Insider Trading Legislation and Corporate Governance

48 Pages Posted: 5 Apr 1999

See all articles by Ernst G. Maug

Ernst G. Maug

University of Mannheim Business School; European Corporate Governance Institute (ECGI)

Date Written: March 25, 1999

Abstract

This paper analyzes the impact of insider trading legislation on corporate governance. In a context where large, dominant shareholders can monitor underperforming companies, managers have an incentive to give early warnings about adverse developments to dominant shareholders. This information is effectively a bribe to induce dominant shareholders to sell their stock and refrain from intervention. If insider trading is unregulated, dominant shareholders collude with management at the expense of small shareholders. The optimal regime forces the company to disclose all material information to the market. Private contracting between companies and shareholders leads to optimal insider trading regulation only if initial shareholders can enter a binding commitment, otherwise large shareholders and managers recontract at the expense of small shareholders. Enforcement also matters. European Union legislation requires inside information to be precise. Such a narrow definition creates a grey zone, where information is private but cannot be classified as inside information. As a result the effectiveness of corporate governance and firm value are reduced. Regulation in the US that treats shareholders with a stake exceeding 10% as insiders is potentially harmful.

JEL Classification: G18, G34, K22, K42

Suggested Citation

Maug, Ernst G., Insider Trading Legislation and Corporate Governance (March 25, 1999). EFA 0664. Available at SSRN: https://ssrn.com/abstract=157598 or http://dx.doi.org/10.2139/ssrn.157598

Ernst G. Maug (Contact Author)

University of Mannheim Business School ( email )

L9, 1-2
Mannheim, 68131
Germany
+49 621 181-1952 (Phone)

HOME PAGE: http://cf.bwl.uni-mannheim.de/de/people/maug/

European Corporate Governance Institute (ECGI)

c/o ECARES ULB CP 114
B-1050 Brussels
Belgium

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