The Real Effect of the Initial Enforcement of Insider Trading Laws

Abstract

Based on a difference-in-differences approach, we find strong evidence that the initial enforcement of insider trading laws improves capital allocation efficiency. The effect is concentrated in developed markets and manifests shortly after the enforcement year. Cross-sectional analyses show that the improvement in capital allocation efficiency is more pronounced in countries with more opaque information environment before the enforcement year. Furthermore, the improvement is more pronounced for more financially constrained firms and firms with severer agency problems. Finally, we find increased accounting performance after the enforcement and the increase is positively associated with the improvement in capital allocation efficiency. Overall, our evidence suggests that the initial enforcement of insider trading laws improves capital allocation efficiency by increasing transparency and reducing market frictions arising from information asymmetry and agency problems.

Keywords: Enforcement; Insider trading laws; Capital allocation efficiency; Investment; Transparency; Market frictions

JEL Classification: D83, G15, G31, K22