The Effects of Insider Trading on Insiders' Choice Among Risky Investment Projects

38 Pages Posted: 27 Jun 2007  

Lucian A. Bebchuk

Harvard Law School; National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR) and European Corporate Governance Institute (ECGI)

Chaim Fershtman

Tel Aviv University - Eitan Berglas School of Economics; Tinbergen Institute

Date Written: February 1991

Abstract

This paper studies certain effects of insider trading on the principal-agent problem in corporations. Specifically, we focus on insiders' choice among investment projects. Other things equal, insider trading leads insiders to choose riskier investment projects, because increased volatility of results enables insiders to make greater trading profits if they learn these results in advance of the market. This effect might or might not be beneficial, however, because insiders' risk-aversion pulls them toward a conservative investment policy. We identify and compare insiders' choices of projects with insider trading and those without such trading. We also study the optimal contract design with insider trading and without such trading, thus identifying the effects that allowing such trading has on other elements of insiders' compensation. Using these results, we identify the conditions under which insider trading increases or decreases corporate value by affecting the choice of projects with uncertain returns .

Suggested Citation

Bebchuk, Lucian A. and Fershtman, Chaim, The Effects of Insider Trading on Insiders' Choice Among Risky Investment Projects (February 1991). NBER Working Paper No. t0096. Available at SSRN: https://ssrn.com/abstract=994522

Lucian A. Bebchuk (Contact Author)

Harvard Law School ( email )

Cambridge, MA 02138
United States
617-495-3138 (Phone)
617-812-0554 (Fax)

HOME PAGE: http://www.law.harvard.edu/faculty/bebchuk/

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Centre for Economic Policy Research (CEPR) and European Corporate Governance Institute (ECGI)

Chaim Fershtman

Tel Aviv University - Eitan Berglas School of Economics ( email )

P.O. Box 39040
Ramat Aviv, Tel Aviv, 69978
Israel
+972 3 640 7167 (Phone)
+972 3 640 9908 (Fax)

Tinbergen Institute ( email )

Burg. Oudlaan 50
Rotterdam, 3062 PA
Netherlands

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