What is everyone's take of a ban on insider trading? Let me start by saying that I don't not believe insider trading is a crime, nor should it be policed by the state. But I believe there is an argument to make for it to be voluntarily banned (through contract) in order to improve the efficiency of the captial markets.
Take for example a stock exchange looking to increase liquiditiy, it could tell the firms that wish to list on its exchange - if you wish to list your stock here, your insiders must agree to not to trade based on non-public information. Of course this would be voluntary not coersed.
The logic as I see it is if insider trading is allowed investors will no longer just be speculating about the valuations of firms but also whether movements in stock prices are a result of knowledge that somebody else has that the trader doesn't. If I own a stock and I know $40/share is the correct valuation and I see the price start dropping...37...35...31...27...I'm going to be freaking out wondering if there is information out there that I don't have. Now i'm forced into a situation where I basically have to decide whether to sell or hold based on sheer speculation not any sound financial decision making. The result is more volitility making me less inclined to invest. Less people investing will mean higher spreads, lower stock prices, less liquidity, and slower overall economic growth.
Of course the flip side of the arguement that people make is that insider trading more quickly introduces new information to the market. But I really don't agree with that statement, because as long as the information is not offically announced, there isn't anything new information. Just speculation.
I agree that introducing information more quickly is a good thing, but public speculation of movements in stock price is not the same as new information.
Also, if insider trading were to be allowed, wouldn't there be an incentive to delay the release of new information so the insiders can have time to buy or sell?
Overall, I think the quality of our captial markets would be higher if insider trading were banned and thus absent government intervention the market would move in this direction on its own.
What do you think? Agree with me? Or am I way off?
At least he wasn't a Keynesian!
DD5: bloomj31:I'll have to think about this. You're allowed to think about it, but if you act on it, they should lock you up for good.
bloomj31:I'll have to think about this.
You're allowed to think about it, but if you act on it, they should lock you up for good.
Hahaha.
Very clever
Jonathan M. F. Catalán: Joe: yes, but don't individual firms have an incentive to let as little information out as possible? This would result in (the continuation of) contract clauses that prohibit employees from giving out trade secrets or other such sensitive information. What does it matter?
Joe: yes, but don't individual firms have an incentive to let as little information out as possible? This would result in (the continuation of) contract clauses that prohibit employees from giving out trade secrets or other such sensitive information.
yes, but don't individual firms have an incentive to let as little information out as possible? This would result in (the continuation of) contract clauses that prohibit employees from giving out trade secrets or other such sensitive information.
What does it matter?
I don't see how it could not matter.
Yes, insider trading should not be illegal in the general sense. But if its a violation of pretty much everybody's contract to do certain insider trading activities, a lot of them are not going to be done. Unless of course the information is worth more than all the money you could make at your job (and you would likely have to factor in a discount for all future jobs because companies are going to be weary on hiring someone who dishes out secret info.
I guess I am not really sure of how likely people are at getting caught doing this. If people aren't likely to get caught, then nothing matters really as its already likely happening as much as would happen anyway. If people are very likely to get caught, then I imagine few would suddenly switch over to become insider traders if it was no longer illegal, as they would mostly be retraining from the activity because they more feared being caught by their own company and losing their job.
You are "Way On". Insider trading should be allowed. It should be up to the firms themselves through contracts to prohibit their insiders from engaging in these practices. You could easily write a contract for executives that states explicit disclosure requirements that must be made before they are able to sell or buy stock. You could easily hold part of all of their compensation in escarole to make sure the executives behave according to their contracts.
You could also have them list friends and certainly relatives who could use insider information as well. Then people like Martha would be free to sell or buy with insider information but the person providing the information would be held in breech of their contract.
Another good way to do this is to use the executive compensation held in escarole to pay the legal fees of the company lawyers who will sue the executive for breech of contract. It is amazing how this will entice executives not to break their contracts.
The current insider trading rules are confusing and really do not stop the behavior. I suggest getting rid of the layers of government and substitute contracts that promote freedom and constrain the behavior.
Jonathan M. F. Catalán: Why? I'm not sure this makes sense. If insider traders are selling their stocks because they know the price is about to drop, perhaps due to some bad news concerning the health of the company, then they make this information available to those who see the drop in price (greater supply of stocks being sold).
Why? I'm not sure this makes sense. If insider traders are selling their stocks because they know the price is about to drop, perhaps due to some bad news concerning the health of the company, then they make this information available to those who see the drop in price (greater supply of stocks being sold).
