The Role of Mandatory Financial Disclosure on Insider Trading: Evidence from Cash Flow Hedge and SFAS 161

• In Event: Financial Statement Disclosure

Abstract

This paper examines whether enhanced disclosures mitigate profitable insider trading that makes use of their informational advantage over cash flow hedge activity. We first show that insiders indeed trade on cash flow hedge. Next, using difference-in-differences around the staggered adoption of SFAS 161, we make a causal inference that enhanced mandatory financial disclosures enunciating the implication of cash flow hedge on earnings reduce the profitability of insider trading. The disclosure effect is salient for circumstances where voluntary or selective mechanisms that monitor insider trading are weak, suggesting that mandatory disclosures supplement the lack of such mechanisms. Overall, this paper suggests that more transparent financial reporting hampers insiders’ profitable stock trading, contributing to a fair marketplace.

Author

• Jungbae Kim, New York University Stern School of Business