J. Account.

Public Policy 28 (2009) 386400

Contents lists available at ScienceDirect

J. Account. Public Policy

journal homepage: www.elsevier.com/locate/jaccpubpol

Ethical norms of CFO insider trading

Steven E. Kaplan a,*, Janet A. Samuels a, Linda Thorne b
a
School of Accountancy, W.P. Carey School of Business, Arizona State University, Cl Business Box 873606, Tempe,
AZ 85287-3606, United States
b
Schulich School of Business, 4700 Keele Street, York University, Toronto, Ontario, Canada M3J 1P3

a r t i c l e

i n f o

Keywords:
Insider trading
CFO
Ethics
Multidimensional ethics scale

a b s t r a c t
Insider trading encompasses the buying or selling of stocks based
on non-public information about the securities in question. Engaging in insider trading is particularly unethical for a Chief Financial
Ofcer (CFO) who holds a duciary responsibility to shareholders
and also typically is ethically obligated by his or her professional
responsibilities. Although the Securities and Exchange Commission
(1934) has expressly forbidden insider trading, the business press
suggests insider trading continues. An application of Cooters [Cooter, R., 1997. Normative failure theory of law. Cornell Law Review
82 (5), 947979; Cooter, R., 2000. Three effects of social norms
on law: Expression, deterrence and internalization. Oregon Law
Review 79 (1), 122] theory of the law and norms suggests that
one explanation for the continuation of insider trading is that
although illegal, norms may fail to consider insider trader to be
unethical. Nevertheless, our knowledge of the norms regarding
insider trading is limited. To address this gap, we examine the ethical norms regarding CFOs insider trading, and consider the extent
to which contextual variables are associated with ethical perceptions of CFO insider trading. We nd that insider trading by CFOs
is generally perceived to be unethical but not by all participants,
nor all ethical measures. Moral equity is particularly informative
for understanding the ethicality of CFO insider trading. When relying on the multidimensional ethics scale (MES) measure of moral
equity, our results reveal that contextual factors, including trading
method used (stock options or share equity) and the direction of
earnings surprise (favorable or unfavorable) are signicant. We
also found that participants that possessed more work experience
or nancial expertise had a greater tendency to consider CFO insider trading to be unethical than those with less work experience or

* Corresponding author.
E-mail address: Steve.Kaplan@asu.edu (S.E. Kaplan).
0278-4254/$ - see front matter 2009 Elsevier Inc. All rights reserved.
doi:10.1016/j.jaccpubpol.2009.07.006

S.E. Kaplan et al. / J. Account. Public Policy 28 (2009) 386400

387

nancial expertise, which suggests the importance of training and

education of the general public. In addition, our ndings suggest
that tougher sanctions will encourage compliance with existing
insider trading laws. Implications of our ndings for public policy
are discussed.
2009 Elsevier Inc. All rights reserved.

1. Introduction
Levitt (1998, p. 3), in his role as Chairman of the Securities and Exchange Committee (SEC), commented on the importance of prohibiting insider trading:
Trading based on privileged access to information can demoralize investors and destabilize investment. It has utterly no place in any fair-minded, law-abiding economy. Its a chronic danger. Its all
too evident in todays marketplace. . . .. The American people see it, bluntly, as a form of cheating.
They along with the S.E.C. have zero tolerance for the crime of insider trading.
Insider trading encompasses the buying or selling of stocks based on non-public information about
the securities in question. Corporate insider trading based on privileged information is a violation of
the Securities Act of 1934 (Meulbroek, 1992, p. 1664). Nevertheless, the popular press (Zuckerman and
Anand, 2007, p. C1; Scannell, 2007, p. B1; Searcey et al., 2007, p. A1) as well as academic research provides evidence of the continuation of insider trading even by those who hold duciary and professional responsibilities, including Chief Financial Ofcers (CFOs) (Huddart et al., 2007, pp. 1819;
Lustgarten and Mande, 1995, p. 259; Park and Park, 2004, pp. 400, 405). To the extent that insider
trading can demoralize investors and destabilize investment (Levitt, 1998, p. 3), the evidence of
continued insider trading is troubling and suggests additional steps may be needed to curb insider
trading. Policy makers interest in insider trading is stimulated, in part, because decisions about
whether and how to regulate insider trading are central to the welfare of the economy at large (Salbu,
1995, p. 314).
Legal scholars (Cooter, 2000, pp. 15801581; Robinson, 2000, pp. 18611863; Stout, 2006, pp.
2728) recognize the interplay between norms and the law in curbing undesirable behavior.
According to the theory of norms and the law (Cooter, 2000, p. 20), violations of laws (such as insider trading) are more than legal and economic decisions but also involve social and ethical considerations. In this regard, Statman (2004, p. 34) states that rules of fairness in the nancial
markets are an outcome of a process that involves the entire community. While various denitions
exist, norms are generally considered to reect beliefs or standards that are understood by members of a group or society that guide and/or constrain individual behavior (Cialdini and Trost, 1998,
p. 152).1 Using correspondent inference theory (Jones and McGillis, 1976, pp. 390398), norms play a
role in the extent to which members of society are expected to make correspondent inferences about
an individual who engages in an illegal behavior, which, in turn, will direct the social sanctions. Thus,
norms are viewed as important for two reasons. First, norms are likely to inuence the formation and
effectiveness of the law, and consequently, the probability of detection and criminal penalty, if convicted (Cooter, 2000, p. 20). For example, norms inuence the extent to which society members are
expected to inform authorities if they learn about illegal behavior. Second, in the absence of detection
by legal authorities, norms inuence the extent to which individuals engaging in illegal behavior suffer social sanctions such as a loss in reputation and opportunities (Ellickson, 1991, p. 207; Cooter,
1997, pp. 968969).
Within the theory of norms and the law (Cooter, 2000, pp. 2122), norms about the extent to
which insider trading is perceived as unethical are expected to play a central role, in part, because
they direct and guide views about legal and non-legal sanctions. While an individuals perceptions
1
Cialdini and Trost (1998) identify four different norms: descriptive norms, injunctive norms, subjective norms, and personal
norms.

