The Timing and Profitability of Insider Trading in Canada

Transcription

1 FIN The Timing and Profitability of Insider Trading in Canada William McNally and Brian F. Smith Waterloo October William McNally, Brian F. Smith and Thomas Barnes. All rights reserved. Short sections may be quoted without permission, if full credit, including this copyright notice, is given to the source. The School of Business & Economics publishes working papers to stimulate discussion of its faculty s ongoing research programs. Your comments to the corresponding author at wmcnally@wlu.ca are welcome. The views and opinions expressed in this paper are the authors sole responsibility. They do not necessarily represent the positions of the School of Business & Economics or Wilfrid Laurier University.

2 The Timing and Profitability of Insider Trading in Canada William J. McNally* Brian F. Smith Abstract This paper examines the timing and profitability of insider trading in Canada from 1987 to In contrast to studies done on earlier time periods, we find that insiders are net sellers of shares. This is especially true of senior officers who sell nearly seven shares for every share they purchase. We attribute this change to the increased use of stock options as compensation. Insiders are shown to be contrarian investors. During the twelve-months before they buy (sell), the abnormal stock return is 12.73% (19.01%). In the month around their trades, insiders buy on dips and sell after run-ups. Some types of insiders demonstrate exceptional timing in their trades. Shares bought by affiliated insiders, which includes bank officers and directors, have abnormal long-term performance. Outside directors earn the highest abnormal returns before selling and avoid the greatest losses by timing their sells. Their superior returns are not attributable to selling prior to bad news. The paper finds evidence that some insiders are profiting by violating securities legislation. In particular, we find an abnormal volume of insider sales prior to bad news and no decrease in insider purchases prior to good news. * McNally and Smith are at the Clarica Financial Services Research Centre, School of Business and Economics, Wilfrid Laurier University. McNally is the contacting author and can be contacted at the School of Business and Economics, Wilfrid Laurier University, 75 University Avenue West, Waterloo, Ontario, Canada N2L 3C5. Phone: ext Fax: wmcnally@wlu.ca. The authors acknowledge financial support from the Social Sciences and Humanities Research Council of Canada. We appreciate the work of our research assistant, Serdar Tari. The usual disclaimer applies.

3 The Timing and Profitability of Insider Trading in Canada Abstract This paper examines the timing and profitability of insider trading in Canada from 1987 to In contrast to studies done on earlier time periods, we find that insiders are net sellers of shares. This is especially true of senior officers who sell nearly seven shares for every share they purchase. We attribute this change to the increased use of stock options as compensation. Insiders are shown to be contrarian investors. During the twelvemonths before they buy (sell), the abnormal stock return is 12.73% (19.01%). In the month around their trades, insiders buy on dips and sell after run-ups. Some types of insiders demonstrate exceptional timing in their trades. Shares bought by affiliated insiders, which includes bank officers and directors, have abnormal long-term performance. Outside directors earn the highest abnormal returns before selling and avoid the greatest losses by timing their sells. Their superior returns are not attributable to selling prior to bad news. The paper finds evidence that some insiders are profiting by violating securities legislation. In particular, we find an abnormal volume of insider sales prior to bad news and no decrease in insider purchases prior to good news.

