Chris Dillow at Stumbling and Mumbling considers the move of the UK Financial Services Authority to crack down on insider trading:
The FSA is promising to crack down on insider dealing. No-one in the City feels the need to change his underpants. After all, what chance do public sector workers have of ever recognizing a well-informed decision?
Which raises the question. Why should insider trading be illegal at all?
He links to a post of mine summarizing Henry Manne’s retrospective look at the insider trading literature. In that post I note that Manne considers the “adverse selection” argument for insider trading laws to be the only significant new defense of the laws. Dillow explains that argument like this:
“Imagine an oil company’s geologist knows he is about to discover a big oil deposit. Before announcing his finding, he and his friends buy the company’s stock at a low price. The gains from his discovery therefore accrue to him, rather than to shareholders. If shareholders fear this will happen, they’ll under-invest in oil companies, with the result that we’ll get too little investment in resource discovery. Efficiency requires that the property right in oil discoveries lie with shareholders, not employees.”
Dillow suggests that the argument might support a restriction embedded in the geologist’s contract, but doesn’t justify laws prohibiting insider trading.
I don’t have a firm belief one way or another on the value of insider trading laws. I’m not a specialist in the area, and I’m content to let others work it out. (It is hard enough work keeping up with a small corner of the energy economics world, much less all of the other interesting work out there.) But I have enough libertarian bent left in me to be inclined to favoring making insider trading optional for corporations. So why not let a company declare, “Beginning on day X, insider trading laws will no longer apply to trading in our company stock,” and let the market sort out whether companies are better off with or without the restrictions.
But merely granting the option may not be enough to gain the efficiency benefits that advocates of repeal promote. After all, some of the suggested benefits are in the form of overall informational efficiency. Some of the benefits of insider trading and more efficient pricing of General Motors stock, for example, would spillover to shareholders of Ford or Nissan (i.e. I notice that the price of GM begins crashing which clues me in that my Ford shares may need a closer look). Would enough benefit accrue to current shareholders in GM for them to be willing to accept whatever risks insider trading might present?
If companies were free to opt out of insider trading restrictions, would too many or too few companies opt out? And if too few would opt out, would there be efficiency grounds for requiring companies to allow insider trading, i.e. reasons to advocate simple repeal of insider trading laws, or even to prohibit contractual prohibitions on insider trading by employees?
Would efficiency arguments for allowing insider trading also justify outlawing voluntary restrictions on insider trading?
(Thanks to Chris Masse for tipping me to the Stumbling and Mumbling post.)