Insider Trading Laws and Stock Markets Around the World: An Empirical Contribution to the Theoretical Law and Economics Debate

ABSTRACT The primary goal of this Article is to bring empirical evidence to bear on the heretofore largely theoretical law and economics debate about insider trading. The Article first summarizes various agency, market, and contractual (or "Coasian") theories of insider trading propounded over the course of this longstanding debate. The Article then proposes three testable hypotheses regarding the relationship between insider trading laws and several measures of stock market performance. Exploiting the natural variation of international data, the Article finds that more stringent insider trading laws are generally associated with more dispersed equity ownership, greater stock price accuracy and greater stock market liquidity, controlling for various economic, legal and institutional factors. These results cast doubt on pure "Coasian" theories of insider trading and suggest the appropriate locus of academic and policy inquiries about the efficiency implications of insider trading and its regulation. Further empirical research is necessary, however, to conclusively resolve the perennial insider trading debate. I. INTRODUCTION II. THE LAW AND ECONOMICS DEBATE OVER INSIDER TRADING A. Agency Theories of Insider Trading 1. Insider Trading as an Efficient Compensation Mechanism 2. Insider Trading as an Agency Cost B. Market Theories of Insider Trading 1. Insider Trading and Stock Price Accuracy a. The Meaning and Economic Significance of Stock Price Accuracy b. The Law and Economics Debate about Insider Trading and Stock Price Accuracy 2. Insider Trading and Stock Market Liquidity a. The Meaning and Economic Significance of Stock Market Liquidity b. The Law and Economics Debate about Insider Trading and Stock Market Liquidity c. A "Coasian" Approach to Insider Trading: Private Contracting III. TESTABLE HYPOTHESES A. Insider Trading Law and Ownership Concentration B. Insider Trading Law and the Information Content of Stock Prices C. Insider Trading Law and Liquidity IV. DESCRIPTION OF THE DATA A. Data Sources 1. The Dependent Variables 2. Insider Trading Regulation and Enforcement a. Insider Trading Law Variables b. Enforcement Environment 3. Additional Economic, Legal and Institutional Variables B. Descriptive Statistics V. REGRESSION ANALYSIS OF INSIDER TRADING LAW AND THE STOCK MARKET A. Insider Trading Law and Corporate Ownership B. Insider Trading Law and Stock Price Informativeness C. Insider Trading Law and Stock Market Liquidity D. Interaction of Sanctions and Public Enforcement Power E. Summary and Discussion of Results VI. CONCLUSION AND IMPLICATIONS FOR THE THEORETICAL LAW AND ECONOMICS DEBATE I. INTRODUCTION The law and economics debate about the desirability of prohibiting insider trading--trading by corporate insiders on material, non-public information--is both long-standing and unresolved. The early legal debate centered on whether insider trading is unfair to public investors who are not privy to private corporate information. (1) However, the fairness inquiry was malleable, lacked a rigorous theoretical framework, and therefore did not yield coherent or practical policy prescriptions. (2) Professor Henry Manne abruptly shifted the debate to an efficiency inquiry with his now classic 1966 book, Insider Trading and the Stock Market. In Insider Trading and the Stock Market, Manne argued that, contrary to the prevailing legal and moral opinion of the time, insider trading is desirable because it is economically efficient. (3) Professor Manne's controversial thesis abruptly shifted the focus from fairness to the economics of insider trading and precipitated an intense debate in the law and economies literature about the efficiency implications of insider trading. …