Insider trading by directors and seniors officers before seasoned equity offerings

An important aspect of corporate governance is how directors discharge their duty to shareholders as monitors of management's opportunistic behavior. The insider trading by officers and directors before seasoned equity offerings (SEO) provide an opportunity to examine this issue, because insiders' sales of the firm's stock are incongruent with the objective of the firm to maximize the proceeds of the SEO. Since the market is aware that firms attempt to inflate their proceeds by managing earnings upwards, these trades may signal that the stock is overvalued. In this study, we compare the earnings management activity and the corresponding market response to earnings management and sales by senior officers and directors. We study a sample of 233 firms that conducted SEOs in the 1987-2004 period and either their directors and/or their senior officers traded in the firm's shares. We find that 15% have insider trading by directors only, and 85% by both directors and senior officers. The market discounts the insider trading at the issuance date (the discount increases in the volume of insiders sales), but it treats insider trading by directors as a favorable signal that reduces the discount. Our study then identifies two ways directors monitor opportunistic insider trading before SEO. One is to ban it, as evident by the fact that under our selection criteria, 791 firms conducted SEOs in the 1987-2004 period. The other is to trade too as a positive signal to the market.