R&D is R&D expense scaled by lagged total assets, averaged over quarters q3 to q. Age is the number of years since the firm first appeared on Compustat. NegSPI is an indicator variable equal
to one if special items in quarter q are negative, zero otherwise.

39

Table 1: Sample Selection

Sample Selection Criteria

Loss String Tests Sample Size
All rm-quarter observations with at least two consecutive
quarterly earnings data in the Compustat database and also
part of the CRSP database during sample period 1988-2010
Less firm-quarters that are part of a loss string that breaks
after calendar year 2012
Less firm-quarters for which we cannot identify loss string
length or break
Less firm-quarters with missing data required to construct
main variables
Less firm-quarters with negative book value of equity or
stock price at the end of the quarter less than $1
Less firm-quarters with quarterly earnings announcement date
missing or more than 60 days after the fiscal quarter end
Less firm-quarters with missing required stock return data
Loss String Tests Sample Size

Number of
FirmQuarters

Number of
FirmQuarters in a
Loss String

508,595

197,850

503,852

193,107

465,492

154,747

446,427

147,788

410,999

120,822

382,429

106,577

329,804

89,402

329,804

89,402

Sample Selection Criteria

Insider Purchase Tests Sample Size
All insider trading transactions made by officers and directors during
sample period 1988-2010
Less transactions without sufficient level of accuracy and reasonableness
(TFN Cleanse Indicator = R or H)
Less transactions occurred outside of the open market
Less transactions with missing transaction price and shares
Less transactions made by same insider at same transaction/filing date
Less transactions without four consecutive quarterly earnings data,
positive book value of the equity, stock price at the end of the quarter
greater than $1, and non-missing earnings announcement date
Less transactions with missing required stock return data
Less non-buy transactions
Insider Purchase Tests Sample Size
Note: 183,344 insider purchase transactions, of which 41,848 (141,496)
transactions occurred in loss (profit) firm-quarters.

Number of
Transactions
10,081,043
5,932,688
3,007,545
3,007,087
935,802
651,906

630,616
183,344
183,344

40

Table 1 (contd)

Sample Selection Criteria

Quarterly Loss Announcement Tests Sample Size
All loss rm-quarter observations in the Compustat database and also part
of the CRSP database during sample period 1988-2010
Less firm-quarters without four consecutive quarterly earnings data
Less firm-quarters with negative book value of equity or stock price at the
end of the quarter less than $1
Less firm-quarters with quarterly earnings announcement date missing or
more than 60 days after the fiscal quarter end
Less firm-quarters with missing required stock return data
Quarterly Loss Announcement Tests Sample Size

Number of
FirmQuarters
158,830
137,201
104,402
90,212
80,958
80,958

41

Table 2
Descriptive Statistics
Variable

Q1

Mean

Median

Q3

Std. Dev.

Panel A: All Firm-Quarters (N=329, 804)

NetBuy
-5.000
MVE
64.62
BM
0.338
LossDuration
0.000
RawRet[-12mo;-1mo] (in %)
-16.779
RawRet[-2;+1] (in %)
-3.323
RawRet[+1mo;+6mo] (in %)
-12.500
RawRet[+7mo;+12mo] (in %)
-12.375

-25.609
2,017.79
0.661
0.812
17.596
0.648
7.317
7.343

0.000
257.79
0.554
0.000
8.333
0.000
4.393
4.455

0.000
1,099.98
0.839
0.000
36.923
4.184
22.152
22.083

94.773
6,016.65
0.479
2.591
58.333
8.244
34.816
35.122

Panel B: Loss Firm-Quarters (N=63,378)

NetBuy
0.000
MVE
36.33
BM
0.324
LossDuration
1.000
RawRet[-12mo;-1mo] (in %)
-41.844
RawRet[-2;+1] (in %)
-6.250
RawRet[+1mo;+6mo] (in %)
-23.077
RawRet[+7mo;+12mo] (in %)
-21.053