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reect ones own self-based beliefs and standards, collectively, individuals perceptions form ethical
norms, which are the basis of the social consensus for various behaviors (Jones, 1991, p. 375;
Mackenzie, 2004, p. 55). Accordingly, our study examines the ethical norms regarding CFOs insider
trading, and considers the extent to which contextual factors may be associated with these
norms.
Our study focuses on the insider trading of a CFO for a publicly traded company. CFOs of publicly
traded companies have access to private information about their companies. By virtue of being a
member of the executive group of a public company, CFOs have duciary and professional responsibilities to a broad range of stakeholders, which have been codied in law (Johnson, 2007, p. 147).
According to the Securities Act of 1934, it is illegal for CFOs, like other insiders, to trade based on their
inside knowledge (Anonymous, 1997, p. 410; Blackman, 1998, p. 47).
An experiment was used to examine the ethical perceptions of CFOs insider trading and consider
the extent to which contextual variables are associated with ethical perceptions of CFO insider trading.
To capture the ethical norms of the broader investment community, participants were working professionals (evening MBA students). Although insider trading by CFOs is generally perceived to be
unethical, a surprising percentage of our participants perceived insider trading not to be unethical.
We nd that insider trading by CFOs generally is perceived to be unethical but not by all participants,
nor all ethical measures. Moral equity is particularly informative for understanding the ethicality of
CFO insider trading. When relying on the multidimensional ethics scale (MES) measure of moral equity, our results reveal that contextual factors, including trading method used (options or equity) and
direction of earnings surprise (favorable or unfavorable) are signicant. We also nd participants that
possessed more work experience and nancial statement expertise had a greater tendency to consider
CFO insider trading to be unethical, which suggests that continued education and training may contribute toward strengthening the social intolerance toward CFO insider trading. Our paper contributes
to the literature by applying the theory of norms and the law to the domain of insider trading and
extending the theory of norms and the law by focusing on ethical norms. We further extend this literature by examining the extent to which accounting related variables may inuence ethical norms
held by individuals.
This paper is organized as follows. The next section considers the legislation and incidence of insider trading and presents the theory of norms and the law (Cooter, 2000, pp. 13) to explain the continued incidence of insider trading today. This is followed by a presentation of the research method
and design, followed by the results, and a discussion of the implications of the ndings.

2. Theory of norms and the law and insider trading

Cooters (2000, p. 5) theory of norms and the law describes how norms impact individuals
decisions on whether to comply with the law. According to Cooter, if everyone believes that others
will obey the law, the norm becomes a self-fullling prophecy and individuals will comply with the
law. Thus, a primary way to strengthen compliance is to align the law with norms either by changing laws or working to inuence norms. Cooter (2000, p. 11) illustrates the role of norms on compliance with the law through an example of non-smoking regulation in airports between the US
and France. In both countries, the law forbidding smoking in airports is the same; however, compliance with the law in the two countries is different. According to Cooter (2000, p. 11), in the US, the
occurrence of smoking in airports is lower than that in France. Cooter contends that the degree of
compliance with non-smoking laws between the US and France differs due to the difference in
norms regarding the ethicality of non-smoking in public places in the two countries. Compared to
France, the social norm considers smoking in public places to be far more unethical in the US,
and the likelihood of airport smokers being shamed for engaging in unethical behavior is much
greater (Cooter, 2000, p. 11).
Our review of the accounting literature shows that a consideration of norms has been limited to tax
compliance research. Within the tax compliance literature, norms are considered an important
theoretical construct that guides taxpayers compliance decisions (Alm et al., 1999, p. 163; Bobek
and Hateld, 2003, pp. 18, 30; Bobek et al., 2007, p. 60; Cowell, 1990, pp. 108114; Davis et al.,

