Private Regulation of Insider Trading in the Shadow of Lax Public Enforcement (and a Strong Neighbor): Evidence from Canadian Firms

Abstract:     
Like U.S. firms, many Canadian firms voluntarily restrict trading by corporate insiders beyond the requirements of insider trading law. We aim to understand the determinants of firms' private insider trading policies (ITPs), which are quasi-contractual devices. Based on the assumption that firms that face greater costs from insider trading (or greater benefits from restricting insider trading) ought to be more inclined than other firms to adopt ITPs or to adopt more stringent ITPs than other firms, we develop five hypotheses. Specifically, we hypothesize that both ITP existence and ITP stringency are positively associated with a firm's size, market-to-book ratio, ownership and control concentration, firm-specific stock return volatility, and cross-listing in the U.S., where insider trading enforcement is more vigorous than in Canada.

We test our hypotheses using data from a sample of firms included in the Toronto Stock Exchange/Standard and Poor's (TSX/S&P) Index. Our results, which are robust to selection effects, support all but one of our hypotheses. They suggest that Canadian firms do not randomly restrict insider trading, but rather do so predictably and with a predictable level of intensity. They also suggest that neither window dressing, liability avoidance, nor U.S. regulatory imperialism fully explains Canadian firms' adoption of ITPs. Rather, our results suggest that at least some firms and shareholders wish to control insider trading to enhance economic efficiency. On balance, our findings suggest that some firms perceive insider trading to be harmful to their interests and thus challenge the claim that private restrictions of insider trading would not arise in the absence of insider trading laws. Many Canadian firms privately restrict insider trading even though they face little threat of insider trading liability. Finally, our results suggest that formal organizational rules may dominate private sanctions in this context, consistent with norms/trust theories of organizational rules rather than economic deterrence theories of such rules.

Number of Pages in PDF File: 80

Keywords: insider trading, private regulation, public enforcement, securities laws, optional corporate rules, extra-territorial effect of U.S. laws

JEL Classification: K00, K22, G38, M14, N20, P50

working papers series