-13.806
845.81
0.795
4.225
-0.566
-1.052
6.213
8.199

0.000
117.47
0.633
2.000
-14.065
-1.018
0.000
2.041

0.000
420.64
1.067
6.000
19.462
3.491
25.965
28.134

76.039
3,347.17
0.636
4.528
64.900
9.608
44.987
45.669

0.000
130.39
0.684
-5.436
1.047
3.145
4.659
1.000
0.056
0.968
-0.380

0.000
571.43
1.090
25.000
6.845
25.017
26.089
3.000
13.645
6.224
12.793

79.036
4,080.99
0.601
60.147
9.649
40.153
40.095
2.827
26.438
10.119
25.334

Panel C: Firm-Quarters Breaking a Loss String (N=26,024)

NetBuy
0.000
-15.028
MVE
34.31
1,130.67
BM
0.409
0.835
RawRet[-12mo;-1mo] (in %)t
-31.782
5.757
RawRet[-2;+1] (in %)
-2.730
2.548
RawRet[+1mo;+6mo] (in %)
-17.328
7.513
RawRet[+7mo;+12mo] (in %)
-14.461
9.223
LossStringLength
1.000
2.419
BHAR[-45;-2] (in %)
-11.974
2.247
BHAR[-1;+1] (in %)
-2.956
2.318
BHAR[+2;+45] (in %)
-12.638
0.867

Notes:
This table presents selected descriptive statistics. The sample covers years 1988 to 2010. NetBuy is the net total
number of shares traded (purchases minus sales) from one day after earnings announcement of the prior quarter to
the end of the current quarter (in thousand shares). MVE is the market value of the equity at the beginning of the
quarter (in million dollars). BM is the book-to-market ratio at the beginning of the quarter. LossDuration is the
number of the quarters since the loss string started, inclusive of the current quarter. RawRet is buy-and-hold raw
stock returns for the window specified (in months or in days), where day zero is the quarterly earnings
announcement date. LossStringLength is the number of consecutive loss quarters before the loss string break
quarter. BHAR is buy-and-hold abnormal stock returns for the window specified, where day zero is the quarterly
earnings announcement date of the loss string break. Abnormal returns are measured using Carharts (1997) four
factor model. For firms that delist during the return window, the remaining return is calculated by using the
delisting return from the CRSP database, and then reinvesting any remaining proceeds in the appropriate benchmark
portfolio.

42

Table 3
Stock Price Response to Breaks of Loss Strings
Subsample

All Firm-Quarters Breaking a Loss String

Nb. Of
FirmQuarters

Mean Buy-and-Hold Abnormal Returns (in %)

(t-statistic)
[-45; -2]
[-1; +1]
[+2; +45]

26,014

2.247
(13.71)

2.318
(36.95)

0.867
(5.52)

By R&D Intensity:
High R&D

5,215

Low R&D

4,155

No R&D

16,644

5.272
(12.59)
3.249
(7.87)
1.050
(5.42)

3.011
(18.62)
2.789
(17.17)
1.983
(27.02)

1.401
(3.51)
0.857
(2.21)
0.703
(3.75)

6.929
(10.52)
2.701
(7.98)
0.687
(3.50)

4.404
(18.12)
2.904
(21.38)
1.282
(16.28)

1.628
(2.75)
0.632
(1.90)
0.693
(3.55)

By Predicted Loss Persistence:

Persistent Loss

2,674

Mid

6,375

Transitory Loss

10,865

Notes:
This table presents buy-and-hold abnormal stock returns for the windows [-45; -2], [-1; +1], and [+2; +45], where
day zero is the quarterly earnings announcement date of the loss string break. The sample covers years 1988 to
2010. Bolded returns and t-statistics are statistically significant (two-tailed p-values < 0.10). Abnormal returns are
measured using Carharts (1997) four factor model. For firms that delist during the return window, the remaining
return is calculated by using the delisting return from the CRSP database, and then reinvesting any remaining
proceeds in the appropriate benchmark portfolio.