4 The Timing and Profitability of Insider Trading in Canada Insider trading is a recurring source of fascination and concern in capital markets. Recently, the Ontario Securities Commission accused ATI's top executive, his wife and four other people of illegal insider trading, alleging they generated $7.9-million in profit or avoided losses by selling shares before a profit warning. 1 Many other cases raise suspicions but are never investigated. For example, in mid-october of 2002, three senior officers of Humpty Dumpty Snack Foods Inc. bought nearly 500,000 shares at $2 in their own company. Ten days after the last purchase, Dominion Citrus Ltd. made a hostile bid for Humpty Dumpty at $3.25 per share. The stock price rose accordingly and the executives, by virtue of their good timing, had earned almost one half of one million dollars in less than three weeks. Although illegal insider trading is suspected, the Ontario Securities Commission (OSC) has not pursued the case. 2 In view of the heightened concern, securities regulators in Canada have recently committed themselves to strengthening the detection and punishment of illegal insider trading. A special task force representing Canadian Securities Administrators (CSAs) and self-regulatory organizations (SROs) was formed to address the issue. The chair of the CSA/SRO task force s steering committee asserted: 3 Insider trading is the most serious problem out there. It's the one where people feel there's an uneven playing field. It's not only bad for the investor who may not have got the information when the other person got it; it's bad for the image of the capital markets. 4 In this paper, we make five contributions to the study of insider trading in Canada. First, we discuss insider trading regulations and summarize the history of convictions in Canada. Second, we provide descriptive statistics on the extent and form of insider 1 ATI settles lawsuit with U.S. investors, Globe and Mail, January 23, Humpty Dumpty heads gain from failed bid, National Post, November 20, In 2001, Market Regulation Services Inc. was established as a joint venture between the TSX and the Investment Dealers Association (IDA) to foster investor confidence in the capital markets and to safeguard investor protection. Tom Atkinson is the president and is the chair of the task force. 4 Insider trading rules assailed: Head regulator says whole system needs overhaul, suggests tougher legislation, p. B1, The Globe and Mail, March 4,

5 trading in Canada. Third, we measure whether insiders time their trades with respect to the past performance of the stock. We find that insiders are contrarian investors, buying (selling) when their shares have underperformed (outperformed) the market. Fourth, we analyze the performance of the shares before and after insider trades and find significant evidence that insiders beat the market, particularly prior to their sells. Fifth, we provide some circumstantial evidence as to whether insiders comply with the Ontario Securities Act s prohibition against trading with undisclosed material information. We demonstrate that selling significantly increases prior to bad news and those who sell in this period earn abnormally high returns. We concentrate our analysis of insider trading on periods when firms are engaged in buybacks of shares. Our rationale for using this sample is that during buybacks, there is evidence of significant information asymmetry between insiders of the firm and outside investors, which creates the opportunity for insiders to take advantage of outsiders. 5 That is, insiders can trade advantageously on the basis of their superior information about the firm s future prospects. There is evidence that firms judiciously time their repurchase trades so as to earn abnormal returns for non-tendering (non-selling) shareholders. 6 To date, there has been limited study of insider trading in Canada. Baesel and Stein (1979) examine insider trading in Canada for 111 TSE-listed large firms from 1968 to During this period, the shares bought (sold) by insiders, especially bank directors, experience significantly positive (negative) returns during the twelve months following the insider trades. Lee and Bishara (1989) analyze insider buys from March 1980 to May 1981 (bull market) and insider sells from June 1981 to June 1982 (bear market). They find that abnormal gains accrue to directors of the firm and to bank directors during the bull market. During the bear market, beneficial owners, senior officers and bank directors avoided abnormal losses by selling. Jabbour, Jalilvand and 5 See Comment and Jarrell (1991), Ikenberry, Lakonishok and Vermaelen (2000) and Brockman and Chung (2001). There is considerable evidence that during and outside periods of share repurchases insiders earn abnormal rates of return on their trades. See for example, McNally, Smith and Barnes (2002) and Lakonishok and Lee (2001). 6 See Brockman and Chung (2001) and McNally, Smith and Barnes (2002). 2

