The Marginal Incentive of Insider Trading: an Economic Reinterpretation of the Case Law

73 Pages Posted: 23 Feb 2006

See all articles by Kristoffel R. Grechenig

Kristoffel R. Grechenig

Max-Planck-Institute for Research on Collective Goods

Abstract

Commentators on insider trading are divided into two camps, one in favor of regulation, the other in favor of deregulation. The pleadings for the two positions are manifold but not irreconcilable. We show that important gains to social welfare come with insider trading on negative information (sales), whereas losses often result from the use of positive information (purchases). Thus, we look at a regulation that allows insiders to use negative but not positive non-public information. Because positive information will be disclosed much sooner than negative information, the marginal incentive (and marginal gain to social welfare, respectively) of insider trading as a disclosure mechanism is greater for sales than for purchases. Likewise, stock bubbles generally occur in terms of overvaluations, not undervaluations, emphasizing the importance of insider trading on negative information as a deterrent. The case law on insider trading has long since recognized the distinction between the two types of information, a fact that commentators have either neglected or criticized. A reinterpretation allows us to reconcile presumed contractions of the case law. Our analysis also explains empirical data suggesting that insider trading involves more selling than buying, while enforcement actions focus on purchasing activity.

Keywords: insider trading, stock bubbles, herding, disclosure, Dirks, O'Hagan

JEL Classification: G30, G38, K22

Suggested Citation

Grechenig, Kristoffel R., The Marginal Incentive of Insider Trading: an Economic Reinterpretation of the Case Law. University of Memphis Law Review, Vol. 37, p. 75, 2006; Columbia Law and Economics Working Paper No. 292. Available at SSRN: https://ssrn.com/abstract=883642

Kristoffel R. Grechenig (Contact Author)

Max-Planck-Institute for Research on Collective Goods ( email )

Kurt-Schumacher-Str. 10
D-53113 Bonn, 53113
Germany
+49 228 91416-51 (Phone)
+49 228 91416-851 (Fax)

HOME PAGE: http://sites.google.com/site/kristoffelgrechenig

Register to save articles to
your library

Register

Paper statistics

Downloads
275
Abstract Views
2,901
rank
109,379
PlumX Metrics