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389

2003, pp. 44, 50; Hanno and Violette, 1996, pp. 5859; Porcano and Price, 1993, p. 198). This literature
generally demonstrates that norms do not universally consider tax evasion to be highly unethical. Perhaps, most relevant to our study are the results of Alm et al. (1999, pp. 155163) who found that individuals tendency to comply with tax regulation was moderated by norms. When the social norm
endorsed compliance, participants generally complied with tax regulations and conversely, when
the social norm failed to reinforce the tax regulation, participants cheated to a much greater extent
(Alm et al., 1999, pp. 162163).
Similar to illegal tax evasion, insider trading is not universally accepted as highly unethical by academics (e.g., Cinar, 1999, p. 345; Ma and Sun, 1998, p. 67; Manne, 1966, pp. 215; Martin and Peterson, 1991, p. 57; Moore, 1990, p. 171; Salbu, 1995, p. 313; Werhane, 1989, p. 841). Many scholars
suggest that insider trading should be prohibited because it is inequitable (Cho and Shaub, 1991,
pp. 8588; Salbu, 1995, p. 320; Shaw, 1990, p. 914). However, some scholars argue that insider trading
is not unethical because prohibitions against insider trading lack ethical underpinnings (Manne, 1966,
p. 15, 2006, p. A16; Martin and Peterson, 1991, p. 58; Werhane, 1989, p. 842). Finally, still others
contend that insider trading represents an economic rather than ethical issue (Ma and Sun, 1998,
pp. 7374). Given the ethical debate, it has been suggested that insider trading will be perceived as
more unethical in some situations than in others (Abdolmohammadi and Sultan, 2002, p. 171; Moore,
1990, p. 177).
Beams et al. (2003, p. 314) investigates the association between insider trading and the contextual
feature of avoiding losses versus achieving gains. Beams et al. (2003, p. 317) found that even though
the economic benets were identical, participants placed in the role of a company insider were more
likely to trade on insider information to avoid a loss than achieve a gain.2 Nevertheless, this study did
not investigate perceptions of the ethicality of insider trading or the importance of contextual factors to
ethical perceptions and norms.
Moore (1990, p. 178) distinguishes between insiders trading based on good news versus bad
news. Good news is privileged information that is expected to raise the companys stock price
when made public whereas bad news is privileged information that is expected to depress the
companys stock price when made public. While insider trader based on good news can be viewed
as compensation for the executive, insider trading based on bad news would encourage harmful
acts and gives rise to inevitable conicts of interest between executives and current shareholders
(Moore, 1990, pp. 178179). While the potential rewards to the insider may be similar for trading on
either good or bad, Moore (1990, p. 178) suggests, but does not test, that ethical perceptions will differ between insider trading based on good news versus bad news, and that insider trading will be
perceived as more unethical for bad rather than good news. This is consistent with empirical
ndings by Cardy and Selvarajan (2006, pp. 5961), who nd that identical behaviors are perceived
as more ethical when outcomes are positive than when outcomes are negative. It follows that
because good news results in a positive outcome for current shareholders (and a congruence of
interests between executives and current shareholders) it is likely to be perceived as more ethical
than bad news, which results in a negative outcome for current shareholders. This gives rise to
the following hypothesis:
Hypothesis 1. Insider trading will be perceived as more unethical when CFOs are trading on an
unfavorable rather than a favorable earnings surprise.
Insiders generally have the ability to trade using either stock equity or stock options. That is, an
insider may buy/sell shares of company stock or buy options to buy/sell shares of company stock at
set price, typically the current equity price. However, for a xed amount of money, one can control
many more shares of stock using stock options compared to using equity. Alternatively, one can
control a xed number of shares of stock for a fraction of the cost using stock options compared
to equity. Archival research (Carpenter and Remmers, 2001, pp. 531532; Chen and Zhao, 2005,
pp. 165171) suggests that insiders use both stock options and equity for insider trading. However,

2
This nding is consistent with prospect theory, in which individuals are more risk seeking for losses than for gains (Kahneman
and Tversky, 1979; Tversky and Kahneman, 1986).

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perceptions of insider trading utilizing stock options versus equity shares may vary. Hall (2000,
p. 123) indicates that stock options are bafingly complex nancial instruments. . . as compared to
share equity. Because of the complexity involved with stock options, their use may be seen as more
deceptive compared to the more straightforward use of share equity. Lewicki and Robinson (1998,
p. 667) classify deception as a form of lying and Akaah and Lund (1994, p. 418) show that deception is considered an unethical behavior. Results from these studies suggest that to the extent that
stock options are a more complex nancial instrument, their use in insider trading would be considered more unethical compared to the use of share equity. This gives rise to the following
hypothesis:
Hypothesis 2. Insider trading will be perceived as more unethical when it involves stock options as
compared to equity shares.
Previous empirical ndings indicate that the ethical norms of insider trading may be related to
individual variables (Terpstra et al., 1991, p. 703). In addition, the scholarly cognitive-development research in general as well as in accounting suggests that work experience and expertise is generally
found to be positively related to individuals ethical reasoning and behavior (Jones et al., 2003, pp.
61, 77). As Abdolmohammadi and Sultans (2002, p. 170) ndings show a signicant association between ethical reasoning and perceived ethicality of insider trading, we propose that key individual
variables will be associated with ethical norms of CFO insider trading. Specically, we propose that
as individuals become more experienced, we expect them to become more aware of and sensitive
to behavior that is inconsistent with the CFOs professional and duciary responsibilities. This gives
rise to the following hypotheses:
Hypothesis 3a. Insider trading will be perceived as more unethical by individuals with greater work
expertise.
Hypothesis 3b. Insider trading will be perceived as more unethical by individuals with greater nancial expertise.
Under economic theory, increasing sanctions and/or detection will increase compliance with law.
However, as discussed above, legal scholars increasingly are recognizing that economic theory may
have an overly narrow view of behavior by overlooking the important role of norms in the functioning
of laws. Under Cooters (2000, p. 21) theory of norms and the law, a primary way to strengthen compliance is to align the law with norms. Prior research in marketing has found that norms inuence perceptions of fairness of penalties (McCarthy and Fram, 2000, pp. 491, 494). In the context of our study,
this suggests that ethical norms will inuence ones perceptions about appropriate sanctions. Consistent with the theory of norms and the law, we view sanctions broadly to include both legal and nonlegal penalties. Legal sanctions include both ones willingness to convey to authorities information
about insider trading as well as legal nes. Non-legal sanctions may include loss of a job, other
employment opportunities, or loss of reputation.
As discussed above in hypothesis one and two, contextual features are expected to be associated
with ethical norms. Under the theory of norms and the law, we expect ethical perceptions to guide
judgments about sanctions for insider trading. Thus, we expect contextual features to inuence ethical
perceptions, which, in turn, will inuence judgments about sanctions. In other words, we expect ethical perceptions to mediate the relationship between contextual features such as earnings surprise and
judgments about sanctions for insider trading. Baron and Kenny (1986, p. 1178) contend that it is
important to examine mediating variables because they increase our understanding of the process
by which observers transform the predictor or input variables. This discussion leads to the following
two hypotheses:
Hypothesis 4a. Ethical perceptions of CFO insider trading are associated with sanction judgments.
Hypothesis 4b. Ethical perceptions of CFO insider trading will mediate the relationship between contextual variables (e.g., favorable vs. unfavorable news; equity shares vs. stock options) and sanction
judgments.

