Insider Trading, Competition, and Real Activities Manipulation

33 Pages Posted: 24 Nov 2013 Last revised: 9 Mar 2016

Hui Chen

University of Zurich

Bjorn Jorgensen

London School of Economics & Political Science (LSE) - Department of Accounting and Finance

Date Written: March 3, 2016

Abstract

Corporate insiders, particularly managers, not only have access to their firms' private information, but also control over their firms' operational decisions. In this paper, we consider a setting where managers manipulate the firms' real activities in anticipation of subsequent insider trading opportunities. We find these managers choose production quantities that are strictly higher than the quantities absent insider trading. The overproduction leads to lower firm profits but higher consumer surplus. When we allow the managers to trade both in their own firms' and their rival firms' stocks, we find that the competition among insiders in the financial market drives down the expected insider trading profits and their incentives to distort production decisions. We then discuss the scenario of "substitute trading" when the managers only trade in their rival firms' shares, and show that the managers can earn some insider benefits without sacrificing their firms' profitability. We also explore the possibility of endogenizing the managers' ownership through compensation contracts.

Keywords: Insider trading, Kyle model, real activities manipulation, overproduction

JEL Classification: M41

Suggested Citation

Chen, Hui and Jorgensen, Bjorn, Insider Trading, Competition, and Real Activities Manipulation (March 3, 2016). Available at SSRN: https://ssrn.com/abstract=2358668 or http://dx.doi.org/10.2139/ssrn.2358668

Hui Chen (Contact Author)

University of Zurich ( email )

Plattenstrasse 14
Zurich, CH-8032
Switzerland

Bjorn N Jorgensen

London School of Economics & Political Science (LSE) - Department of Accounting and Finance ( email )

Department of Accounting Room, OLD 2.17
Houghton Street
London, WC2A 2AE
United Kingdom

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