Loan Loss Accounting and Stock Trading by Bank Insiders

Can the adoption of new accounting standards requiring recognition of forward-looking estimates change the stock trading behavior of insiders? We explore this question by studying the trading activity of banks’ insiders around the recent implementation of the Current Expected Credit Loss (CECL) model for loan loss accounting by publicly-listed U.S. bank holding companies. We first descriptively document that higher audit quality and insiders’ legal background are associated with greater CECL compliance (i.e., the reporting of timelier loan loss provisions in the post-CECL period). Next, we infer bank insiders’ pre-existing information advantage about credit losses by the extent to which their stock trades in the pre-CECL period are informative of one-year ahead changes in non-performing loans. We analyze the effects of CECL compliance separately for two groups of banks: (i) those that enter the CECL regime with already advantaged insiders, and (ii) those with insiders that do not exhibit an information advantage entering the CECL period, but subsequently make investments in information production and acquisition.  For both groups, we document a significant shift in the trading behavior of insiders due to CECL compliance. We observe lower informativeness of insider purchases and lower insider stock purchasing activity when banks are more CECL-compliant. Interestingly, we observe a potential increase in insider purchase profits when banks are less CECL compliant despite their newly acquired information, consistent with opportunistic trading by insiders of this subsample of banks. We interpret our collective results to suggest that compliance with the forward-looking CECL standard alters bank insiders’ incentives to signal future credit risk information to the capital markets through their trades.