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391

3. Method
3.1. Overview
The study involved an experiment in which 138 evening MBA students received a scenario where
the Chief Financial Ofcer (CFO) engages in insider trading based on his knowledge that current period
earnings for the rm will differ from expected earnings. The rm in the case was described as a global
publicly traded rm in the chemical industry with sales over $6 billion and more than 12,000 employees. In the scenario, the CFO learns that the quarterly earnings for the current period are expected to
differ substantially from the consensus analysts earnings per share (EPS) forecast and, based on this
information, engages in insider trading. In response to the scenario, participants provided ethical perceptions (ethical norms) and sanction judgments. Selected prior year nancial information for the
company was presented and information about specic nancial ratios for the chemical industry
was also provided. We manipulated the direction of earnings surprise (e.g., favorable vs. unfavorable)
and trading method used (e.g., stock vs. options). After reading the scenario, participants were asked to
rate their ethical perceptions regarding the CFOs insider trading and their perception of appropriate
sanctions for the CFO for engaging in insider trading. Finally, participants responded to manipulation
check questions and gave background information. This research was reviewed and passed ethics approval from the researchers institutions.
3.2. Participants
The 138 participants were obtained through the cooperation of an evening MBA program from a
major metropolitan state university. All were volunteers and received no credit for participating in
the research. Evening MBA students typically are working professionals who are familiar with a broad
range of business operations and the stock market, are older and have substantial work experience.
The average age of participants was 29.6 years (standard deviation of 4.9) with 7.1 years of work experience (standard deviation of 6.2). In response to a post-experimental question, 76% of participants responded that they believed the CFOs actions were illegal, 12% indicated the actions were legal and the
remaining 12% indicated that they did not know if the actions were legal or illegal. Seventy percent of
participants were male and 79% had invested in the stock market in the past. Participants self-reported
a mean of 9.3 nancial statements read in the past year (standard deviation of 18.4). Mean self-assessed ability to read and understand nancial statements was 4.9 on a seven-point scale (standard
deviation of 1.1) where 1 was anchored on very poor and 7 was anchored on very strong. Thus,
this group appears to be reasonably representative of a relatively knowledgeable group of nancial
statement users.
3.3. Dependent variables
The dependent variable related to the rst three hypotheses is ethical perceptions of insider trading
by a CFO. Six measures were used to operationalize ethical perceptions of insider trading. These six
measures represent proxies for participants ethical norms for insider trading by a CFO. The rst measure is a global measure (global ethics), which is a single item measure of individuals ethical perception of the CFOs insider trading. Specically, participants were asked to provide an ethical perception
of the CFOs trading action based on knowledge of the companys expected earnings for the current
period. The end points on a seven-point scale are action is extremely unethical and action is extremely ethical, with a score of 4 representing the mid-point. This question was reverse-coded such
that higher numbers reect judgments that the action is unethical.
The remaining ve measures are based on the responses to the multidimensional ethics scale
(MES) (Cohen et al., 1993, p. 17; Reidenbach and Robin, 1988, pp. 874877, 1990, pp. 641, 649).
The MES is intended the capture individuals ethical perceptions across a set of different ethical
perspectives with regards to another entitys (e.g., individual, group, or organization) behavior. That
is, the MES indicates the extent to which an individual believes that another entitys behavior is