43

Table 4
Insider Trading before Breaks of Loss Strings

Variable

Nb. of
FirmQuarters
Full Sample

Break

26,024

String1

23,889

String2

10,909

String3

6,238

String4

3,941

String5to6

5,426

String7to8

3,541

String9to10

2,396

String11+

7,038

Full Sample

Coefficient
(t-statistic)
By R&D Intensity
High R&D
No R&D

By Predicted Persistence
Persistent
Transitory

2.211
(3.11)
4.519
(6.15)
3.894
(4.38)
5.196
(4.73)
4.853
(3.66)
3.552
(2.49)
4.745
(2.86)

5.723
(3.36)
11.700
(6.67)
11.175
(5.00)
12.808
(5.83)
11.770
(5.52)
8.583
(3.48)
11.045
(3.95)

0.275
(0.41)
2.481
(2.98)
2.315
(2.23)
2.777
(2.20)
1.821
(0.90)
1.667
(0.91)
2.333
(1.10)

-4.550
(-2.48)
-4.416
(-2.16)
-2.223
(-1.13)
-1.445
(-0.68)
-3.935
(-1.85)
-6.436
(-2.42)

4.144
(1.89)
2.764
(1.16)

9.579
(2.77)
8.984
(2.94)

2.297
(0.73)
4.897
(1.67)

-4.225
(-1.23)
-5.620
(-1.57)

-20.797

-21.945

20.732

-21.598

(-20.63)

(-19.83)

(20.39)

(-20.55)

-8.383

-7.394

-8.194

-8.302

(-7.30)

(-5.30)

(-6.61)

(-6.67)

-0.066

0.068

-0.781

0.640

(-0.52)

(0.41)

(-3.29)

(3.27)

-0.213

-0.230

-0.226

-0.225

(-18.37)
0.163
(7.16)
0.026
(2.90)
0.024
(3.11)

(-18.28)
0.197
(7.37)
0.028
(2.67)
0.027
(3.06)

(18.09)
0.187
(7.25)
0.024
(2.62)
0.023
(2.90)

(-18.81)
0.178
(7.54)
0.028
(2.83)
0.027
(3.34)

Size

BM

LossDuration

RawRet[-12mo;+1mo]

RawRet[-2;+1]
RawRet[+1mo;+6mo]
RawRet[+7mo;+12mo]

8.927
(5.61)
8.740
(5.20)
4.939
(2.13)
8.657
(2.57)
9.940
(3.45)
9.249
(2.52)
14.16
1
(2.99)
9.487
(1.81)
21.50
4
(20.26
)
8.213
(6.31)
1.913
(1.89)
0.238
(18.38
)
0.193
(7.27)
0.029
(2.93)
0.025
(3.20)

44

Year Fixed Effects

Quarter Fixed Effects
Nb. of Profit Firm-Quarters
Nb. of Loss Firm-Quarters
2
Adjusted R (in %)

266,426
63,378
6.05

245,616
22,060
6.37

Included
Included
257,055
266,426
32,002
19,095
5.79
6.15

266,426
19,095
6.07

Notes:
This table presents the result from the regression of NetBuy on dummy variables indicating the time between the
current quarter and the loss string break quarter. The sample covers years 1988 to 2010. Bolded coefficients and tstatistics are statistically significant (two-tailed p-values < 0.10). Year and quarter fixed effects are included but not
reported for brevity. Standard errors are clustered by both firm and quarter. NetBuy is the net total number of shares
traded (purchases minus sales) from one day after earnings announcement of the prior quarter to the end of the
current quarter (in thousand shares). Break is an indicator variable equal to one if the current quarter is the loss
string break quarter, zero otherwise. StringX is an indicator variable equal to one if the current quarter is part of a
loss string at least X quarters long and is X quarters before the loss string break quarter, zero otherwise. Size is the
natural logarithm of the market value of the equity at the beginning of the quarter. BM is the book-to-market ratio at
the beginning of the quarter. LossDuration is the number of the quarters since the loss string started, inclusive of the
current quarter. RawRet is buy-and-hold raw stock returns for the window specified (in months or in days), where
day zero is the quarterly earnings announcement date.