See I disagree that they "make the information available". As an investor all I see is a drop in the price. Not only that, but suppose 95% of people believe the stock to be valued at $40 and the insiders believe it to be valued at $20. The price will fall, but not down to $20, maybe 36 - 37, but not down to its correct level. The rest of us are left to speculate as to what caused the price drop. Should the firm be valued at 37? 30? 20? How am I supposed to make an informed decision in this case? The only thing that was "made available" was that somebody knows something I don't. What that something is...I don't know. How does that someting effect the value of the firm...I don't know. What is the real value of the firm...I don't know. As a result people will start speculating causing large swings in the stock that otherwise would not have happened.
Joe: Yes, insider trading should not be illegal in the general sense. But if its a violation of pretty much everybody's contract to do certain insider trading activities, a lot of them are not going to be done. Unless of course the information is worth more than all the money you could make at your job (and you would likely have to factor in a discount for all future jobs because companies are going to be weary on hiring someone who dishes out secret info.
Inside traders are not always employees. Inside traders are just individuals who are able to acquire intimate information on a certain company. They could be personal friends, lawyers, stock brokers, CEOs and other high officers in a company. Inside trading doesn't necessarily hurt a company, either, except if the company is trying to commit fraud by making their stocks reflect a sign of high health. But, those with information on a company's impending bankruptcy or anything that reflects negatively on the health of company are bound to sell their stocks; as prices go down this will signal to others to sell their stocks.
I guess I am not really sure of how likely people are at getting caught doing this. If people aren't likely to get caught, then nothing matters really as its already likely happening as much as would happen anyway.
I'm not sure what you consider being "caught" is. Usually, high officers of a company will reap large incomes from selling stock early, because they know better than most other people on the true state of the health of the company. This is seen as immoral because CEOs can "drive their company into the ground" and still make large incomes. But, the fact of the matter is that even if the CEOs weren't to sell their stocks based on intimate information, most people will still lose out and would probably lose out more. The inside traders revealed the true state of the company's financial health much faster than it would have been revealed otherwise.
Chris Pacia: See I disagree that they "make the information available". As an investor all I see is a drop in the price. Not only that, but suppose 95% of people believe the stock to be valued at $40 and the insiders believe it to be valued at $20. The price will fall, but not down to $20, maybe 36 - 37, but not down to its correct level. The rest of us are left to speculate as to what caused the price drop.
See I disagree that they "make the information available". As an investor all I see is a drop in the price. Not only that, but suppose 95% of people believe the stock to be valued at $40 and the insiders believe it to be valued at $20. The price will fall, but not down to $20, maybe 36 - 37, but not down to its correct level. The rest of us are left to speculate as to what caused the price drop.
So? How would it be different without the inside trader? Or, do you prefer not to know about the price drop and instead continue to buy the stock at high prices, and lose even more money in the future? How a person reacts to the price mechanism is subjective, but it nonetheless stands that inside traders do you a favor by causing a drop in the price before the price of the stock is bid up even more by malinformed individuals.
Should the firm be valued at 37? 30? 20? How am I supposed to make an informed decision in this case? The only that that was "made available" was that somebody knows something I don't. What that something is...I don't know. How does that someting effect the value of the firm...I don't know. What is the real value of the firm...I don't know. As a result people will start speculating causing large swings in the stock that otherwise would not have happened.
People speculate no matter what information is provided by the price mechanism. That's the nature of the stock market. Do you want them to speculate on false information, or based on no information at all?
Chris Pacia:See I disagree that they "make the information available". As an investor all I see is a drop in the price.
yes, this is how the market is coordinated. By prices.
Chris Pacia:Not only that, but suppose 95% of people believe the stock to be valued at $40 and the insiders believe it to be valued at $20.
Nobody thinks anything like what you're describing. Some stock holders with better knowledge think $40 is overvalued so they attempt to sell. If they get a buyer for above their minimum selling price, they will sell. That is all.
Chris Pacia:How am I supposed to make an informed decision in this case?
Your question has nothing to do with inside trading but with prices as signals in general. particularly to the capital markets.
Jonathan M. F. Catalán: People speculate no matter what information is provided by the price mechanism. That's the nature of the stock market. Do you want them to speculate on false information, or based on no information at all?
My point is without insider trading the price would be much more stable at say $40, even if this is a malinformed price. Then when the inside information becomes public, the price will drop down to around $20 and remain faily stable around that price. To me that is more preferable then having wild swings in prices as a result of speculation of insider trading. I think having the stability will attract more liquidity, make it easier to calculate, and improve the quality of the market.
Anyway, I'm not married to my position, I think you make good points. This is why I asked the question, to try to flush out my own belief on the subject.
Chris Pacia: My point is without insider trading the price would be much more stable at say $40, even if this is a malinformed price.
My point is without insider trading the price would be much more stable at say $40, even if this is a malinformed price.