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unethical using a specic ethical perspective. The MES was originally developed by Reidenbach and
Robin (1988, p. 873, 1990, p. 641). Reidenbach and Robin (1990, p. 649), after considering an initial
set of 33 items, introduced an eight item MES scale, capturing three different underlying dimensions
related to ethical perceptions with regards to another entitys behavior: moral equity, relativism, and
contractualism. First, moral equity is grounded in Aristotles principle of formal justice, which captures the inherent fairness, justice, goodness, and rightness of a decision (Reidenbach and Robin,
1990, p. 650). Second, relativism describes the extent to which behavior is ethical in relation to
the guidelines or requirements inherent in an individuals cultural or social system (Reidenbach
and Robin, 1990, pp. 650651). Third, contractualism (also called deontology) describes the extent
to which behavior is ethical in relation to its correspondence to implied obligations, contracts, duties
and rules (Cohen et al., 1996, p. 101; Reidenbach and Robin, 1990, p. 651). Ones understandings and
beliefs about these implied obligations, contracts, duties and rules subsequently inuence the
perceptions of ethicality one makes under the contractualism dimension. Reidenbach and Robin
(1990, p. 644) provide evidence demonstrating the validity and reliability of the three factor scale.
Flory et al. (1992, pp. 292296) provide further evidence supporting the validity and reliability of
the three factor scale based on certied management accountants responses to four ethical
dilemmas. More recently, Ayers and Kaplan (2005, pp. 125126) apply the three factor MES scale
to examine individuals whistleblowing intentions.
Cohen et al. (1993, pp. 1921) provide additional evidence on the validity and reliability of the
MES. Their pretest provides additional evidence on the original set of 33 items used by Reidenbach
and Robin (1988, p. 874, 1990, p. 641). Based on their analysis, they introduced the ve factor MES
that also included two other ethical perspectives: utilitarism and egoism. Utilitarianism is the extent
to which ethical perceptions consider the benets obtained and the costs incurred among stakeholders affected by the action (Cohen et al., 1996, p. 101). Lastly, egoism captures the extent to which
perceptions of ethicality are related to the self interest of the individual taking action (Cohen
et al., 1998, p. 254). Cohen et al. (1996, pp. 105107, 1998, p. 255) provide further evidence for
the ve factor MES. Overall, these results generally indicate that the original three MES ethical
factors (moral equity, relativism, and contractualism) are reliable and that the reliability of the other
two ethical factors (utilitarism and egoism) varies somewhat across different behaviors (Vitell and
Ho, 1997, p. 699).
The ve ethical factor MES was used in this study. The seven-point response scale was used for the
items from the MES, with a score of 4 representing the mid-point. Consistent with the global ethical
measure, these ve ethical dimension measures were scored such that a higher number indicates that
insider trading is considered to be more unethical for the ethical dimension.
Since multiple items are used for each ethical perspective, Cronbachs alpha was computed
for each MES dimension to assess the reliability of each dimension in this study. Cronbachs alpha
for each dimension is as follows: (1) alpha = .93 for the moral-equity dimension, (2) alpha = .84
for the relativism dimension, (3) alpha = .93 for the contractualism dimension, (4) alpha = .14 for
the egoism dimension, and (5) alpha = .63 for the utilitarianism dimension. With the exception of
the egoism dimension, the above results indicate that the ethical dimensions are reliable in this
study. These reliability results are similar to those reported by Cruz et al. (2000, pp. 230232),
who applied the ve factor MES to examine tax related behaviors. In that study, Cronbachs alpha
was substantially lower for egoism (and below acceptable levels of reliability) than the other four
dimensions. For completion, we present results for the egoism dimension, even though the measure
is unreliable.
The dependent variable related to hypothesis four is sanction judgments. To operationalize this
variable, participants indicated their extent of agreement with the following sanctions: (1) ring
the CFO, (2) informing the Securities and Exchange Commission (SEC) of the CFOs insider trading,
(3) the CFO paying a large monetary ne (based on the amount of the insider trading benet to the
CFO plus a punitive amount), and (4) the CFO going to prison for one year. Participants indicated their
level of agreement using a seven-point scale anchored by strongly disagree (1) and strongly agree
(7). Cronbachs alpha is 0.84 for the four sanctions; therefore, for the purposes of our analysis, we combine the four sanctions into a single variable that we refer to as sanction. Specically, sanction was
formed by summing the four individual scores and dividing by four.

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393

3.4. Independent manipulated variables

The rst two hypotheses required the experimental manipulation of contextual variables: direction
of earnings surprise (unfavorable or favorable) and trading method (options or equity). Accordingly,
participants were randomly assigned to one of four (independently crossed) conditions. For the favorable earnings surprise condition, the scenario indicated that EPS for the current quarter was expected
to be approximately $0.70, which was well above the consensus analysts EPS forecast of $0.55. Alternatively, in the unfavorable earnings surprise condition the scenario indicated that the EPS for the current quarter was expected to be approximately $0.40, which was well below the consensus analysts
EPS forecast of $0.55. The setting adopted in our experiment for earnings surprise is consistent with
Moores (1990) example where a manager possesses either privileged good news or bad news. More
specically, in our manipulation, the CFO possesses privileged information that earnings for the company are expected to be higher (or lower) than the markets expectations based on nancial analysts
consensus estimate of earnings per share. Using this manipulation allows us to experimentally control
the size of earnings surprise so it is similar regardless of the direction.
For trading method, participants were assigned to either equity or options. Under the equity condition, the scenario indicated that the CFO purchased or sold shares of the companys stock. Under the
options condition the scenario indicated that the CFO purchased call or put options for shares of the
companys stock, based on whether the earnings news surprise was in a favorable or unfavorable
direction.
Responses to a debrieng item were used to determine that participants attended to the manipulation of earnings surprise. Specically, the debrieng item read, Given the available information,
please indicate whether actual rst quarter earnings for XYZ Company are expected to be better than
or worse than analysts consensus forecast. Participants were asked to select a response from among
the following three: (1) actual rst quarter earnings expected to be better than analysts consensus
forecast, (2) actual rst quarter earnings expected to be worse than analysts consensus forecast,
and (3) do not know. Of the 138 participants, 8 answered this question incorrectly and were dropped.
The statistical analyses are based upon the responses from the remaining 130 participants.
3.5. Independent measured variables
Hypothesis three predicts that two individual differences will be associated with perceptions of
ethicality of CFO insider trading: work experience and F/S expertise. Work experience refers to selfreported years of work experience and F/S expertise is the self-assessed ability to read and understand
nancial statements. Participants self-assessed their ability to read and understand nancial statements using a seven-point scale anchored by very poor (1) and very strong (7).
3.6. Statistical analysis
We test four hypotheses. The rst three hypotheses are tested using ANCOVA for different dependent measures of ethical perceptions, and includes the independent measures of earnings surprise,
trading method, and the interaction of earnings surprise  trading method, and the covariates of work
experience and F/S expertise. Results for the rst three hypotheses are presented in Table 2. Table 3
presents the results for the fourth hypothesis that considers whether ethical perceptions mediate
the relationship between contextual variables and sanction judgments.