45

Table 5
Abnormal Stock Returns from Insider Purchase Transactions to Breaks of Loss Strings
Quarter
Relative
to the Break

Nb. of
Insider
Purchases
Full
Sample

16,033

-1

13,355

-2

6,004

-3

3,183

-4

2,095

-5 to -6

2,528

-7 to -8

1,455

-9 to -10

Full
Sample

Mean Buy-and-Hold Abnormal Returns (in %)

(t-statistic)
By R&D Intensity
By Predicted Persistence
High R&D
No R&D
Persistent
Transitory

16.152
(37.20)
11.843
(26.51)
13.686
(16.53)
24.945
(17.79)
22.472
(11.53)
23.660
(12.17)
16.358
(6.23)
-3.263

31.638
(25.32)
28.990
(22.30)
34.939
(17.13)
53.844
(21.02)
50.395
(15.08)
47.465
(14.06)
30.940
(8.23)
13.788

(-0.96)
-4.259
(-1.56)

(2.71)
-4.993
(-1.61)

894
-11 and before

1,571

12.048
(24.65)
6.016
(12.16)
5.968
(6.29)
7.243
(4.19)
-0.619
(-0.25)
7.526
(2.94)
3.398
(0.78)
21.794
(-4.52)
-14.631
(-1.96)

31.232
(17.96)
30.691
(15.20)
47.179
(17.20)
41.347
(12.87)
54.855
(16.42)
27.531
(6.96)
2.448

3.722
(7.88)
0.608
(0.58)
-6.789
(-2.99)
-5.383
(-1.53)
4.329
(1.06)
0.456
(0.08)
-30.654

(0.45)
-3.375
(-1.04)

(-3.79)
-37.536
(-5.07)

Notes:
This table presents buy-and-hold abnormal stock returns from the day of the insider purchase transaction to i) two
days after the quarterly earnings announcement date of the loss string break, or ii) 120 trading days after the insider
purchase transaction, whichever date is later. The sample covers years 1988 to 2010. Bolded returns and t-statistics
are statistically significant (two-tailed p-values < 0.10). Abnormal returns are measured using Carharts (1997) four
factor model. For firms that delist during the return window, the remaining return is calculated by using the
delisting return from the CRSP database, and then reinvesting any remaining proceeds in the appropriate benchmark
portfolio. Observations are grouped according to the number of quarters between the insider purchase transactions
and the loss string breaks.

46

Table 6
Abnormal Stock Returns around Insider Purchase
Transaction Dates and SEC Filing Dates
Subsample

Nb. of Insider Purchases

Pre-SOX

All Loss Firm-Quarters

All Profit Firm-Quarters

23,771
89,537

Post-SOX
18,077
51,959

Loss vs. Profit Firm-Quarters

By R&D Intensity:
High R&D

5,146

3,819

12,429

10,579

By Predicted Loss Persistence:

Persistent Loss

5,991

5,095

Transitory Loss

8,077

5,878

No R&D
High vs. No R&D

Persistent vs. Transitory Loss

Mean BHAR (in %)

(t-statistic)
Pre-SOX
Post-SOX
1.634
(20.13)
0.825
(31.03)
0.809
(12.19)

2.632
(32.90)
1.130
(41.20)
1.502
(22.68)

2.277
(11.64)
1.167
(11.32)
1.110
(5.45)

3.869
(21.77)
2.118
(20.12)
1.751
(8.53)

2.273
(11.98)
0.821
(7.77)
1.452
(7.11)

3.753
(22.15)
1.163
(10.48)
2.590
(13.10)

Notes:
This table presents buy-and-hold abnormal stock returns around insider purchase transaction dates and SEC filing
dates. Two windows are compounded: [0; +2] where day zero is the insider purchase transaction date and [0; +2]
where day zero is the insider purchase SEC filing date. If the two windows overlap, abnormal returns are calculated
from the insider purchase transaction date to two days after the insider purchase SEC filing date. The sample covers
years 1988 to 2010 (pre-SOX and post-SOX correspond to insider transactions completed before and on or after
August 29, 2002, respectively). Bolded returns and t-statistics are statistically significant (two-tailed p-values <
0.10). Abnormal returns are measured using Carharts (1997) four factor model. For firms that delist during the
return window, the remaining return is calculated by using the delisting return from the CRSP database, and then
reinvesting any remaining proceeds in the appropriate benchmark portfolio. .

