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Insider Trading, Outside Search, and Resource Allocation: Why Firms and Society May Disagree on Insider Trading Restrictions

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  • Khanna, Naveen
  • Slezak, Steve L
  • Bradley, Michael
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    Abstract

    We show that entrepreneurs may prefer to allow insider trading even when it is not socially optimal. We examine a model in which an insider/manager allocates resources on the basis of his private information and outside information conveyed through the secondary-market price of the firm's shares. If the manager is allowed to trade, he will compete with informed outsiders, reducing the equilibrium quality of outside information. While the benefits to production of outside information are the same for society and entrepreneurs, we show that the social and private costs are different. Thus, entrepreneurs and society may disagree on the conditions under which insider trading restrictions should be imposed. Article published by Oxford University Press on behalf of the Society for Financial Studies in its journal, The Review of Financial Studies.

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    Bibliographic Info

    Article provided by Society for Financial Studies in its journal Review of Financial Studies.

    Volume (Year): 7 (1994)
    Issue (Month): 3 ()
    Pages: 575-608

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    Handle: RePEc:oup:rfinst:v:7:y:1994:i:3:p:575-608

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    Cited by:
    1. Goldstein, Itay & Ozdenoren, Emre & Yuan, Kathy, 2010. "Trading Frenzies and Their Impact on Real Investment," CEPR Discussion Papers 7652, C.E.P.R. Discussion Papers.
    2. Medrano, Luis Angel & Vives, Xavier, 2002. "Regulating Insider Trading when Investment Matters," CEPR Discussion Papers 3292, C.E.P.R. Discussion Papers.
    3. Philip Bond & Itay Goldstein & Edward S. Prescott, 2006. "Market-based regulation and the informational content of prices," Working Paper 06-12, Federal Reserve Bank of Richmond.
    4. Denis, David J. & Xu, Jin, 2013. "Insider trading restrictions and top executive compensation," Journal of Accounting and Economics, Elsevier, vol. 56(1), pages 91-112.
    5. Jennie Bai & Thomas Philippon & Alexi Savov, 2012. "Have financial markets become more informative?," Staff Reports 578, Federal Reserve Bank of New York.
    6. Foucault, Thierry & Gehrig, Thomas, 2006. "Stock price informativeness, cross-listings and investment decisions," Les Cahiers de Recherche 840, HEC Paris.
    7. Maug, Ernst, 2002. "Insider trading legislation and corporate governance," European Economic Review, Elsevier, vol. 46(9), pages 1569-1597, October.
    8. Itay Goldstein & Philip Bond, 2012. "Government intervention and information aggregation by prices," 2012 Meeting Papers 225, Society for Economic Dynamics.
    9. Gilbert, Aaron & Tourani-Rad, Alireza & Wisniewski, Tomasz Piotr, 2006. "Do insiders crowd out analysts?," Finance Research Letters, Elsevier, vol. 3(1), pages 40-48, March.
    10. Khanna, Naveen & Mathews, Richmond D., 2012. "Doing battle with short sellers: The conflicted role of blockholders in bear raids," Journal of Financial Economics, Elsevier, vol. 106(2), pages 229-246.
    11. Hirshleifer, David & Subrahmanyam, Avanidhar & Titman, Sheridan, 2004. "Feedback and the Success of Irrational Investors," Working Paper Series 2004-8, Ohio State University, Charles A. Dice Center for Research in Financial Economics.
    12. Khanna, Naveen & Sonti, Ramana, 2004. "Value creating stock manipulation: feedback effect of stock prices on firm value," Journal of Financial Markets, Elsevier, vol. 7(3), pages 237-270, June.
    13. Roll, Richard & Schwartz, Eduardo & Subrahmanyam, Avanidhar, 2009. "Options trading activity and firm valuation," Journal of Financial Economics, Elsevier, vol. 94(3), pages 345-360, December.
    14. Philip Bond & Alex Edmans & Itay Goldstein, 2012. "The Real Effects of Financial Markets," Annual Review of Financial Economics, Annual Reviews, vol. 4(1), pages 339-360, October.
    15. Wisniewski, Tomasz P., 2004. "Reexamination of the link between insider trading and price efficiency," Economic Systems, Elsevier, vol. 28(2), pages 209-228, June.
    16. Goldman, Eitan, 2004. "The impact of stock market information production on internal resource allocation," Journal of Financial Economics, Elsevier, vol. 71(1), pages 143-167, January.

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