Insider Trading around Dividend Announcements Theory and Evidence

KOSE JOHN and LARRY H. P. LANG*
ABSTRACT
The informational role of strategic insider trading around corporate dividend announcements
is studied based on the efficient equilibrium in a signalling model
with endogenous insider trading. Insider trading immediately prior to the announcement
of dividend initiations has significant explanatory power. For firms
with insider selling prior to the dividend initiation announcement, the excess
returns are negative and significantly lower than for the remaining firms (with no
insider trading or just insider buying) as implied by our model. Another implication
is that dividend increases may elicit a positive or negative stock price response
depending on the firm's investment opportunities.

THEREIS CONSIDERABLE EMPIRICAL evidence on stock price reaction to the
announcement of dividend changes.' Since the documented evidence suggests
that these announcements convey to the market some private information
possessed by corporate insiders, signalling models have been used to explain
the price reaction. Although recent signalling models have shed some light
on important aspects of the announcement effect of dividends, many questions
remain. Why should dividend increases be treated always as good news
by the market? How do the investment opportunities available to the firm
affect the market response to dividend changes?' Since insiders often have
material private information prior to announcements of major dividend
changes (e.g., initiation of dividends), how would their own trading activity reflect this?3 How would disclosures of this trading (say, through filings with
the Securities and Exchange Commission) (SEC) and consequent market
inferences affect the information content of the dividend announcements?