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The Effects of Insider Trading on Insiders' Choice Among Risky Investment Projects

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Author Info
Lucian Arye Bebchuk
Chaim Fershtman

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Abstract

This paper studies certain effects of insider trading on the principal-agent problem in corporations. Specifically, we focus on insiders' choice among investment projects. Other things equal, insider trading leads insiders to choose riskier investment projects, because increased volatility of results enables insiders to make greater trading profits if they learn these results in advance of the market. This effect might or might not be beneficial, however, because insiders' risk-aversion pulls them toward a conservative investment policy. We identify and compare insiders' choices of projects with insider trading and those without such trading. We also study the optimal contract design with insider trading and without such trading, thus identifying the effects that allowing such trading has on other elements of insiders' compensation. Using these results, we identify the conditions under which insider trading increases or decreases corporate value by affecting the choice of projects with uncertain returns .

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Technical Working Papers with number 0096.

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Date of creation: Feb 1991
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Handle: RePEc:nbr:nberte:0096

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References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
  1. Lucian Arye Bebchuk & Chaim Fershtman, 1990. "The Effect of Insider Trading on Insiders' Reaction to Opportunities to 'Waste' Corporate Value," Discussion Papers 889, Northwestern University, Center for Mathematical Studies in Economics and Management Science. [Downloadable!]
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  2. Radner, Roy, 1979. "Rational Expectations Equilibrium: Generic Existence and the Information Revealed by Prices," Econometrica, Econometric Society, vol. 47(3), pages 655-78, May. [Downloadable!] (restricted)
  3. Mirman, Leonard J & Samuelson, Larry, 1989. "Information and Equilibrium with Inside Traders," Economic Journal, Royal Economic Society, vol. 99(395), pages 152-67, Supplemen. [Downloadable!] (restricted)
  4. Finnerty, Joseph E, 1976. "Insiders and Market Efficiency," Journal of Finance, American Finance Association, vol. 31(4), pages 1141-48, September. [Downloadable!] (restricted)
  5. Glosten, Lawrence R. & Milgrom, Paul R., 1985. "Bid, ask and transaction prices in a specialist market with heterogeneously informed traders," Journal of Financial Economics, Elsevier, vol. 14(1), pages 71-100, March. [Downloadable!] (restricted)
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  6. Dye, Ronald A, 1984. "Inside Trading and Incentives," Journal of Business, University of Chicago Press, vol. 57(3), pages 295-313, July. [Downloadable!] (restricted)
  7. Kyle, Albert S, 1985. "Continuous Auctions and Insider Trading," Econometrica, Econometric Society, vol. 53(6), pages 1315-35, November. [Downloadable!] (restricted)
  8. Laffont, Jean-Jacques & Maskin, Eric S, 1990. "The Efficient Market Hypothesis and Insider Trading on the Stock Market," Journal of Political Economy, University of Chicago Press, vol. 98(1), pages 70-93, February. [Downloadable!] (restricted)
  9. Seyhun, H. Nejat, 1986. "Insiders' profits, costs of trading, and market efficiency," Journal of Financial Economics, Elsevier, vol. 16(2), pages 189-212, June. [Downloadable!] (restricted)
  10. Ausubel, Lawrence M, 1990. "Insider Trading in a Rational Expectations Economy," American Economic Review, American Economic Association, vol. 80(5), pages 1022-41, December. [Downloadable!] (restricted)
  11. Jaffe, Jeffrey F, 1974. "Special Information and Insider Trading," Journal of Business, University of Chicago Press, vol. 47(3), pages 410-28, July. [Downloadable!] (restricted)
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(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Lucian Arye Bebchuk & Chaim Fershtman, 1990. "The Effect of Insider Trading on Insiders' Reaction to Opportunities to 'Waste' Corporate Value," Discussion Papers 889, Northwestern University, Center for Mathematical Studies in Economics and Management Science. [Downloadable!]
    Other versions:
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