47

Table 7
Abnormal Stock Returns around and following Quarterly Loss Announcements
Panel A: All Firm-Quarters
Subsample

Nb. Of
FirmQuarters

Mean Buy-and-Hold Abnormal Returns (in %)

(t-statistic)
[-1; +1]
[+2; +61]
[+2; +121]

All Loss Firm-Quarters

80,953

-1.508
(-42.38)

-0.983
(-7.60)

-0.975
(-4.96)

By R&D Intensity:
High R&D

21,931

No R&D

37,042

-1.354
(-18.56)
-1.561
(-31.59)
0.207
(2.43)

1.222
(4.39)
-2.454
(-13.81)
3.676
(11.67)

2.169
(5.14)
-3.204
(-11.85)
5.373
(11.23)

-1.462
(-20.55)
-1.489
(-26.79)
0.027
(0.30)

-0.197
(-0.72)
-0.875
(-4.84)
0.678
(2.06)

-0.170
(-0.41)
-0.572
(-2.08)
0.402
(0.81)

High vs. No R&D

By Predicted Loss Persistence:

Persistent Loss

24,040

Transitory Loss

24,041

Persistent vs. Transitory Loss

Panel B: All Firm-Quarters, by Insider Purchase Activity

Subsample

Nb. Of
FirmQuarters

All Loss Firm-Quarters:

High Insider Purchase Activity

12,929

No Insider Purchase Activity

53,710

High vs. No Insider Purchase Activity

Mean Buy-and-Hold Abnormal Returns (in %)

(t-statistic)
[-1; +1]
[+2; +61]
[+2; +121]

-1.341
(-14.78)
-1.565
(-36.16)
0.224
(2.27)

-0.302
(-0.90)
-1.180
(-7.47)
0.878
(2.43)

-0.156
(-0.31)
-1.206
(-5.02)
1.050
(1.91)

48

Table 7 (contd)
Panel C: High and No R&D Subsamples, by Insider Purchase Activity
Subsample

High R&D Subsample:

High Insider Purchase Activity
No Insider Purchase Activity

Nb. Of
FirmQuarters

3,079
14,617

High vs. No Insider Purchase Activity

No R&D Subsample:
High Insider Purchase Activity
No Insider Purchase Activity

6,635
24,509

High vs. No Insider Purchase Activity

Mean Buy-and-Hold Abnormal Returns (in %)

(t-statistic)
[-1; +1]
[+2; +61]
[+2; +121]

-0.889
(-4.50)
-1.453
(-16.49)
0.563
(2.65)

3.292
(4.18)
0.691
(2.06)
2.601
(3.19)

6.332
(5.27)
1.579
(3.09)
4.753
(3.83)

-1.523
(-12.70)
-1.603
(-26.52)
0.079
(0.60)

-2.163
(-5.04)
-2.498
(-11.41)
0.335
(0.70)

-3.418
(-5.23)
-3.311
(-9.93)
-0.107
(-0.15)

Panel D: Predicted Persistent and Transitory Loss Subsamples, by Insider Purchase Activity
Subsample

Predicted Persistent Loss Subsample:

High Insider Purchase Activity
No Insider Purchase Activity

Nb. Of
FirmQuarters

3,622
16,247

High vs. No Insider Purchase Activity

Predicted Transitory Loss Subsample:

High Insider Purchase Activity
No Insider Purchase Activity
High vs. No Insider Purchase Activity

3,994
15,225

Mean Buy-and-Hold Abnormal Returns (in %)

(t-statistic)
[-1; +1]
[+2; +61]
[+2; +121]

-1.279
(-6.83)
-1.516
(-17.80)
0.236
(1.18)

0.933
(1.26)
-0.595
(-1.81)
1.528
(1.96)

1.785
(1.60)
-0.794
(-1.60)
2.579
(2.20)

-1.588
(-11.35)
-1.528
(-21.97)
-0.059
(-0.39)

-0.791
(-1.69)
-0.796
(-3.51)
0.006
(0.01)

-1.248
(-1.79)
-0.280
(-0.81)
-0.968
(-1.27)

Notes:
This table presents buy-and-hold abnormal stock returns for the windows [-1; +1], [+2; +61], and [+2; +121], where
day zero is the quarterly loss announcement date. The sample covers years 1988 to 2010. Bolded returns and tstatistics are statistically significant (two-tailed p-values < 0.10). Abnormal returns are measured using Carharts
(1997) four factor model. For firms that delist during the return window, the remaining return is calculated by using
the delisting return from the CRSP database, and then reinvesting any remaining proceeds in the appropriate
benchmark portfolio.

49

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