Insider Trading in Derivative Securities: An Empirical Examination of the Use of Zero-Cost Collars and Equity Swaps by Corporate Insiders

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Abstract
We provide an examination of the use of zero-cost collars and equity swaps by corporate insiders to hedge the risk associated with their personal holdings in the company's equity. These financial instruments have important implications for insider trading and incentive-based contracts. Our analysis indicates that these transactions generally involve high ranking insiders (CEOs, board members and senior executives) and cover over a third of their equity holdings. We also find that insiders appear to initiate hedging transactions immediately following large price runups, prior to increases in stock price volatility, and prior to poor earnings announcements. In addition, abnormal returns following insider hedging activities are more negative than those associated with ordinary insider sales. Overall, the evidence indicates that executives can use these hedging instruments to significantly alter their effective ownership positions in the firm.

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