How Insiders Cut Their Losses When Bankruptcy Looms

Although most shareholders take a huge hit when a company files a Chapter 11 bankruptcy petition, corporate insiders tend to avoid much of the pain. That's the conclusion of a new study of insider trading at companies listed on the New York and American Stock Exchanges that sought Chapter 11 protection from 1975 to 1991.

Focusing on the three years preceding a bankruptcy filing, researchers H. Nejat Seyhun and Michael Bradley of the University of Michigan School of Business Administration found that insider selling at companies headed for bankruptcy exceeds insider stock sales at similar companies that do not file. Moreover, selling tends to escalate and be more highly concentrated among presidents and chairpersons as bankruptcy nears. By contrast, such selling typically stops completely in the 30 days just prior to a bankruptcy filing, a period subject to heavy regulatory scrutiny.

All of this, say Seyhun and Bradley, suggests that "a law designed to protect firms from inefficient liquidations during unforeseen downturns has instead become a strategy to protect corporate officers at the expense of other shareholders." By selling off their holdings as a bankruptcy approaches, they say, insiders reduce their incentives to maximize corporate performance and ensure a company's survival.

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