Tempting Trading Opportunities and Litigation Consequences

Abstract

This paper considers the conflicting disclosure and trading incentives faced by managers who become aware of negative earnings news. Prior work indicates that potential legal and reputational consequences provide managers with incentives to voluntarily disclose this news. Despite these incentives, managers' warnings of negative news occur relatively infrequently. Therefore, I predict and test whether the receipt of negative news provides some managers with incentives to delay disclosing negative news in order to trade to exploit information asymmetries. I find a negative relation between abnormal trade by insiders prior to the market's receipt of negative earnings news and the timeliness of disclosure. Further analysis indicates that abnormal trade results in increased litigation consequences for the firm but only limited repercussions for managers. That is, after controlling for a number of factors argued to influence settlement negotiations, I document a positive relation between lawsuit settlement amounts and measures of abnormal trade, but I find no relation between abnormal trade and repercussions (in the form of employment turnover or SEC action) to managers involved in the trading.