Internal Control over Financial Reporting and Managerial Rent Extraction: Evidence from the Profitability of Insider Trading
Abstract
This paper examines the profitability of insider trading in firms with ineffective internal control and managed by insiders who are more likely to act in their own self-interest as indicated by ineffective “tone at the top”. We find the profitability of insider share sales, but not share purchases, are significantly greater in firms with ineffective internal control. Moreover, we find that insider selling profitability is even greater in firms with ineffective “tone at the top”. These findings contribute to our understanding of the settings where shareholders are most at risk for wealth transfers via insider trading. We also document that insider selling profitability contributes to an increase in the probability of CEO/CFO turnover in the presence of ineffective internal control. The results of our study highlight important and previously undocumented market consequences of ineffective internal control over financial reporting.
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Paolo Perego
