Directors’ Trades as Signals of Their Firms’ Future Financial Performance: Evidence from the Australian Share Market

In June 2001 the Australian Companies and Securities Advisory Committee issued a Discussion Paper that questions the frequency of insider trading and the need for further regulation. In the spirit of recent capital markets-based research in accounting, we address two questions in this paper. The first is whether and if so how, stock market prices react to information implicit in directors' trades. The second is whether directors' trades can be interpreted as signals of (accounting measures of) their firms' future operating performance. There is a significant share price reaction to the announcement of directors' sales and purchases. The stock market's reaction to directors' trades is not always immediate, and there is evidence consistent with company directors waiting for a price rise before they sell (or a fall before they buy). Directors' sales signal an expected deterioration in accounting performance measures, particularly in the longer term, but there is no relationship for their purchases. The relationship for sales is stronger and more significant for larger trades, smaller firms and trades that comply with the timeliness requirement of s205G of the Corporations Law; and it differs by industry. Our findings suggest that directors' trades are a potentially reliable signal about the long term performance of their firm.