4. Results
4.1. Distribution statistics for ethical perceptions
Table 1 presents descriptive statistics for each measure of ethical perception. A seven-point response scale was used for each measure such that 4 represents the mid-point. Scores above four
for any of these measures indicate an unethical perception whereas scores below four on any of these

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Table 1
Descriptive statistics of ethical perceptions of the Chief Financial Ofcers (CFOs) insider trading action.
Global ethicsa

Moral equityb

Relativismc

Utilitarianismc

Contractualismc

Egoismc

Perceptions above 4
Perceptions = 4
Perception below 4

103
14
12

80
11
9

109
5
14

85
4
11

88
12
29

68
9
22

65
28
35

51
22
27

103
9
17

80
7
13

95
20
13

74
16
10

Totald

129

100

128

100

129

100

128

100

129

100

128

100

Global ethics was one question with a seven-point scale with a higher number representing a more unethical perception
(1 = action is extremely ethical and 7 = action is extremely unethical).
b
Moral equity is the average of four questions with a seven-point scale with a higher number representing a more unethical
perception for this dimension.
c
Relativism, utilitarianism, contractualism and egoism are each the average of two questions with a seven-point scale with a
higher number representing a more unethical perception for the dimension.
d
Column may not sum to 100 due to rounding.

measures indicate an ethical perception. Table 1 shows the number and percentage of participants
responding above, at, or below the mid-point. As shown, the vast majority of responses were above
the mid-point, reecting unethical perceptions. However, Table 1 also provides evidence that unethical perceptions were not universal, with the percentage of ethical responses (e.g., below the midpoint) ranging between 9% and 27%. This descriptive evidence indicates that, across the set of measures, a minority of participants do not assess insider trading as unethical, which is consistent with
Statman (2005, p. 81).
4.2. Hypothesis 1
Hypothesis 1 postulates that insider trading will be perceived as more unethical when the CFO
trades on unfavorable earnings news rather than favorable earnings news. As shown in Table 2 Panel
A, earnings surprise is signicant for the dependent variables of moral equity (p < .01) and for the
dependent variables of relativism and contractualism (p < .10). As shown, in Table 2 Panel B, the means
for each of these three measures are in the expected direction. Earnings surprise is not signicant for
the dependent variables of utilitarianism and egoism. Thus, there is limited for support for H1.
4.3. Hypothesis 2
Hypothesis 2 proposes that insider trading will be perceived to be more unethical when the CFO is
using options versus when the CFO is using equity. As shown in Table 2 Panel A, trading method is
signicant only for the dependent variable of moral equity (p < .05), and the means, shown in Table
2 Panel B, are in the expected direction. Thus, there is limited for support for H2.
4.4. Hypothesis 3
Hypotheses 3a and 3b postulate that ethical perceptions will be related to work experience and
nancial expertise, respectively, such that greater work experience or more nancial expertise will
lead to stronger unethical perceptions. As shown in Table 2 Panel A, work experience is signicantly
associated with moral equity and relativism (p < .05) and with global ethics (p < .10). F/S expertise is
signicantly associated with global ethics and moral equity (p < .01) and contractualism (p < .05).
Thus, there is limited for support for H3a and H3b.
4.5. Hypothesis 4
Hypothesis 4a predicts that ethical perceptions of CFO insider trading will be signicantly associated with sanction judgments. Support for this would be found when there is a signicant correlation
between ethical perceptions and sanction judgments. We tested this using global ethics as well as the

Table 2
Ethical perceptions of the Chief Financial Ofcers (CFOs) insider trading action.
Source

Global ethicsa
p-Value

Relativisma

p-Value

p-Value

Utilitarianisma

Contractualisma

Egoisma

p-Value

p-Value

2.96

0.09

1.39

0.24

1.34
0.47
4.71
0.03

0.25
0.49
0.03
0.87

0.15
0.55
0.20
1.85

0.70
0.46
0.66
0.18

p-Value

Panel A: analysis of variance summary table with ethical perceptions of the CFOs insider trading as the dependent measures
1.48
0.23
5.99
0.02
2.86
0.09
1.04
0.31
Earnings surprise
(ES)b
c
Trading method (TM)
1.77
0.19
4.01
0.05
0.57
0.45
0.02
0.89
ES  TM
0.96
0.33
0.01
0.92
2.03
0.16
0.56
0.46
d
7.62
0.01
8.73
0.00
0.22
0.64
0.61
0.43
F/S expertise
3.20
0.08
4.35
0.04
4.92
0.03
0.42
0.52
Work experiencee
Treatment

Global ethics
Equity

Panel B: descriptive statistics of ethical

Favorable
5.62f
(1.61)
Unfavorable
5.63 (1.92)
Overall
a
b
c
d
e
f

Moral equity
Options

Overall

perceptions by treatment
5.57
5.59
(1.68)
(1.63)
6.25
5.97
(1.36)
(1.65)
5.63 (1.76) 5.94
5.81
(1.54)
(1.64)

Relativism

Contractualism

Equity

Options

Overall

Equity

Options

Overall

Equity

Options

Overall

5.25
(1.55)
5.82
(1.48)
5.54
(1.53)

