Insider Trading - Econlib - 0 views
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Insider trading” refers to transactions in a company’s securities, such as stocks or options, by corporate insiders or their associates based on information originating within the firm that would, once publicly disclosed, affect the prices of such securities.
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Corporate insiders are individuals whose employment with the firm (as executives, directors, or sometimes rank-and-file employees) or whose privileged access to the firm’s internal affairs (as large shareholders, consultants, accountants, lawyers, etc.) gives them valuable information.
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Famous examples of insider trading include transacting on the advance knowledge of a company’s discovery of a rich mineral ore (Securities and Exchange Commission v. Texas Gulf Sulphur Co.), on a forthcoming cut in dividends by the board of directors (Cady, Roberts & Co.), and on an unanticipated increase in corporate expenses (Diamond v. Oreamuno).
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Such trading on information originating outside the company is generally not covered by insider trading regulation.
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Insider trading is quite different from market manipulation, disclosure of false or misleading information to the market, or direct expropriation of the corporation’s wealth by insiders.
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Regulation of insider trading began in the United States at the turn of the twentieth century, when judges in several states became willing to rescind corporate insiders’ transactions with uninformed shareholders.
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One of the earliest (and unsuccessful) federal attempts to regulate insider trading occurred after the 1912–1913 congressional hearings before the Pujo Committee, which concluded that “the scandalous practices of officers and directors in speculating upon inside and advance information as to the action of their corporations may be curtailed if not stopped.”
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The Securities Acts of 1933–1934, passed by the U.S. Congress in the aftermath of the stock market crash, though aimed primarily at prohibiting fraud and market manipulation, also targeted insider trading.
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As of 2004, at least ninety-three countries, the vast majority of nations that possess organized securities markets, had laws regulating insider trading
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Several factors explain the rapid emergence of such regulation, particularly during the last twenty years: namely, the growth of the securities industry worldwide, pressures to make national securities markets look more attractive in the eyes of outside investors, and the pressure the SEC exerted on foreign lawmakers and regulators to increase the effectiveness of domestic enforcement by identifying and punishing offenders and their associates operating outside the United States.
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Many researchers argue that trading on inside information is a zero-sum game, benefiting insiders at the expense of outsiders. But most outsiders who bought from or sold to insiders would have traded anyway, and possibly at a worse price (Manne 1970). So, for example, if the insider sells stock because he expects the price to fall, the very act of selling may bring the price down to the buyer.
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A controversial case is that of abstaining from trading on the basis of inside information (Fried 2003).
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There is little disagreement that insider trading makes securities markets more efficient by moving the current market price closer to the future postdisclosure price. In other words, insiders’ transactions, even if they are anonymous, signal future price trends to others and make the current stock price reflect relevant information sooner.
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Accurately priced stocks give valuable signals to investors and ensure more efficient allocation of capital.
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The controversial question is whether insider trading is more or less effective than public disclosure.
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Insider trading’s advantage is that it introduces individual profit motives, does not directly reveal sensitive intercorporate information, and mitigates the management’s aversion to disclosing negative information (
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Probably the most controversial issue in the economic analysis of insider trading is whether it is an efficient way to pay managers for their entrepreneurial services to the corporation. Some researchers believe that insider trading gives managers a monetary incentive to innovate, search for, and produce valuable information, as well as to take risks that increase the firm’s value (Carlton and Fischel 1983; Manne 1966).
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Another economic argument for insider trading is that it provides efficient compensation to holders of large blocks of stock
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A common contention is that the presence of insider trading decreases public confidence in, and deters many potential investors from, equity markets, making them less liquid (Loss 1970).
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Empirical research generally supports skepticism that regulation of insider trading has been effective in either the United States or internationally, as evidenced by the persistent trading profits of insiders, behavior of stock prices around corporate announcements, and relatively infrequent prosecution rates (Bhattacharya and Daouk 2002; Bris 2005).
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Despite numerous and extensive debates, economists and legal scholars do not agree on a desirable government policy toward insider trading. On the one hand, absolute information parity is clearly infeasible, and information-based trading generally increases the pricing efficiency of financial markets. Information, after all, is a scarce economic good that is costly to produce or acquire, and its subsequent use and dissemination are difficult to control. On the other hand, insider trading, as opposed to other forms of informed trading, may produce unintended adverse consequences for the functioning of the corporate enterprise, the market-wide system of publicly mandated disclosure, or the market for information.