Insightful Insiders? Insider Trading and Stock Return Around Debt Covenant Violation Disclosures

Abstract

This paper documents significant trading by insiders around a first-time debt covenant violation disclosure in an SEC filing and is interesting from a research and regulatory standpoint because of three considerations - delay and relative infrequency of new covenant violation disclosures lack of attention to disclosure issues by regulators and dearth of research. Importantly we find a lead relation between net insider selling in the 12 months before a debt covenant violation disclosure and investors' negative returns and net insider buying up to 12 months after disclosure and investors' positive returns. This relation is robust to the presence of other information. These results support our contention that insiders' trades around a covenant violation disclosure may benefit from an information advantage unavailable to other market participants. The aggregate return to insiders - the sum of the losses avoided from selling and the gains from buying - approaches almost two billion dollars over an eight-year study period.