6 Switzer (2000) study 128 Canadian takeover target firms from 1985 to 1995 and find that net insider buying (selling) prior to takeover announcement has a significant positive (negative) impact on abnormal stock returns. They attribute some of the early run-up in share prices to the insider trading. Interestingly, in contrast to these other studies, Heinkel and Kraus (1987) find that insiders do not earn significantly abnormal returns on the Vancouver Stock Exchange over the period between June 1979 and March The paper is organized as follows. The first section summarizes the insider trading regulations of the Ontario Securities Commission (OSC) and the OSC s history of prosecutions for insider trading violations. The second section describes insider trading in Canada by type of insider and nature of trends. The third section measures whether insiders earn abnormal rates of return when they buy and sell shares. The fourth section analyzes whether superior returns of insiders are the result of illegal trading with undisclosed material information. The fifth section summarizes results and provides conclusions. 1 Insider Trading Restrictions and Enforcement in Canada The Ontario Securities Act (OSA) governs firms that trade on the TSX. Ontario s provincial securities laws define insiders as directors and senior officers, parties who control at least 10% of the votes of a company and firms who repurchase their own securities (OSA, Section 1(1)). Other insiders include officers and directors of affiliates, as well as employees of commercial/investment banks and employees of target or bidder firms within six months of a takeover. Trades by insiders must be reported to the OSC (OSA, Section 107(2)) within 10 days of the trade. Prior to 2000, insiders were allowed to report within 10 days from the end of the month of the trade. They must report the date, price and quantities of shares acquired and sold as well as any options exercised. This data is subsequently reported by the OSC in the weekly Ontario Securities Bulletin and maintained electronically by Micromedia Inc. on the Insider Reporting Database. For the last few years, the OSC has been working on, but has not yet implemented, an allelectronic insider reporting mechanism referred to as System for Electronic Disclosure by Insiders (SEDI). 3

7 Insiders who trade with knowledge of a material fact about a firm that is not generally disclosed are liable to their trading counterparty for damages (OSA, Section 134(1)). The damages are calculated by the hypothetical profit from the insider s purchase or sale of the shares and subsequent reversal of those trades over the 20 days following the general disclosure of the material information (OSA, Section 134(6)). Insiders are also liable for any gains ascribed to parties they tipped off prior to general disclosure of the material information (OSA, Section 134(2.)). Over the period January 1980 to October 2002, there were 23 prosecutions by provincial securities commissions for illegal insider trading but only 15 convictions. 7 In two of these cases, insiders were charged with failure to report their trading activity. Penalties for convictions range from $1,200 to $23 million. In the U.S., the Securities and Exchange Commission has prosecuted or settled 550 insider-trading cases since The higher rate of enforcement in the U.S. may be attributed to proportionately greater resources as well as to different approaches to investigation such as rewarding those who provide information leading to a conviction. 8 Despite the low frequency of successful Canadian insider trading prosecutions, there is still a benefit to some enforcement activity as suggested by Bhattacharya and Daouk (2002). Their international study of securities markets in 103 countries shows that there is a net benefit to restricting insider trading when the restrictions are enforced and result in convictions. In the case of repurchase programs, Smith and McNally (2002) find that nearly half of all firms engaged in share buyback programs do not report their repurchase trades to the Ontario Securities Commission. This suggests that a large percentage of insiders in general are not reporting their trades. Given that those who engage in trading with material information are less likely to report their trades, this documented lapse in reporting suggests that any evidence we find of illegal insider trading based on reported trades is likely to underestimate the true extent of this activity. 7 Smith and McNally (2002) 8 When insiders go bad, Globe and Mail, October 23,

8 2 Composition of Insider Trading Activity in Canada Our sample of insider trades is drawn from the Insider Reporting Database from the period between January 1987 and December We analyze trades by all insiders, except the firms themselves, during the years in which the firms are engaged in normal course issuer bids (NCIB). Our sample includes data reported by insiders from 522 different companies. There are 10,415 purchases and 11,978 sale transactions. The sample includes about one fifth of all of the trades reported to the OSC by the insiders in those companies over the sample period. The data was extensively screened for errors in dates, security names and prices. Over the period of the study, there is $2.4 and $4.5 billion of shares bought and sold by insiders, respectively. The preponderance of insider sales to buys is in contrast to studies of Canadian markets in the 1960s, 1970s and 1980s (per Baesel and Stein (1979) and Lee and Bishara (1989)) in which the amount of insider buying exceeded that of insider selling. We consider senior officers the best informed of all insiders by virtue of their knowledge of day-to-day operations of the firm. We expect directors who are not senior officers to be less informed and thus we categorize them separately from senior officers. On the other hand, these directors may be more knowledgeable about overall industry and stock market conditions and thus better able to assess the relative valuation of the firm. For the purpose of this paper, we refer to directors who are not senior officers as outside directors. Large shareholders are parties who are neither officers nor directors but who own or control more than 10% of the voting shares of the firm. Other insiders include officers and directors of affiliates, as well as employees of commercial/investment banks and employees of target or bidder firms within six months of a takeover. We reference this group as affiliated insiders. The first three columns in Table 1 report the total dollar buying and selling activity of the four different classifications of insiders. We find that large shareholders are the largest inside buyers of the firm s shares. Large shareholders purchased $1.47 billion of shares equal to 60% of the total dollar amount of insider purchases. They were also the largest sellers with over $1.94 billion shares sold which represent 43% of the total amount of insider sales. 5

