An International Meeting of the American Accounting Association American Accounting Association 2006 Annual Meeting August 6–9, 2006 Washington, D.C.

Dain C. Donelson
University of Illinois at Urbana - Champaign

Abstract: Studies have shown that insiders earn abnormal returns, but that strategies emulating insider trading patterns are less successful (e.g., Lakonishok and Lee 2001). This paper uses a fundamental analysis strategy based upon common operating performance metrics to distinguish information-based insider trades from noise trades. This paper shows that insiders who trade consistently with accounting fundamentals earn higher returns than normal insider trading premiums, returns based on accounting fundamentals, or the two premiums added together. This paper also shows that a strategy following these insider trades earns abnormal returns that are higher than the fundamental analysis strategy alone. Finally, a strategy long in value firms with insider buying and strong fundamentals while short in growth firms with insider selling and weak fundamentals earns higher returns, but these returns may be subject to additional risk as they have higher variance.

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