Academic journal article Journal of Private Enterprise

Insider Trading: Is There an Economist in the Room?

Academic journal article Journal of Private Enterprise

Insider Trading: Is There an Economist in the Room?

Article excerpt

Abstract

This paper examines economists' opinions on insider trading and their policy recommendations. We review the economic literature and survey 3,000 economists to ask them their thoughts on insider trading. We find that economists traditionally favor government regulation of insider trading. In addition, the results of our survey show that, when unfamiliar with insider trading, economists tend to rely on the more familiar model of the perfectly competitive market as a normative benchmark to assess the desirability of insider trading. As a result, these economists also tend to support government regulation of insider trading. Our analysis sheds a new light on the formation of economists' normative views. It also offers a possible explanation, complementing Public Choice models, for the origins and dynamics of the regulatory process.

JEL Codes: A11, K22

Keywords: Economists; Insider trading; Interventionism; Morality; Normative; Opinion; Regulation; Survey

I. Introduction

This paper investigates economists' opinions on insider trading. More particularly, it investigates the policy recommendations that economists give, with a special focus on whether insider trading should be regulated and whether the government should be the main force behind the regulation.

Insider trading is probably the most known and publicized whitecollar crime. The media often depict the perpetrators, the insiders, as cutthroat, manipulative, greedy individuals. In addition, since the 1930s, insider trading has been subject to ever-increasing attention on the part of the government. The Securities Exchange Commission, created in 1934 to regulate financial markets, has seen its budget dedicated to enforcing insider- trading laws increase exponentially. At the same time, Congress has supported imposing more and more severe sanctions against insider trading. By criminalizing insider trading and imposing monetary penalties as well as sanctions involving jail- time, the government has made this fight against insider trading a true "witch-hunt."1

On the other hand, not until 1966, when Henry Manne published his book, Insider Trading and the Stock Market, do we find some economic analysis of insider trading. In this book, Manne challenges the commonly accepted idea, at least among legal scholars, that insider trading should be prohibited. Manne' s seminal work starts with a simple observation: No rigorous analysis of insider trading was ever done. According to Manne (1966b, p. 113), economists did not pay attention to the issue, and lawyers were too incompetent to engage in a serious scientific analysis of the subject. There was a unanimous, dogmatic agreement among commentators, lawmakers, and policymakers that "insider trading is a sin, and the war against it is a holy one" (Manne, 1966b, p.113). Insider Trading and the Stock Market can be viewed as an attempt by Manne to put some sense and analytical rigor back into a debate in which "logic has been totally lost to emotion" (Manne, 1966b, p.113). As Bainbridge (2001, p.65) observes, "it is only a slight exaggeration to suggest that Manne stunned the corporate law academy by daring to propose deregulation of insider trading."

Whether we agree with Manne' s arguments that insider trading ought to be deregulated for efficiency considerations, there is no doubt that his arguments are at the origin of the prolific debate that followed among lawyers, economists, financiers, and policy-makers. Moreover, the recurrent insider-trading scandals publicized in the media continue to fuel the seemingly endless debate.

At this point in time, it seems interesting to see what opinions economists have formed on insider trading. After all, as Manne argued, economists seem better equipped than others to analyze this issue, which receives a lot of attention from government officials, and is regularly the object of media attention every time a new major insider trading case arises. …

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