Executives know how to manipulate investors

Corporate insiders are could make a fortune if they were allowed to trade on their inside knowledge, which is obviously why they can’t just willy-nilly buy and sell shares of their company whenever they want. Nevertheless, within the limits that they are allowed to trade, they nevertheless try to gain an edge. And to do that, it seems that many companies time the publication of earnings guidance and public announcements. Take a look at the charts below, taken from a study by three researchers from the Wharton School. The chart shows the likelihood for corporate insiders to sell some of their stock in the 30 trading days before and after a company conference (e.g. a Capital Market Day) and an official earnings announcement.

Likelihood of insider sales around company conferences (top) and earnings announcements (bottom)

Source: Bushee et al. (2020).

Corporate insiders are prevented from trading in their company stock before an earnings announcement, but they typically schedule company conferences during periods when they theoretically can buy or sell shares of their company. It is curious that insider sales become more likely in the days before a company event and then become less likely again in the days after the event.

Insider sales may not be particularly suspicious if there is no abnormal return for the insiders before the company event. But this is where insiders can game the system. Corporate executives can decide to disclose information like new business initiatives or smaller, nonmaterial contract gains at their discretion and thus they can use these disclosures to hype a stock before a company event. The chart below shows the likelihood a company issues a press release in the days before and after a company conference. There is a significant increase in the likelihood a company issues one or more press releases in the two weeks before a conference.

Likelihood of a company press release before a company conference

Source: Bushee et al. (2020).

Of course, these press releases are done in order to attract attention to the company and the upcoming company conference. None of the press releases are made for material developments that need to be disclosed as soon as possible for regulatory reasons. Instead, these tend to be feel-good press releases that put the company in the best light possible and hype the business and its performance. And even though these press releases tend to contain nonconsequential information, the share price reacts to this marketing campaign. Stocks that are hyped before a company conference through press releases, etc. experience positive abnormal return before the conference and negative abnormal return afterward. Companies that don’t hype their business before a conference, on the other hand, don’t experience such a positive abnormal return before or after.

Abnormal returns before and after a conference

Source: Bushee et al. (2020).

And this hype before a company conference allows corporate insiders to cash in on stocks they want to sell. By hyping the stock, they can sell their stocks in the days before a company conference and when the conference eventually proves to be rather disappointing, they are no longer suffering the decline in share price in the weeks after. 

Pump and dump schemes by analysts were made illegal a long time ago, but this is not illegal trading based on insider knowledge. It is simply taking advantage of the enthusiasm of investors and analysts before a company event. For investors and analysts, this should just be a warning that corporate executives know how to play the game and to be aware that they are trying to influence your opinion to their advantage.