9 Outside directors are the second largest inside buyers whereas senior officers are the second largest inside sellers. Senior officers are net sellers whereas outside directors are net buyers. Their ratios of total dollar volume of insider sells to buys are 6.64 and 0.80, respectively. We attribute this finding to the fact that senior officers acquire proportionately more shares through options than do outside directors. Senior officers acquire two shares through share options for every one share bought through a normal share purchase whereas the proportions are the inverse for outside directors. 3 Timing and Abnormal Stock Performance Around Insider Trades If insiders are informed then they will buy before the stock exhibits abnormal increases and sell before the stock exhibits abnormal decreases. Figure 1 shows the abnormal stock return in the period from 10 days before to 10 days after insider purchases. Insiders appear to buy on dips. On average, the stock price decreases from ten days until the day immediately prior to the day of the purchase by 0.8%. Starting on the day of the purchase until 5 days after the trade, the stock price increases by 1.0%. From day 6 to day 10 following the insider purchases, the stock price increases marginally. The t-statistic of the cumulative abnormal performance is 34.8 (significant at 1% level). Thus, the current rules requiring disclosure within 10 days of a trade mean that outside investors who attempt to mimic the insiders will earn at least 1% less per trade than the insiders themselves. Figure 2 shows that insiders tend to sell after run-ups in share prices. During the ten days prior to insider sales, the abnormal return on the stock is an average of 5%. However, share prices neither rise nor fall abnormally in the ten days following the insider sales. Thus, on average, early disclosure of selling activity is not expected to earn higher returns for outside investors. In Table 2 we examine the timing of insider trades from a longer-term perspective; we measure abnormal returns of the stocks over the two years before and after insider trades. The abnormal return is the buy-and-hold-return--the compound stock return (dividend and split adjusted) less the compound return on the value-weighted 6

10 market portfolio. 9 The analysis is done separately for insider buys and sells and then subdivided according to type of insider. On average, the fourth column of Table 2 shows that insiders act as contrarian investors. Insiders buy stocks that have underperformed the market and sell stocks that have outperformed the market. During the twelve months prior to insider buys, the stock decreases by an abnormal 12.73% whereas during the twelve months prior to insider sells, the stock increases by an abnormal 19.01%. Both figures as well as those for the four types of insiders are significant at the 1% level. Outside directors appear to earn the largest returns in the two years prior to their sales nearly 50%. One caveat to drawing this conclusion is that our data does not allow us to match specific insider purchases with sales. Thus, we do not know the actual holding period return associated with each trade. However, the magnitude of the abnormal returns consistently over each of the two years prior to sales indicates that insiders have better information than outside investors and make substantial profits. If the timing of insider trades was perfect, then insiders should earn abnormal returns on purchases and avoid abnormal losses on sales. That is, inside buys (sells) should be followed by significantly positive (negative) long-term performance. To test this hypothesis, we measure the abnormal performance of the shares in the two years following the insider trades. In the first year following insider buys, stock returns trail the market s by 7.62% and then gain back most of the loss with an abnormal performance of 5.88% in the second year following the trade. In the first and second year following insider sells, abnormal returns are not significantly different from zero. Thus, insiders, on average, do not appear to have perfect timing in their trades. The abnormal performance following trades of different types of insiders suggests that some insiders are more informed than others. In both of the years following purchases by affiliated insiders (including bank directors) the abnormal performance of the shares is positive. The positive return is statistically significant in the second year. This finding is consistent with the abnormal performance of Canadian bank directors identified in Baesel and Stein (1979) and Lee and Bishara (1989) in the 1968 to 1972 and 1980 to 1982 periods, respectively. As a group, outside directors demonstrate the best 9 This method follows Barber and Lyon (1997). 7

