We all know that insider trading is illegal. I remember a conversation I had with a coworker about it. He basically asked if I thought it should be okay. I said sure, although I had no argument for why it should not be prohibited. In the end, I asked him why it should. His reponse was something along the lines of, "Well, its bad. So, it should be illegal."
Recently, I've begun to wonder if not only should it not be prohibited, but if it just might actually be useful in the market. Something along the lines of sending the proper signals ahead of time maybe?
My question is then, can an ethical argument be made for supporting insider trading? A secondary question would be, were it allowed, would it improve the efficiency of the associated market processes, or just hinder it?
To help answer this question by way of example, consider the following hypothetical scenario: Company X is about to go under. Employee A, given advanced warning, decides to profit from the inevitable collapse by short selling company stock. Employee A also tells her family to do likewise. Eventually, hundreds of people come to learn of the heretofore unannounced collapse. At some point, the local paper gets a hold of the information, and the entire local community now finds themselves in the position of being able to profit off Company X's failure. Were they to do it, would it be ethical, and, would it benefit the market, or just hurt it?
liege: @DD5, In the link you provided, Rothbard does indeed talk about it. In fact, here's a passage I found interesting: There is, in short, nothing wrong and everything right with inside trading. If anything, inside traders should be hailed as heroes of the free market instead of being apprehended in chains Trouble is, Rothbard gave no explanation as to why they should be exalted as heroes. What beneficial effect does trading with inside knowledge confer on the market and end consumers? An ethical defense of inside trading, or at least one against its prohibition, seems easy enough to make. As Daniel wrote, property rights are an issue. Beyond that, the claim can be made against victimless crimes. In the above reference, Rothbard neglected to explain how inside trading benefits the market. As close as he got was to suggest that inside traders should be the recipient of profits instead of "lucky" traders with no inside information. I'd like to point out that this is a normative statement, and as such, is merely an opinion that can't be verified.
@DD5,
In the link you provided, Rothbard does indeed talk about it. In fact, here's a passage I found interesting:
There is, in short, nothing wrong and everything right with inside trading. If anything, inside traders should be hailed as heroes of the free market instead of being apprehended in chains
Trouble is, Rothbard gave no explanation as to why they should be exalted as heroes. What beneficial effect does trading with inside knowledge confer on the market and end consumers?
An ethical defense of inside trading, or at least one against its prohibition, seems easy enough to make. As Daniel wrote, property rights are an issue. Beyond that, the claim can be made against victimless crimes.
In the above reference, Rothbard neglected to explain how inside trading benefits the market. As close as he got was to suggest that inside traders should be the recipient of profits instead of "lucky" traders with no inside information. I'd like to point out that this is a normative statement, and as such, is merely an opinion that can't be verified.
I think the point is that efficient speculation (as well as any entrepreneurship) is first and most about information. It is exactly the people with the best information and insight that we want doing the speculation. This is what successful speculative and entrepreneurship activity should be all about. We have turned the people with the most information (the most likely to be efficient) into criminals.
Speculation benefits the market by hastening the adjustment process of prices. Of course productive speculation depends on correct guesses. So it follows that people with more information are in position to make better guesses.
Each successive person in that chain is at further disadvantage because demand is tumbling down (number of buyers is shrinking).
The easy answer to the question: "insider trading" is nothing more than a dysphemism for making an informed decision. So, if you appreciate the act of making an informed decision, you might as well appreciate this particular case.
If you accept that insider trading is bad because some relatively more ignorant person loses more than otherwise, this means that the underlying principle is: perfectly equal access to information by all is required for an action to be just. That would disqualify pretty much any action from being just.
liege:... "Well, its bad. So, it should be illegal."
Why is it bad?
liege:Recently, I've begun to wonder if not only should it not be prohibited, but if it just might actually be useful in the market. Something along the lines of sending the proper signals ahead of time maybe?
Exactly.
liege:My question is then, can an ethical argument be made for supporting insider trading? A secondary question would be, were it allowed, would it improve the efficiency of the associated market processes, or just hinder it?
Yes.
liege:To help answer this question by way of example, consider the following hypothetical scenario: Company X is about to go under. Employee A, given advanced warning, decides to profit from the inevitable collapse by short selling company stock. Employee A also tells her family to do likewise. Eventually, hundreds of people come to learn of the heretofore unannounced collapse. At some point, the local paper gets a hold of the information, and the entire local community now finds themselves in the position of being able to profit off Company X's failure. Were they to do it, would it be ethical, and, would it benefit the market, or just hurt it?
There is also the property rights argument. If I own stock, don't I have the right to sell it whenever I want?
To paraphrase Marc Faber: We're all doomed, but that doesn't mean that we can't make money in the process. Rabbi Lapin: "Let's make bricks!" Stephan Kinsella: "Say you and I both want to make a German chocolate cake."
I think Rothbard talks about it here
The problem is that executives and insiders have an information assymetry with respect to the general public.
This problem won't occur in a really free market, because there would be no corporations or stock market as presently exists.
I have my own blog at FSK's Guide to Reality. Let me know if you like it.
fsk: The problem is that executives and insiders have an information assymetry with respect to the general public. This problem won't occur in a really free market, because there would be no corporations or stock market as presently exists.
Can you please elaborate, or direct me to a place on your blog where you talk about this?
Schools are labour camps.
eliotn:Can you please elaborate, or direct me to a place on your blog where you talk about this?
Homerun for the Guide to Reality!
fsk:The problem is that executives and insiders have an information assymetry with respect to the general public.
Every specialist has this relationship with the public. The public should not be gambling with their finances on the stock market expecting to understand the complexity of said market, brought to them by newspaper or CNBC. That's just common sense.
fsk:This problem won't occur in a really free market, because there would be no corporations or stock market as presently exists.
There will always be people closer to the action who know more than the layman. But I agree, there won't be an institutional bias.
I like Daniel's point, that as far as property rights go people should be able to sell their property whenever they want for whatever price they want. It is simply logical that if somebody knows something that indicates they should be buying or selling, they should take that action if they believe it will benefit them. If somebody knows that a company is going to suffer big losses, it would be completely idiotic to force them to not sell their equity in it. You can also see who is selling and buying shares of corporations in large numbers. You can easily see when and how many shares of Microsoft Bill Gates is selling (just an example I know he isn't CEO anymore). People can see what the insiders are doing and use this as a guide for their own choices if they want.
Insider trading, in its most common understanding, has been answered very well by previous posters. But what has not been brought up yet is insider trading in which contracts or legaly binding duties are involved. In this case, the contract can put limits on the actions of the property owner or a fiduciary relationship puts certain obligations upon the property owner.
In these cases, the insider may play two roles - the first as an individual who sees a profit opportunity - and the second as a member of a corporation in which, by contract with the shareholders, that person may have a fiducuary as well as contractual responsibility to make known certain information. A conflict of interest is apparent in this circumstance and, in some cases, fraud is evident.
It must be restated though that greater economic efficiency is gained through a freedom in insider trading. The process of insider trading will apply pressure and give information to the market that would not be there in the absence of that particular trade. It is only that certain aspects of insider trading may auctually break contracts and therefore be illegal.