5.63
(1.46)
6.23 (1.00)

5.44 (1.50)

4.85 (1.70)

4.60 (1.53)

6.04 (1.25)
5.78
(1.39)

5.44
(1.39)
5.06 (1.51)

5.22
(1.86)
5.92
(1.44)
5.57
(1.69)

5.65
(1.58)
6.01 (1.41)

5.95
(1.25)

4.83
(1.59)
4.84 (1.70)

4.73
(1.68)
5.17 (1.50)

5.43
(1.73)
5.97
(1.41)
5.69
(1.63)

4.96 (1.60)

5.85
(1.49)

Dened in Table 1.
Earnings surprise was manipulated between participants at two levels: favorable (actual earnings greater than expected) and unfavorable (actual earnings less than expected).
Trading method was manipulated between participants at two levels: equity and options.
F/S expertise is the self-assessed ability to read and understand nancial statements.
Work Experience refers to self-reported years of work experience.
Panel values are the means. Standard deviations are shown in parentheses below the means.

S.E. Kaplan et al. / J. Account. Public Policy 28 (2009) 386400

Moral equitya

395

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S.E. Kaplan et al. / J. Account. Public Policy 28 (2009) 386400

other MES dimensions (moral equity, relativism, utilitarianism, egoism and contractualism). Correlations between global ethics, moral equity, relativism, utilitarianism, egoism and contractualism and
sanction were .53, .80, .48, .50, .13 and .60, respectively, and, except for egoism, each p-value was
<0.0001. These results provide support for Hypothesis 4a.
Hypothesis 4b proposes that ethical perceptions will mediate the relationship between contextual
variables (earnings surprise and trading method) and sanction judgments. This hypothesis presupposes a relationship between contextual variables and sanction judgments. Table 3, under the column
for Model 1, presents the results showing the relationship between each contextual variable and sanction. As shown in Table 3 Model 1, both earnings surprise and trading method are signicantly associated with sanction (p < .10), indicating a relationship between each contextual variable and sanction.
Baron and Kenny (1986, p. 1177) detail the steps to test for the presence of a mediating variable.
The rst condition they identify is an association between the independent variables, earnings surprise and trading method, and a potential mediating variable (ethical perceptions). Results for this
condition were presented earlier when discussing H1 and H2. These results showed a signicant relationship between earnings surprise and trading method and the ethical perception measures of moral
equity, relativism and contractualism. These results indicate that moral equity, relativism, and contractualism remain potential mediator variables. The next condition for mediation requires that the
potential mediation variable (ethical perceptions) be associated with the dependent variable (sanction). Results for this condition were presented earlier when discussing H4a. These results showed
that this condition was satised for all ethical perception measures, except for egoism which were
not signicant.
For the nal condition identied by Baron and Kenny (1986, p. 1177), when the mediator is
included as a variable in the complete model, the mediation variable must be associated with the
dependent variable (sanction) and the independent variables (earnings surprise and trading method)
lose signicance. Based on results presented above, moral equity, relativism, and contractualism
remain potential mediator variables. To test the nal condition, each of these three variables was
separately added to Model 1. As shown in Table 3, Model 2, moral equity is highly signicant and earnings surprise and trading method are no longer signicant. Furthermore, when considering the models

Table 3
Sanction judgments for the Chief Financial Ofcers (CFOs) insider trading action.
Source

Model 1
F

Model 2
p-Value

Model 3
p-Value

Model 4
p-Value

p-Value

Panel A: analysis of variance summary table with sanction judgments for the CFO as the dependent measure and ethical dimensions as
mediatorsa
Earnings surprise (ES)
3.59
0.06
0.05
0.83
1.82
0.18
1.52
0.22
Trading method (TM)
3.43
0.07
0.00
0.96
2.61
0.11
1.43
0.23
ES  TM
0.44
0.51
2.45
0.12
0.02
0.90
2.54
0.11
F/S expertise
4.62
0.03
0.04
0.84
4.74
0.03
1.13
0.29
Work experience
5.04
0.03
1.16
0.28
2.08
0.15
8.09
0.01
Moral equity
179.73
0.00
Relativism
25.99
0.00
Contractualism
72.48
0.00
R-squared
0.14
0.66
0.29
0.46
Earnings surprise

Trading method
Equity

Panel B: descriptive statistics of sanction judgments for the CFOa

Favorable
5.19b (1.47)
Unfavorable
5.43 (1.59)
Overall
5.31 (1.53)

Options

Overall

5.38 (1.35)
5.99 (0.99)
5.72 (1.20)

5.28 (1.41)
5.73 (1.32)
5.52 (1.36)

a
Sanctions judgments for the CFO is an average of four questions relating to paying a ne, going to prison, ring the CFO and
informing the Securities and Exchange Commission. Responses were on a seven-point scale with higher numbers reecting
stronger agreement with potential consequences for the CFO.
b
Panel values are the means. Standard deviations are shown in parentheses below the means.

S.E. Kaplan et al. / J. Account. Public Policy 28 (2009) 386400

397

included in Table 3, the explanatory power from Model 2, as reected in the R-squared, is substantially
larger compared to the other models. Overall, these results indicate that moral equity appears to represent a mediator variable for the relation between contextual variables (earnings surprise and trading
method) and sanction judgments, and provide support for H4b.