11 timing of all insiders in their sales. During the one-year period following their sales, they avoid a statistically significant average abnormal decline of 9.06%. In this section, we have provided evidence that insiders have good but not perfect timing ability. Insiders as a whole appear to time their purchases well on a short-term basis but only affiliated insiders demonstrate superior timing on a long-term basis. Insiders sell after significant abnormal returns. Outside directors demonstrate the best sell timing as shown by the fact that they enjoy the largest gains before sale and avoid significant abnormal losses in the year following the sale. In the next section, we investigate whether this evidence of timing ability can be attributed to their access to material information prior to its public disclosure. 4 Impact of Material Information on Timing and Performance Insiders are prohibited from trading when they have access to material information that is not available to the rest of the market (OSA Section 134). To evaluate whether insiders are trading with material information, we compare the volume of trading before and after significant public announcements. To identify major public announcements, we used CANSTOCK, an electronic database of all public newswire releases for the TSX over the period July 1995 to December To be classified as good news, announcements have to meet two criteria. First, they fall under one of the following categories: quarterly earnings per share increase over the previous year, positive earnings revision, dividend increase, large contract win, debt financing, takeover target or other good news. Second, over the two-day window surrounding the announcement day, the abnormal return on the firm s stock must be positive. 10 We find 2,059 good news items. Conversely, to be classified as bad news, announcements have to meet two criteria. First, they fall under one of the following categories: quarterly earnings per share decrease over the previous year, negative earnings warning, dividend decrease, large contract loss, equity issue, or other negative news. Second, over the two-day window surrounding the announcement day, the abnormal return on the firm s stock must be negative. There are 689 bad news items. 10 The excess of the stock return over the TSX 300 total return measures the abnormal return for the same two-day period. 8

12 The mean abnormal returns for good and bad news days were 4.8% and 5.2%, respectively. Both figures are significantly different from zero at the 1% level. We first compare the average daily volume traded before and after good and bad news. We find that there is no difference between the daily volume of shares purchased by insiders over the 22 trading days before and after positive announcements. A Wilcoxon test indicates no significant shift in the daily volume of purchases (p-value of 0.18). 11 Thus, insiders do not appear to be holding back from buying prior to good news. The pattern of insider sales before bad news provides additional evidence of illegal insider trading. The daily total volume of shares sold by insiders is higher before than after the day the bad news is announced. The Wilcoxon test indicates a higher volume of sales in the period before at the 10% significance level (p-value of 0.06). Some insiders appear to be actively selling before negative news. We next measure the scale of the insider trading in the two weeks prior to material news releases as a whole and for each of the different groups of insiders. The scale of the informed insider buying during the two weeks prior to good news is quite large. As shown in Table 3, in aggregate, purchasing in the two weeks preceding the good news constitutes 8.27% (by number of trades) and 7.75% (by dollar value) of all buying by insiders. Large shareholders do the highest percentage of their purchasing (12.89% by dollar value) in the two-week period. However, as per Table 2, buying before good news does not benefit them, as the long-term abnormal returns following their purchases is significantly negative. The volume of shares sold in the two weeks preceding the bad news constitutes only 2.2% of the total number of shares sold by all insiders during the period of study. These findings provide circumstantial evidence of illegal insider trading. The evidence is not conclusive because we do not know whether insiders were actually aware of the news in the days prior to its release. However, there is ample opportunity for insiders to trade because there is a long period between when information is available to managers and when it is disclosed to the public. In the case of ATI, insiders apparently knew of problems with the firm s sales two months in advance of the public revenue warnings. 11 We use a non-parametric test because of the small sample. 9

