Insider trading and the problem of corporate agency
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.
|Date of creation:||1995|
|Date of revision:|
|Publication status:||Published in Journal of Law, Economics, and Organization, October 1997|
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- 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.
- Michael Manove, 1989. "The Harm from Insider Trading and Informed Speculation," The Quarterly Journal of Economics, Oxford University Press, vol. 104(4), pages 823-845.
- 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.
- Ausubel, Lawrence M, 1990. "Insider Trading in a Rational Expectations Economy," American Economic Review, American Economic Association, vol. 80(5), pages 1022-41, December.
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