Does Social Trust Mitigate Insiders’ Opportunistic Behavior? Evidence from Insider Trading

Abstract

Does social trust restrain or exacerbate opportunistic behaviors of corporate insiders? On the one hand, insiders who are susceptible to a high trust environment surrounding them will be less opportunistic; on the other hand, unethical insiders may exploit high trust people to engage in more opportunistic behaviors. In this paper, we test the two competing hypotheses by investigating how trust surrounding corporate headquarters affects insider trading profitability under the assumption that opportunistically informed trades are with higher trading profits. We show that social trust negatively affects insiders’ trading gains. This relation holds after instrumental variable regressions and a difference-in-difference framework. Additionally, the role of trust is more prominent when insiders face more trading opportunities arising from information asymmetry, weak monitoring, and concentrated ownership structure, but attenuates when formal regulations are in place. We also examine the indirect channels including cautious financial reports, informative disclosure, and active communications with investors through which social trust can deter informed trading. Overall, our evidence suggests that social trust can discourage opportunistic proclivity and spur ethical deeds among managers.

JEL Classification: A13, G10, G14, G30, M14