13 To further investigate the link between insider trading, undisclosed information and abnormal performance, we conduct a cross-sectional regression of the excess stock returns preceding and succeeding insider purchases and sales. The regressions are estimated on the pooled sample using a random-effects method to control for similarities across trades for each firm. The independent variables include the logarithm of market capitalization (logsize), and four dummy variables. The market capitalization variable is added to control for cross-sectional differences in risk and expected return. Smaller firms are expected to have greater systematic risk and higher expected returns. Three of the dummy variables identify categories of insiders: outside directors, large shareholders, affiliated insiders and corporate officers (captured by the intercept term). The fourth dummy, Informed Trade, takes the value of one if a purchase occurs within a two-week period before good news and if a sale occurs before bad news. The first two columns of Table 4 show the results for before and after purchases. On average, there are negative abnormal returns preceding purchases, as was indicated in Table 2. The regression shows that abnormal returns are inversely related to firm size. The finding reflects the greater risk of smaller firms not captured by our measure of abnormal return. There are declines prior to purchases by all four groups of insiders, but the declines are not as great preceding the purchases by large shareholders. If the decline is indicative of the insiders timing ability, then it appears that large shareholders do not have the same quality of information and timing ability as the other insiders. The second column of Table 4 shows the returns after purchases. The regression shows that they fall more for large shareholders, again showing their poor timing. Surprisingly the coefficient for Informed Trade is not significantly different from zero. This means that the twelve-month stock performance after insider purchasing is not enhanced by buying in the two-week period before good news. The third and fourth columns of Table 4 show the regression results for the periods before and after sales. The regression results again show that insiders of small firms earn bigger returns than insiders of large firms. Large shareholders and affiliated insiders earn smaller abnormal returns than officers, but directors earn substantially larger returns than the other three groups. The significant coefficient on the Informed Trade 10

14 dummy indicates that insiders who sell before bad news earn higher returns than other insiders. The fourth column shows results for the period after sales. If insiders have good timing ability, then the abnormal returns should be negative following their sale. Table 2 shows that, on average, there is no decline following sales. The informed trading dummy is significant and negative which shows that sales prior to bad news are very well timed. The regression results show that returns fall more steeply after sales by outside directors, which suggests that they are able to time their sales prior to a significant decline. The fact that this finding holds true after controlling for illegal trading on the basis of material information, suggests that outside directors may be more skilled than other insiders in how they value the firm relative to the market. 5 Conclusions This paper makes a number of contributions to the discussion of insider trading in Canada. We examine approximately $7 billion of insider trades in Canada over the period 1987 to In contrast to studies of insider trading in Canada in the 1960s, 1970s and 1980s, we find that insiders are net sellers of shares. This is especially true of senior officers who sell nearly seven shares for every share they purchase. We attribute this change to the increased use of stock options as compensation. On average, we find that insiders are contrarian investors. They buy (sell) following twelve months of negative (positive) abnormal performance of their firm s shares. This contrarian trading is also exhibited in the performance of the stock in the short-run. In the month around their trades, insiders buy on dips and sell after run-ups. We compare timing and profitability of trades of various types of insiders. Consistent with past research, affiliated insiders (including corporate and investment bankers) exhibit the best timing among insider buyers. Outside directors earn the highest abnormal returns before selling and avoid the greatest losses by timing their sells. Over the two years prior to their sales, outside directors earn nearly 50% abnormal returns and avoid abnormal losses of 9% following their sales. Their superior returns are not attributable to selling in the two weeks prior to bad news. We suspect that these particular 11

