Essays on empirical asset pricing and insider trading

This dissertation consists of three essays that study the relationship between future stock returns and firm accounting information as well as insider trading behavior. In the first paper we show that the recent trajectory of a firm's profits predicts future profitability and stock returns. We also find that analysts adjust their earnings forecasts slowly according to the information in the profit trend, suggesting that investors underreact to the information in the profit trend. On the other hand, we find no evidence of investor overreaction, and our results cannot be explained by well-known risk factors. The second and third paper study the relationship between corporate insider trading behavior and future stock returns. The second paper introduces the concept of investment horizons to the insider trading literature. We construct an empirical measure of an insider's trading horizon and show that it is a significant determinant of the informativeness of insider trading activity. In particular, both purchases and sales by short term insiders are more informative than those made by long term insiders. Short term insiders are more likely to have better access to firm information, come from firms with weaker corporate governance, be male, and trade less frequently following SEC investigations. We also find that short term insider trading has better predictive power on future earnings surprises and large stock price changes. The third paper investigates the trading behavior and performance of insiders with legal expertise. We show that insiders with legal education earn significantly lower abnormal returns when they make purchases, compared to those without legal expertise. These findings are stronger in well-governed firms. Also, purchases by legal insiders are less likely to be followed by positive earnings surprises and are associated with lower future firm profitability. In addition, legal insiders trade less after SEC investigations on illegal insider trading. The results suggest that insiders with law degrees behave more conservatively, especially in firms with strong corporate governance.