Managerial Opportunism and Earnings Surprises

This study explores managerial insider trading as a function of differences between managers’ and the market’s assessment of company earning components – specifically operating cash flows and accruals. It builds a perspective of managers as sophisticated investors who while engaging in earnings management ultimately make insider trading decisions based on the divergence between their private valuation of earnings components and the market’s. The study applies the methodological framework of the Mishkin (1983) test. It finds supporting evidence that insider buying behavior is consistent with the predictions of managerial insider trading based on a contemporaneous market valuation divergence of both operating cash flows and accruals. Although insider selling is not indicative about a contemporaneous market overvaluation the findings by examining and comparing the market valuation divergence in the period of insider selling and in the following period suggest that insiders do time their sales in the period of higher excess returns.