Two Approaches to Examining the Ethics of Insider Trading
53 Pages Posted: 25 Sep 2007
Date Written: September 2007
The common view is that insider trading is always unethical and illegal. But such is not the case. Some forms of insider trading are legal. Furthermore, applying ethical principles to insider trading causes one to conclude that it is also sometimes ethical. This chapter attempts to get past the hype, the press reports and the political grandstanding to get to the truth of the matter.
The author applies two sets of ethical principles - utilitarianism and rights theory - in an attempt to determine when, and under what circumstances, insider trading is ethical. The views of Henry Manne, an early proponent of insider trading, are critically examined, as are the major arguments against insider trading.
Is insider trading good for the company if it is used as a form of executive compensation, which makes it possible to pay lower salaries than would otherwise be the case? Does insider trading cause the stock market to work more efficiently? If insider trading does increase efficiency, is that sufficient to call for its total legalization, or are there other things to be considered?
Several arguments against insider trading have been put forth over the last few decades but there are problems with all of them. One of the main arguments is the fairness argument. The problem with this argument is that different people have different definitions of unfairness. A closely related argument is the level playing field argument, which advocates wider dissemination of information so that it is less asymmetric. One problem with the level playing field argument is that it is better applied to sporting competitions than to trading in information. Some economists argue that forcing the disclosure of nonpublic information can actually result in more harm than good and must necessarily involve the violation of property rights.
Other arguments examined in this chapter include the fiduciary duty argument, the problem of outside traders, the misappropriation doctrine and the restrictions that insider trading laws place on freedom of speech and press. The chapter concludes by setting forth some principles or guidelines to determine when insider trading should be punished and when it should not.
Keywords: ethics, insider trading, utilitarianism, property rights, contract rights
JEL Classification: D23, D61, D63, D82, G14, G3, K22, M14
Suggested Citation: Suggested Citation