There is an extensive literature in finance, which documents that executive and non-executive directors have an informational advantage when they trade in the shares of their firm. However, even if directors trade after the announcement of material information to the public, they may still convey information to the market about the firm’s prospects. Such information may include information that is broader than firm-specific data, such as data on peers and wider trends in the industry. We argue that directors obtain such information via the board seats they hold in other firms.
In our study, we use network analysis to measure the connectedness of the executive and non-executive directors of UK listed firms and to examine whether a director’s connectedness – or centrality in the network – has an impact on the market reaction to his insider trades. In addition, we investigate whether director centrality also affects the frequency, value and profitability of insider trades. We distinguish between the following types of insider transactions: purchases and sales, transactions by the various types of insider (e.g., the CEO and the chairman), and routine and non-routine or opportunistic trades. We expect that the centrality of the director matters more for opportunistic rather than non-routine trades.
What do we find? First, the market reaction to the insider trades of better connected directors is stronger. Second and as expected, the effect of director centrality on the market reaction is only observed for opportunistic trades. These results are robust to the use of alternative measures of director centrality, additional measures of insider trading patterns, alternative event windows and sub-sample analysis. Finally, and somewhat surprisingly, better connected directors trade less frequently than the remaining directors. Still, their trades are more profitable.
This study makes at least three contributions to the literature. First, to the best of our knowledge it is the first systematic study of the relation between insider trading and director connectedness using network analysis. Second, the study confirms that the gains insiders make from trading their firm’s shares depend not only on firm-specific information – as amply documented by extant literature – but also by non-firm-specific information. Finally, in contrast to existing studies this study goes beyond the analysis of the gains from insider trades as it also investigates how network centrality affects trading patters such as trading frequency. We find consistent evidence that network centrality affects insiders’ trading patterns.