Executive Stock Option Exercises and Inside Information

Abstract

This paper examines whether corporate insiders use private information to time the exercises of their executive stock options. Prior to May 1991, insiders had to hold the stock they acquired through option exercise for six months. We find that exercises from this regulatory regime precede significantly positive abnormal stock returns. This suggests that insiders timed exercises so that the subsequent forced investment in the stock coincidedwith favorable price performance. By contrast, we find little evidence of the use of inside information to time exercises since the removal of the holding restriction in May 1991. When insiders can sell the acquired shares immediately, the use of private information should manifest itself as negative abnormal stock price performance following option exercise. However, only in the subsample of exercises by top managers at small firms, a tiny fraction of the full sample, do we find significantly negative post-exercise stock price performance after May 1991. We conclude that, in most cases, insiders' potential information advantage in timing exercises is not an important issue in valuing executive stock options.