I'm not sure why you have an obsession with price stability in the stock market. The price of a company's stock should reflect that company's general health. If a company begins to take losses then it's expected that the value of its stock will decrease, as less investors are willing to risk their money with that company (if a company is losing money so are the stockholders, or investors).
Inside traders preform a valuable service by conveying the information they know on the company's general health through the price mechanism.
Then when the inside information becomes public, the price will drop down to around $20 and remain faily stable around that price.
"Inside information" only becomes public once that information has been conveyed. This is usually done through an inside trader.
To me that is more preferable then having wild swings in prices as a result of speculation of insider trading. I think having the stability will attract more liquidity, make it easier to calculate, and improve the quality of the market.
Inside trading does not cause "wild swings". The only reason why a stock would take a huge hit is if there is a threat of bankruptcy or huge financial losses. Prices fall quickly because inside traders will tell other day traders, who then opt to sell their stock as well.
Chris Pacia: I think having the stability will attract more liquidity, make it easier to calculate, and improve the quality of the market.
What stability? If the stock value is delayed from adjusting to a more realistic reflection of the firm's ability to make money in the future, how does this improve stability or calculations? On the contrary, people continue to act upon the false information that the stock value is signaling. Ultimately, the real state of affairs will be revealed, but only after the value of the stock continued to go in the wrong direction for a prolonged period of time. All this because those with the most knowledge are prohibited from acting on their knowledge.
I could be wrong, I haven't done any research, but as an investor I would prefer to invest in less volitile stocks. If all investors hold the same opion I do, then there would be a greater quantitiy of investment (lower spreads, higher prices) if markets were less volitile. You seem to be under the assumption that given insider trading, non insiders would sit back and just say "Oh, the price dropped. How bout that." No, there would be alot of speculative activitiy on the part of investors. With many people with different forms of information, the price would be all over the place. With a ban on insider trading, everyone has access to the same information, thus less price volitility.
If you can prove to me that insider trading will not cause more volitility and thus less liquidity, then I will take your position. So far, you haven't done that.
Chris Pacia: I could be wrong, I haven't done any research, but as an investor I would prefer to invest in less volitile stocks.
I could be wrong, I haven't done any research, but as an investor I would prefer to invest in less volitile stocks.
Well, you want to invest in stocks that will rise in price, so that you can make a profit. You absolutely don't want to invest in a stock which you buy at a high price, expecting it to continue to rise, only for the price to suddenly fall. This is why inside trading is valuable to you; it sends you a signal through the price mechanism that the strength of the company is not reflected accurately by the current price of the stock.
If all investors hold the same opion I do, then there would be a greater quantitiy of investment (lower spreads, higher prices) if markets were less volitile.
You are working under the assumption that inside trading causes volatility. It does not, otherwise the stock market would always be rising and falling wildly. Inside traders usually only cause big changes when a company is revealed to be either financially bankrupt or about to hit gold. That said, the price of stocks always falls and rises at small increments - this is just how the stock market works.
You seem to be under the assumption that given insider trading, non insiders would sit back and just say "Oh, the price dropped. How bout that."
No we aren't. We are clearly working on the assumption that inside traders send a message to other day traders by selling their stocks and causing the price of the stock to decrease. Other day traders act on this information.
With many people with different forms of information, the price would be all over the place.
Err, even without inside traders trading in general has different people with different information. Inside traders just provide more information to these same traders through the price mechanism. This is how the price mechanism works. This is how the market in general works. Have you read Human Action?
With a ban on insider trading, everyone has access to the same information, thus less price volitility.
Um, except not?
Chris Pacia:If you can prove to me that insider trading will not cause more volitility and thus less liquidity, then I will take your position. So far, you haven't done that.
Lack of liquidity is what causes increased volatility, and not the other way around. More agents expressing their view on an instrument, by definition, increases liquidity. Draw the inevitable conclusion on volatility from there.
Z.
z1235: Lack of liquidity is what causes increased volatility, and not the other way around. More agents expressing their view on an instrument, by definition, increases liquidity. Draw the inevitable conclusion on volatility from there.
This is an important point. I'd like to quote from my article on the recession of 1937:
All that was necessary was a catalyst to bring about a slowing in the pace of credit expansion. This was provided by the stock market. Heavy regulation in the years leading up to 1937, including heavy taxes and legal impediments on inside trading, reduced incentives to invest in the market.
The result was a stock market in which a large proportion of shares were held by a relatively small pool of investors. This naturally "thinned" the markets, meaning that minor changes relating to buying and selling could reflect dramatically on the prices of individual stocks.*
* Anderson (1979), pp. 441–442.