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Insider trading and the problem of corporate agency

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  • Thomas H. Noe

Abstract

This paper models an economy in which managers, whose efforts affect firm performance, are able to make "inside" trades on claims whose value is also dependent on firm performance. Managers are able to trade only on "good news," that is, on returns above market expectations. Further, managers cannot trade at all unless permission for such trading is granted by shareholders. Insider trading is in derivative securities and thus does not adversely affect the firm's cost of raising funds. In this setting, it is shown that a prohibition on insider trading may still generate welfare improvement over a regime that allows shareholders to determine insider trading policy. This result obtains because insider trading, although improving managerial effort incentives for any fixed compensation level, also improves the bargaining position of shareholders relative to managers. This reduces the willingness of shareholders to provide expensive effort-assuring managerial compensation packages.

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File URL: http://www.frbatlanta.org/filelegacydocs/wp952.pdf
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Bibliographic Info

Paper provided by Federal Reserve Bank of Atlanta in its series Working Paper with number 95-2.

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Date of creation: 1995
Date of revision:
Publication status: Published in Journal of Law, Economics, and Organization, October 1997
Handle: RePEc:fip:fedawp:95-2

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Keywords: Stock market ; Securities;

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References

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  1. Michael J. Fishman & Kathleen M. Hagerty, 1992. "Insider Trading and the Efficiency of Stock Prices," RAND Journal of Economics, The RAND Corporation, vol. 23(1), pages 106-122, Spring.
  2. Manove, Michael, 1989. "The Harm from Insider Trading and Informed Speculation," The Quarterly Journal of Economics, MIT Press, vol. 104(4), pages 823-45, November.
  3. Ausubel, Lawrence M, 1990. "Insider Trading in a Rational Expectations Economy," American Economic Review, American Economic Association, vol. 80(5), pages 1022-41, December.
  4. Anat R. Admati, Paul Pfleiderer, 1988. "A Theory of Intraday Patterns: Volume and Price Variability," Review of Financial Studies, Society for Financial Studies, vol. 1(1), pages 3-40.
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Cited by:
  1. Laura Beny, 2006. "Do Investors Value Insider Trading Laws? International Evidence," William Davidson Institute Working Papers Series wp837, William Davidson Institute at the University of Michigan.
  2. Chih-Jen Huang, 2010. "The joint decision to manage earnings through discretionary accruals and asset sales around insider trading: Taiwan evidence," Journal of Economics and Finance, Springer, vol. 34(3), pages 308-325, July.
  3. Dewally, Michaƫl & Peck, Sarah W., 2010. "Upheaval in the boardroom: Outside director public resignations, motivations, and consequences," Journal of Corporate Finance, Elsevier, vol. 16(1), pages 38-52, February.
  4. Jan Zabojnik, 2014. "Stock-based Compensation Plans and Employee Incentives," Working Papers 1325, Queen's University, Department of Economics.
  5. Brenner, Steffen, 2011. "On the irrelevance of insider trading for managerial compensation," European Economic Review, Elsevier, vol. 55(2), pages 293-303, February.
  6. Bebchuk, Lucian Arye & Jolls, Christine, 1999. "Managerial Value Diversion and Shareholder Wealth," Journal of Law, Economics and Organization, Oxford University Press, vol. 15(2), pages 487-502, July.
  7. Leonard F.S. Wang & Ya-Chin Wang, 2010. "Stackelberg real-leader in an insider trading model," Studies in Economics and Finance, Emerald Group Publishing, vol. 27(1), pages 30-46, March.
  8. Hu, Jie & Noe, Thomas H., 2001. "Insider trading and managerial incentives," Journal of Banking & Finance, Elsevier, vol. 25(4), pages 681-716, April.
  9. Jie Hu & Thomas H. Noe, 1997. "Insider trading, costly monitoring, and managerial incentives," Working Paper 97-2, Federal Reserve Bank of Atlanta.
  10. P.J. Engelen & Luc van Liedekerke, 2006. "An ethical analysis of regulating insider trading," Working Papers 06-05, Utrecht School of Economics.
  11. Maug, Ernst, 2002. "Insider trading legislation and corporate governance," European Economic Review, Elsevier, vol. 46(9), pages 1569-1597, October.
  12. Jie Hu & Thomas H. Noe, 1997. "The insider trading debate," Economic Review, Federal Reserve Bank of Atlanta, issue Q 4, pages 34-45.

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