Insider trading and the problem of corporate agency
AbstractThis 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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Bibliographic InfoPaper provided by Federal Reserve Bank of Atlanta in its series Working Paper with number 95-2.
Date of creation: 1995
Date of revision:
Publication status: Published in Journal of Law, Economics, and Organization, October 1997
Other versions of this item:
- Noe, Thomas H, 1997. "Insider Trading and the Problem of Corporate Agency," Journal of Law, Economics and Organization, Oxford University Press, vol. 13(2), pages 287-318, October.
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"Managerial Value Diversion and Shareholder Wealth,"
NBER Working Papers
6919, National Bureau of Economic Research, Inc.
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- Brenner, Steffen, 2011. "On the irrelevance of insider trading for managerial compensation," European Economic Review, Elsevier, vol. 55(2), pages 293-303, February.
- Hu, Jie & Noe, Thomas H., 2001. "Insider trading and managerial incentives," Journal of Banking & Finance, Elsevier, vol. 25(4), pages 681-716, April.
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