15 groups of insiders earn higher abnormal returns because of their greater knowledge of market and industry conditions. Despite the prohibition against trading with material information, insiders do not desist from buying (selling) in the days immediately prior to positive (negative) company news releases. Approximately, 8% of insider buys and 2% of insider sells are made during the two weeks prior to good and bad news. Furthermore, insider sales are significantly higher before than after bad news. This pattern of trading provides circumstantial evidence that many insiders are taking advantage of their privileged position. On average, there has been less than one insider trading conviction a year since There have been only two cases where insiders were charged with failure to report their trading activity. The relative paucity of prosecutions in Canada relative to the United States suggests that the OSC should consider some of the approaches used by the American regulators for dealing with illegal insider trading. For example, in the U.S., whistle-blowers are entitled to a portion of the fines levied on convicted individuals. Second, efforts should be taken to improve compliance with insider trading reporting rules. There are far too many firms that are not reporting repurchases to the OSC and we expect that this holds true for other insiders. Third, given the paper s finding that stock prices rise in the ten-day period after insider buys (a period which corresponds to the current delay in notifying the OSC), we recommend that announcements of insider trading should be made much faster than current rules prescribe. In fact, we recommend that the OSC require insider trades to be flagged at the time of each trade. This will prevent insiders from quietly disposing of or acquiring a position in their firm s stock on the basis of material information. Finally, we recommend that insiders be restricted from trading in a period just prior to pre-planned announcements such as earnings releases. This will limit the potential gains from illegal trading activity while placing only a relatively small time restriction on insiders. 12

16 References Baesel, J.B. and G.R. Stein, 1979, The Value of Information: Inferences from the Profitability of Insider Trading, Journal of Financial and Quantitative Analysis 14, Barber, B.M. and J.D. Lyon, 1997, Detecting Long-Run Abnormal Stock Returns: The Empirical Power and Specification of Test Statistics, Journal of Financial Economics 43, Bhattacharya, U. and H. Daouk, 2002, World Price of Insider Trading, Journal of Finance 57, Brockman, P. and D.Y. Chung, 2001, Managerial Timing and Corporate Liquidity: Evidence from Actual Share Repurchases, Journal of Financial Economics 61, Comment, R. and G.A. Jarrell, 1991, The Relative Signaling Power of Dutch- Auction And Fixed Price Self-Tender Offers and Open-Market Share Repurchases, Journal of Finance 46, Harris, L., 2003, Trading and Exchanges, Oxford University Press, New York. Heinkel, R. and A. Kraus, 1987, The Effect of Insider Trading on Average Rates of Return, The Canadian Journal of Economics 20, Ikenberry, D., J. Lakonishok and T. Vermaelen, 2000, Stock Repurchases in Canada: Performance and Strategic Trading, Journal of Finance 55, Jabbour, A., A. Jalilvand and J. Switzer, 2000, Pre-bid price run-ups and insider trading activity: Evidence from Canadian acquisitions, International Review of Financial Analysis, 9,

17 Lakonishok, J. and I. Lee, 2001, Are Insider Trades Informative? Review of Financial Studies 14, Lee, M. and H. Bishara, 1989, Recent Canadian Experience on the Profitability of Insider Trades, The Financial Review 24, McNally, W.J., B.F. Smith and T. Barnes, 2002, Underreaction, Abnormal Returns and Supply Curve Elasticity: Evidence from Open Market Share Repurchases, Working Paper, Wilfrid Laurier University. McNally, W.J. and B.F. Smith, 2002, Do Insiders Play by the Rules? Working Paper, Wilfrid Laurier University. 14

18 Table 1 Summary of Insider Trading Activity 1987 to 2000 This figure shows the total dollar amount of insider trading, the ratio of insider sells to buys and the average dollar value of trades per report filed with OSC. The data covers all repurchase programs on the Toronto Stock Exchange over the period 1987 to The insider trading figures exclude repurchases by the firm. Type of Insider Total Dollar Value ($ millions) Buys Sells Ratio of Total $ Value of Sells to Buys Average $ Value of Trades Buys Sells Ratio of Number of Options Exercised to Shares Bought Senior Officer $264.6 $1, $51,672 $278, Outside Director , , Large Shareholder 1, , ,945 1,807, Other Insider , , Total $2,446.4 $4, $234,889 $378,

19 Figure 1 Cumulative Abnormal Returns Surrounding Insider Buys This figure shows the cumulative abnormal returns of shares during the period from 10 trading days before until 10 trading days after purchases by insiders. Abnormal returns are computed as the stock return less the return on the TSE 300 total return index. Cumulative Average Abnormal Returns (%) Event Days 16

