Corporate Social Responsibility and Insider Trading

See Chava (2010), El Ghoul et al. (2011), Dhaliwal et al. (2011) for the overview of CSR research.

See Meulbroek (1992), Cornell and Sirri (1992), Healy and Palepu (1995), Chakravarty and McConnell (1997), and Aktas et al. (2007) for the overview of insider trading research, and see McGee (2008, 2009) for ethical perspectives of insider trading. See more the detailed literature review of CSR and insider trading in the next section. Throughout the article, we interchangeably use insider trading and insider transactions following the previous literature (see, for instance, Lakonishok and Lee 2001).

Legal trades by insiders are common, as employees of publicly traded corporations often have stock or stock options. These trades are made public in the United States through Securities and Exchange Commission filings, mainly Form 4. Prior to 2001, U.S. law-restricted trading such that insiders mainly traded during windows when their inside information was public, such as soon after earnings releases (Stein 2001). SEC rule 10b5-1 clarified that the prohibition against insider trading does not require proof that an insider actually used material non-public information when conducting a trade; possession of such information alone is sufficient to violate the provision, and the SEC would infer that an insider in possession of material non-public information used this information when conducting a trade. However, SEC rule 10b5-1 also created for insiders an affirmative defense if the insider can demonstrate that the trades conducted on behalf of the insider were conducted as part of a pre-existing contract or written binding plan for trading in the future (Stein 2001). For example, if an insider expects to retire after a specific period of time and, as part of his or her retirement planning, the insider has adopted a written binding plan to sell a specific amount of the company's stock every month for two years and later comes into possession of material non-public information about the company, trades based on the original plan might not constitute prohibited insider trading. On the other hand, Sects. 16(b) and 10(b) of the Securities Exchange Act of 1934, the rules against insider trading on material non-public information, directly and indirectly address illegal insider trading. We also interchangeably use “good” and “legal” insider trading as well as “bad” and “illegal” insider trading. In fact, the regulation of insider trading is a relatively recent phenomenon, and the U.S. is the first major country to enact an insider trading law. As of 1990, thirty-four countries had insider trading laws restricting or prohibiting insider trading, and only nine of them had prosecuted anyone for insider trading (McGee 2008). By 2000, eighty-seven countries had passed insider trading laws, and 38 had prosecuted at least one insider trading case (McGee 2008).

Insider trading can also take place for liquidity reasons. For example, insiders unexpectedly need a lot of money, and they have to sell some shares, not necessarily based on their private information.

Using the comprehensive U.S. insider trading data from 1986 to 2008, Lee et al. (2011) suggest that there has been a steady increase over time in the proportion of trades by insiders that occur right after quarterly earnings announcements. For example, before the adoption of ITSFEA in 1988, approximately 35 % of insider trades occurred in the month immediately following an earnings announcement. After 2002, over 50 % of all trades occur in the month following earnings announcements.

Another argument in favor of insider trading is that inside information is property, and preventing individuals from trading their property violates their property rights (Manne 1985).

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We also conduct fixed-effect regressions and find qualitatively similar results of the positive association between CSR and insider trading. To conserve the space, we do not report the fixed-effect regressions. The positive relation also remains unchanged when we include ROA and the change of ROA as additional independent variables to control for performance.

This is in contrast to random effects or mixed effects models in which either all or some of the explanatory variables are treated as if they arise from the random causes.

Although unreported, we also conduct Heckman (1979) two-stage regressions model to further address error term issues related to the self-selection bias and find the main results of a positive association between CSR and insider trading remain intact.

When we check the impact of CSR activities on insider trading based on the period of two months before earnings announcement, we find a similar negative, but insignificant relation between LAG(CSRINDEX) and all four measures of insider trading.