6 ms·

I find myself agreeing too, but tentatively. What exactly is the argument for insider trading laws in the first place? In the absence of such laws would manager

I find myself agreeing too, but tentatively. What exactly is the argument for insider trading laws in the first place? In the absence of such laws would managers have the wrong incentives?

cma 12y ago
The money insiders make would otherwise go to other parties/counterparties when the news became public. Insiders charge a rent on everyone else. So do non-insiders doing above-board sales research, but they are subject to competition, keeping the rent/tax down. In addition to the rent, there is also a benefit provided in accurately pricing securities, but there is no law of economics saying this benefit will exactly cancel out the rent or anything of the sort. There are fundamental things (like limited number of sufficiently high-level insiders) restricting competition in conventional insider trading to minimize the rent charged from insider "research".
- savanaly 12y ago
  Is it a transfer of income, or a genuine loss of resources? It seems like the losses to everyone else are offset one to one by the gains to the insider traders.
  - notahacker 12y ago
    It's not a zero-sum game if the effects are a disincentive to invest on the part of parties without strong connections to insiders.
  - cma 12y ago
    Yes, a transfer. What I meant by other parties/counterparties is that a sale that went to an insider might instead go to the next highest bidder, and the gains once the good earnings news was released would go to him or her. Or the absence of the insider might mean the bid never goes high enough and the seller stays with the shares, to later make the gain. Zero sum, but basically all the normal market participants are avoiding a "presence of an insider" tax when insider trading can be curtailed.
- notahacker 12y ago
  Non-insiders doing above-board research also don't have perverse incentives; they can't profit from selling intelligence on their own screwups (accidental or otherwise)
pash 12y ago
Insider trading was first outlawed in the United States by the Securities and Exchange Act of 1934. The major motivation for the ban was to increase the public's confidence that they could invest in financial securities without being taken to the cleaners by insiders who had a major informational advantage. [0] Economic theory does lend some support for the idea that markets will perform better when the public is confident enough to participate in them broadly, and broad participation should drive valuations higher. (The latter is a dubious benefit.) But there is likewise plenty of theoretical justification for the harm done to markets by insider-trading laws. Markets are basically mechanisms for aggregating and analyzing information, and insider trading laws restrict the supply of basic facts. Mispricing ensues. There are other justifications for banning insider trading, albeit all rationalizations post facto, as far as the legal history goes. Allowing a manager to trade her company's shares (particularly to short them) can put her incentives out of step with those of the company's other shareholders. But the managerial misbehavior that could provoke is already illegal under various other regimes. And the principal-agent problem is no argument at all for setting up a system like we have, one which bans trading by knowledgeable people who are in no position to influence corporate decisions. But the economics are almost beside the point. The promise made by insider trading laws is that any Joe Schmoe can trade on the same footing as sophisticated professional investors, and that promise is a farce. It's a farce not only because the incentives will always drive some people to break insider trading laws, but because ordinary people do not have ready access to all of the legally "public" facts anyway; many of them are locked up in obscure or expensive databases. And if Joe Schmoe did have all the public facts, he would still lack the other big piece of the informational puzzle, which is the ability to interpret the facts properly. That more than anything requires real expertise. In my opinion, the public-confidence angle is the strongest component of the case for outlawing insider trading, but I think it's a rather weak case in the end. The perverse truth is that if insider trading laws inspire the public to think they can play the markets on equal footing with sophisticated investors, then insider trading laws have succeeded in installing a false confidence; they have hoodwinked the public. ---- 0. This has remained a main justification (at least rhetorically) for maintaining and strengthening insider trader laws over the past eight decades. For example, an act amending the rules in 1984 has this preamble: "Insider trading threatens ... markets by undermining the public’s expectations of honest and fair securities markets where all participants play by the same rules."
RobinL 12y ago
The size of the pie is basically fixed. Companies are worth only a certain amount (under big assumptions, the net present value of future dividends). The more insider traders make, the less everyone else makes.

I find myself agreeing too, but tentatively. What exactly is the argument for insider trading laws in the first place? In the absence of such laws would managers have the wrong incentives?

cma 12y ago

The money insiders make would otherwise go to other parties/counterparties when the news became public. Insiders charge a rent on everyone else. So do non-insiders doing above-board sales research, but they are subject to competition, keeping the rent/tax down. In addition to the rent, there is also a benefit provided in accurately pricing securities, but there is no law of economics saying this benefit will exactly cancel out the rent or anything of the sort. There are fundamental things (like limited number of sufficiently high-level insiders) restricting competition in conventional insider trading to minimize the rent charged from insider "research".

savanaly 12y ago
Is it a transfer of income, or a genuine loss of resources? It seems like the losses to everyone else are offset one to one by the gains to the insider traders.
- notahacker 12y ago
  It's not a zero-sum game if the effects are a disincentive to invest on the part of parties without strong connections to insiders.
- cma 12y ago
  Yes, a transfer. What I meant by other parties/counterparties is that a sale that went to an insider might instead go to the next highest bidder, and the gains once the good earnings news was released would go to him or her. Or the absence of the insider might mean the bid never goes high enough and the seller stays with the shares, to later make the gain. Zero sum, but basically all the normal market participants are avoiding a "presence of an insider" tax when insider trading can be curtailed.
notahacker 12y ago
Non-insiders doing above-board research also don't have perverse incentives; they can't profit from selling intelligence on their own screwups (accidental or otherwise)

pash 12y ago

Insider trading was first outlawed in the United States by the Securities and Exchange Act of 1934. The major motivation for the ban was to increase the public's confidence that they could invest in financial securities without being taken to the cleaners by insiders who had a major informational advantage. [0] Economic theory does lend some support for the idea that markets will perform better when the public is confident enough to participate in them broadly, and broad participation should drive valuations higher. (The latter is a dubious benefit.) But there is likewise plenty of theoretical justification for the harm done to markets by insider-trading laws. Markets are basically mechanisms for aggregating and analyzing information, and insider trading laws restrict the supply of basic facts. Mispricing ensues. There are other justifications for banning insider trading, albeit all rationalizations post facto, as far as the legal history goes. Allowing a manager to trade her company's shares (particularly to short them) can put her incentives out of step with those of the company's other shareholders. But the managerial misbehavior that could provoke is already illegal under various other regimes. And the principal-agent problem is no argument at all for setting up a system like we have, one which bans trading by knowledgeable people who are in no position to influence corporate decisions. But the economics are almost beside the point. The promise made by insider trading laws is that any Joe Schmoe can trade on the same footing as sophisticated professional investors, and that promise is a farce. It's a farce not only because the incentives will always drive some people to break insider trading laws, but because ordinary people do not have ready access to all of the legally "public" facts anyway; many of them are locked up in obscure or expensive databases. And if Joe Schmoe did have all the public facts, he would still lack the other big piece of the informational puzzle, which is the ability to interpret the facts properly. That more than anything requires real expertise. In my opinion, the public-confidence angle is the strongest component of the case for outlawing insider trading, but I think it's a rather weak case in the end. The perverse truth is that if insider trading laws inspire the public to think they can play the markets on equal footing with sophisticated investors, then insider trading laws have succeeded in installing a false confidence; they have hoodwinked the public. ---- 0. This has remained a main justification (at least rhetorically) for maintaining and strengthening insider trader laws over the past eight decades. For example, an act amending the rules in 1984 has this preamble: "Insider trading threatens ... markets by undermining the public’s expectations of honest and fair securities markets where all participants play by the same rules."

RobinL 12y ago

The size of the pie is basically fixed. Companies are worth only a certain amount (under big assumptions, the net present value of future dividends). The more insider traders make, the less everyone else makes.