Can firms’ own insider trading restrictions affect financial reporting quality?

In our recent paper (see here), we find the answer to this question is yes.

Insider trading is a great tool to explore what motivates firms to communicate the way they do — and sometimes, there’s even more information in the lack of trading. Take, for instance, firms’ self-imposed insider trading restrictions, also known as blackout periods. Many companies, in an attempt to protect their investors from trades by firm insiders who have access to private information ahead of everyone else, have adopted such restrictions. Usually, in the days or weeks before meaningful events, trading is not allowed. But we found one surprising effect of these restrictions: better financial reporting quality.

We measure these restrictions for a large sample of US firms based on the extent to which insiders trade shortly after their firms’ quarterly earnings announcements. We find that the adoption of insider trading restrictions is associated with a reduction of 9.92% in absolute discretionary accruals. We find that firms that voluntarily restrict insider trading have lower incentives to manipulate earnings. Our findings are robust to controlling for changes in corporate governance, and we do not find evidence of a substitution effect between accruals and real earnings management, target beating or timeliness of loss recognition. Taken together, our results indicate that the voluntary adoption of blackout periods that limit insider trading improves the quality of financial reporting.

If you want to find out more about our analysis, check the article here.