Insider trading as a signal used in investment decisions on the AltX : the influence of insider ownership and control

Abstract

Much work has been conducted on the signalling effect that a directors’ trade has on outsiders. This is based on the premise that insiders, or directors, shareholders and managers of companies have access to information about their companies that outsiders do not (Bhana, 2007; Fidrmuc, Goergen and Renneboog, 2006; Hodgson and van Praag, 2006), raising questions about the efficiency of markets (Fidrmuc, Goergen and Renneboog, 2004). Other research concludes that the greater the shareholding percentage or percentage control held by an insider, the greater would be their access to company information, and that this would lead directly to an increase in the strength of the signal to the market. Hillier and Marshall (2002) find that the abnormal returns occur most strongly where directors have increased their shareholding. Fidrmuc, Goergen and Renneboog in various studies found that the opposite is true, particularly for purchases, citing a perceived danger of increased entrenchment as the reason for this anomaly. This study will use the AltX of the JSE and attempt to show that there is a positive return on shareholder investment following an insider purchase and a negative return on investment following an insider sale as outsiders react to these signals and the information contained in these trades. This study will also attempt to prove that the percentage control of a director who purchases their own shares has an inverse relationship to the abnormal returns. This study uses the event study methodology and analyses the abnormal returns in the event windows extending back to twenty days prior to the events and for the following twenty days after the event. Abnormal returns are modelled using the control portfolio model of Mordant and Muller (2003) which is based on the Fama and French Three-Factor model. These abnormal returns are then tested for significance using T-tests and the bootstrapping technique. Relationships between shareholding interest and returns is established using linear correlation. No statistical significance could be found on the returns compared to the market following either a purchase or sale insider trade. However, it was found that the reaction to purchases was significantly higher than the reaction to sales, and results indicate that the reaction to sales on the AltX of the JSE leads to abnormal losses in the short term. This study finds that there is no indistinguishable relationship between shareholding and returns that are different to zero. While it is clear that other bourses internationally demonstrate clear evidence of the existence of signals contained in insider trades, and other South African studies find corroborative evidence on the JSE main board, there is no evidence that insider trades on the AltX contain any signalling value in them for outsiders, particularly pertaining to purchases. Although not economically significant, sales do suggest that there is information contained in the trade, but is this reaction in the market due to the information contained in the trade, or simply due to a culture of trading on market sentiment?