IQ and corporate insiders’ decisions to time insider and outsider trading

• Published date: 01 November 2021
• Author: Florian Eugster,Jenni Kallunki,Henrik Nilsson,Hanna Setterberg
• Date: 01 November 2021
• DOI: http://doi.org/10.1111/eufm.12302

DOI: 10.1111/eufm.12302

ORIGINAL ARTICLE

IQ and corporate insiders’decisions to time

insider and outsider trading

Florian Eugster

1

|Jenni Kallunki

2

|Henrik Nilsson

3

|

Hanna Setterberg

1

1

Department of Accounting, Mistra

Center for Sustainable Markets,

Stockholm School of Economics,

Stockholm, Sweden

2

Department of Economics, Accounting

and Finance, University of Oulu, Oulu,

Finland

3

Department of Accounting, Stockholm

School of Economics, Stockholm,

Sweden

Correspondence

Florian Eugster, Department of

Accounting, Mistra Center for

Sustainable Markets, Stockholm School

of Economics, P.O. Box 6501, SE‐113 83

Stockholm, Sweden.

Email: florian.eugster@hhs.se

Abstract

We examine how corporate insiders’cognitive ability (IQ)

affects their decisions to time insider and outsider trading

before abnormal stock price changes. Our analysis of ar-

chival data on male corporate insiders in Sweden shows

they are less prone to time their insider selling and to sell

in larger amounts, before abnormal stock price declines as

IQ increases. We also find that insiders with a higher IQ

are better at timing their outsider buying. Taken together,

our results show that corporate insiders’IQ affects their

trading decisions differently, depending on whether they

are trading in their insider or outsider stocks.

KEYWORDS

Insider trading, IQ, abnormal returns, reputational risk

JEL CLASSIFICATION

G14; G30; G40; K42

EUROPEAN

FINANCIAL MANAGEMENT

Eur Financ Manag. 2021;27:814–840.814

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wileyonlinelibrary.com/journal/eufm

This is an open access article under the terms of the Creative Commons Attribution‐NonCommercial‐NoDerivs License, which permits

use and distribution in any medium, provided the original work is properly cited, the use is non‐commercial and no modifications or

adaptations are made.

© 2021 The Authors. European Financial Management published by John Wiley & Sons Ltd.

We are grateful to the editor (John A. Doukas) and an anonymous referee for their insightful comments that have

improved this paper.We also thank seminar participants at theCopenhagen Business School, Humboldt University and

Columbia Business School for their useful comments in previous versions of this paper. Our thanks go to Juha‐Pekka

Kallunki, PerOlsson and Martin Walker, as well, fortheir useful comments and suggestions.We further thank Euroclear

Sweden, the Finansinspektionen, the Skatteverket and the Swedish Armed Forces forproviding the necessary data. This

study has beenevaluated and approved by the RegionalEthical Review Board in Umeå,Sweden (DNR 08:074 Ö and DNR

I3‐0449/2009).The authors gratefullyacknowledge financial supportfrom the NASDAQ OMX Nordic Foundation,the OP

Group Foundation,the Swedish Handelsbanken ResearchFoundation (Jan Wallander stipendiumW2014‐0492:1) and the

Swedish Research Council.

1|INTRODUCTION

A large body of literature examines the trading behaviour of corporate insiders on the stocks of

their firms (e.g., Betzer & Theissen, 2009; Friederich et al., 2002; Huddart & Ke, 2007; Joseph &

Wintoki, 2013; Seyhun, 1986). These studies have linked the cross‐sectional variation in insider

trading behaviour and gains to firm characteristics such as size (Lakonishok & Lee, 2001),

growth and value stocks (Gregory et al., 2013; Rozeff & Zaman, 1998), corporate governance

mechanisms (Betzer & Theissen, 2009; Jagolinzer et al., 2011; Skaife et al., 2013), the quality of

earnings (Aboody et al., 2005) and takeover announcements (Davis et al., 2020). The literature

largely treats insiders as having homogeneous personal traits, effectively assuming that they all

make similar trading decisions. A few recent studies investigate how various insider‐specific

factors are related to insiders’trading behaviour (Davidson et al., 2020; Hillier et al., 2015;

Kallunki et al., 2009,2016,2018). For instance, Hillier et al. (2015) find that insiders’personal

attributes as proxied by insider fixed effects explain up to a third of the variability of insider

returns and dominate unobservable and observable firm and trade characteristics. However,

the question of what the specific factors are that drive the observed variation in individual

insiders’trading behaviour is still largely open.

In this paper, we address this question by examining how cognitive ability (IQ) affects

corporate insiders’decisions to time their insider trading before abnormal changes in the stock

price.

1

We also examine how insiders’IQ affects their outsider trading, that is, trading in stocks

where they do not hold any insider position.

We rely on behavioural finance literature, which shows that IQ is a significant driver of

regular investors’trading behaviour and performance (e.g., Grinblatt et al., 2011,2012).

However, little is known about whether and how IQ affects the trading behaviour of corporate

insiders, who are a unique class of traders in the stock market. By virtue of their position,

insiders routinely have access to valuable private information about their firms’prospects,

which gives them an information advantage over other investors in the stock market. On the

contrary, regulatory authorities and the general public monitor insiders’trading on insider

stocks and impose reputational and legal costs on insiders when their trading is perceived as

opportunistic or self‐serving (Bris, 2005; Dai et al., 2015; Gao et al., 2014; Seyhun, 1992). To the

extent that smarter insiders are better at evaluating these potential costs of insider trading,

having a higher IQ could restrict informed insider trading.

In their outsider trading, insiders do not have access to nonpublic information. Hence, a

higher IQ could lead to greater success in timing the trades of these stocks (Grinblatt

et al., 2012). However, as insiders hold top positions in the business community, they have

valuable insights into economic and business activities, which could give them superior skills

in interpreting the public information used in making stock trading decisions. To the degree to

which insiders have such skills, an insider's IQ might play only a modest role in decisions of

when to trade the stocks of firms other than the insider's own.

1

Insiders are employees of a firm who hold specific information that is likely to affect the firm's stock price. Insider trading refers to an insider's trading in

insider stocks, that is, the stocks of firms where the insider holds an insider position, whereas outsider trading refers to an insider's trading in outsider stocks,

that is, the stocks of firms where the insider does not hold any insider position. The register of Swedish insiders is maintained by the Finansinspektionen (the

Swedish Financial Supervisory Authority), the regulatory authority in Sweden that corresponds to the U.S. Securities and Exchange Commission (SEC). See

Section 2.3 for a formal definition of an insider in the Swedish setting.

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