20 Figure 2 Cumulative Abnormal Returns Surrounding Insider Sells This figure shows the cumulative abnormal returns of shares during the period from 10 trading days before until 10 trading days after sales by insiders. Abnormal returns are computed as the stock return less the return on the TSE 300 total return index. Cumulative Average Abnormal Returns (%) Event Days 17

21 Table 2 Mean Abnormal Performance of Shares During Two Years Before and After Insider Trades Table 2 shows the mean of the abnormal performance of the shares for which there were insider buys and sells over each of the 4 years surrounding the insider trades. The abnormal performance of each trade is estimated by subtracting the TSE 300 total return from the share return for each of the years. One and two asterisks indicate significance at the 5% and 1% levels, respectively. Panel A: Insider Purchases Year -2 Year -1 Year + 1 Year + 2 Number of Observations With Data Before Trade After Trade Senior Officer 0.79% %** -7.81%** 0.27% 4,094 3,257 Outside Director 8.79%** %** -6.36%** 5.04%** 2,178 1,843 Large Shareholder 1.32% -4.47%** %** 26.59%** 1, Affiliated Insider 7.40%** -9.17%** 1.06% 6.38%* Total 3.57%** %** -7.62%** 5.88%** 8,186 6,600 Panel B: Insider Sales SeniorOfficer 9.39%** 16.97%** 0.46% -3.42% 5,147 3,841 OutsideDirector 9.09%** 35.98%** -9.06%** 1.27% 1,972 1,707 LargeShareholder 14.07%** 6.88%** -5.44% 29.45%** Affiliated Insider 11.43%** 13.24%** 7.54%** -0.82% 1,900 1,446 Total 10.18%** 19.01%** -0.80% 0.76% 10,008 7,604 18

22 Table 3 Insider Trading Within Two Weeks Prior to Significant News Announcement Table 3 reports the timing of trades of various insider groups with respect to announcements of material information. For each group of insider listed in column one, the second and third columns respectively, shows the number and dollar value of buys that occur within 2 weeks prior to good news. Comparable figures are shown in the fourth and fifth columns for trades occurring within 2 weeks prior to bad news. The values in the table are calculated as a percentage of the total dollar value of trading done by each group. For example, the senior officers purchased $11.5M worth of shares in the two weeks prior to good news announcements, which is 7.46% of the $154M worth of shares that they bought in our sample. The sample includes only trades between July 1995 and December Buys within 2 weeks prior to Good News Sells within 2 weeks prior to Bad News Group of Insiders By Number of Trades By Dollar Value By Number of Trades By Dollar Value All Types 8.27% 7.75% 2.10% 1.39% Senior Officers 7.23% 7.46% 1.75% 0.94% Outside Directors Large Shareholders Affiliated Insiders

23 Table 4 Regression of Excess Returns Around Insider Trades This table shows the results of a regression explaining variation in the one-year abnormal returns before and after purchases and sales. The dependent variable is the compound annual return less the return on the market. Estimation performed using a random coefficients model to control for firm-effects. Logsize is the logarithm of market capitalization; Outside Director is a dummy variable taking the value of one if the trader is a director of the firm or of the company with a controlling stake in the firm but not a senior officer; Large Shareholder is a dummy which takes the value of one if the insider is a shareholder with a minimum 10% voting stake in the firm but is neither an employee or director; Affiliated Insider is a dummy for affiliated insiders. The intercept captures the average return for corporate officers (assuming all other variables are zero). Informed Trade is a dummy variable which takes the value of one if the trade occurs within two weeks of a major corporate announcement. (Buys before good news and sells before bad news.) One and two asterisks indicate significance at the 1% and 5% levels, respectively. The sample includes only trades between July 1995 and December Insider Purchases Insider Sales Before After Before After Intercept 3.68** 3.13** 6.09** 2.92** Logsize -0.27** -0.22** -0.42** -0.20** Outside Director ** -0.10** Large Shareholder 0.14* -0.09** -0.14** 0.04 Affiliated Insider * 0.14** Informed Trade ** -0.14** Number of Observations 6,656 6,663 7,460 7,462 20