5. Discussion
The purpose of our study was to provide evidence on individuals ethical norms regarding CFOs
insider trading. Specically, this study examined the extent to which contextual variables inuence
individuals ethical norms, and the extent to which ethical norms inuence sanction judgments. Multiple measures of ethical perceptions were included in the study to proxy for individuals ethical norms.
Understanding ethical norms are important because they represent and inform rules of behavior enforced within a community (Giddens, 1984, p. 30; Statman, 2004, p. 34). This notion that the norms of
a community play a vital role in compliance is consistent with Cooters (2000, p. 20) theory of norms
and the law. This theory holds that compliance will be enhanced by aligning laws with norms. Thus,
our research extends Cooters theory into the domain of ethical norms, and in so doing, provides insights into factors associated with, and perceptions of, CFO insider trading.
Under the Securities Act of 1934, insider trading based on material privileged information is illegal,
and a top manager engaging in insider trading may receive civil and/or criminal penalties. Penalties for
insider trading contained in the 1934 law were subsequently increased by both the Insider Trading
Sanctions Act of 1984 and the Insider Trading and Securities Enforcement Act of 1988 (Meulbroek,
1992, pp. 16641665). Under current law, civil penalties may be up to three times the amount of
the insiders benet (e.g., prot gained or loss avoided) and jail terms may be as long as 10 years. Thus,
the law is clear that engaging in insider trading based on material privileged information is wrong and
the penalties can be harsh. Policy makers have also made indicated that these laws are important for
maintaining investors condence in our capital markets.
Under the theory of norms and the law (Cooter, 2000, p. 20), insider trading laws will function better when they align with norms. Our study provides evidence on this alignment and factors contributing to the extent of alignment. We nd that while participants generally assess insider trading by a
CFO to be unethical, this was not a universal view by all participants. For each ethical perception measure, a minority of participants do not perceive CFO insider trading as unethical. Our evidence that a
majority of participants assess insider trading to be unethical is consistent with the scholarly research,
which generally indicates that the majority of scholars consider insider trading to be unethical and
that a minority of scholars do not. This nding should be informative to policy makers because it
shows that ethical norms among participants do not appear to fully align with insider trading laws.
To the extent that policy makers support current insider trading laws, our results suggest that they
may want to take steps to foster ethical norms likely to curb insider trading. In considering potential
steps, our results may be used to suggest directing efforts primarily towards individuals who are relatively uninformed about nancial statements and investing. These efforts might take the form of education, training, or simply public service announcements or web-based communications. This
suggestion is based on our nding that ethical norms among individuals more knowledgeable of nancial statements (and presumably more knowledgeable investors) appear to align with the law better
than individuals less knowledgeable of nancial statements.
Our ndings also indicate that perceptions of ethicality vary according to context and are consistent with Joness (1991, p. 371) issue contingent model of ethical decision making. However, our results demonstrate that the sensitivity of individuals ethical perceptions to contextual variables
depends, in part, on the measure used. For example, the inuence of contextual variables on individuals ethics perceptions was most apparent using the moral equity measure. In this regard, our results
show that trading method (options or equity) and direction of earnings surprise (favorable or unfavorable) is each associated with perceptions of moral equity. These ndings provide further support for
using the MES as opposed to only using a global ethics measure in ethics research when perceptions of
ethicality are expected to vary across contexts. Had only a global measure of ethics been used in the
current study, we would have been less informed about the inuence of the two contextual variables

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S.E. Kaplan et al. / J. Account. Public Policy 28 (2009) 386400

including in this study. This nding might be used to suggest that public policy efforts (e.g., education,
training, public service announcements, etc.) intended to better align ethical norms among individuals
with insider trading laws should focus moral equity considerations.
Lastly, our results demonstrate that ethical norms play an important role in guiding sanction judgments. This evidence is important because it suggests that individuals generally do not compartmentalize ethical assessments formed about CFO insider trading. This evidence suggests that ethical norms
are an important component in the social sanctions likely to be imposed by individuals as well the legal sanctions individuals will support for insider trading. This nding further supports the need for
policy makers to be informed about individuals ethical norms and steps that might be taken to foster
ethical norms likely to curb insider trading.
Given the paucity of research on ethical norms about insider trading, we encourage further research. For example, future research could consider other contextual and individual variables in the
association between perceptions and sanctions. Such research might consider whether ethical perceptions of the appropriateness of sanctions vary according to the insiders professional and duciary
responsibilities.
Several limitations should be noted regarding the study. As part of the experimental approach, participants responded to a hypothetical scenario about insider trading by the CFO of a public company.
This approach is becoming increasingly common within nancial accounting research (Libby et al.,
2002, p. 800) and previously has been used to examine ethical beliefs about insider trading by Statman
(2005, p. 78). An experiment is particularly well suited to the current focus because it allows us to directly measure ethical perceptions and sanction judgments. However, use of an experimental approach generally limits the information available to participants. For example, our study did not
provide information on the size of the insider trade, historical and current stock prices, etc. These additional pieces of information may inuence ethical perceptions and sanction judgments. Additionally,
our study only examined insider trading by a CFO. Insider trading can be conducted by a variety of
individuals and ethical perceptions and sanction judgments may differ for different perpetuators.
We used MBA students as our participants to capture the ethical norms and sanction judgments of
the general business community. While we believe that the perceptions of this group are important
and are likely to be generally representative of nonprofessional investors (Elliott et al., 2007, pp.
155156), they may not reect the perceptions of other groups such as professional investors, nancial analysts, creditors, top managers, or judges. Given that our results suggest the importance of
expertise and work experience to several of ethical norm measures, further research using participants
with different levels of expertise and work experience is encouraged.
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