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The Effect of Insider Trading on Insiders' Reaction to Opportunities to 'Waste' Corporate Value

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  • Lucian Arye Bebchuk
  • Chaim Fershtman

Abstract

This paper analyzes certain effects of insider trading on the principal-agent problem in corporations. Specifically, we focus on those managerial choices that confront managers with the need to decide between options that produce different corporate value but do not differ in the managerial effort involved. In the absence of insider trading, and as long as managers' salaries are positively correlated with their firm's results, managers will make such choices efficiently, and consequently such choices have previously received little attention. We show that, in the presence of insider trading, managers may make such choices inefficiently. With such trading, managers might elect to have a lower corporate value-that is, they may "waste" corporate value-because having such a value might enable them to make greater trading profits. We analyze the conditions under which the problem we identify is likely to arise and the factors that determine its severity. We also identify those restrictions on insider trading that can eliminate this problem.

Suggested Citation

  • Lucian Arye Bebchuk & Chaim Fershtman, 1990. "The Effect of Insider Trading on Insiders' Reaction to Opportunities to 'Waste' Corporate Value," Discussion Papers 889, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
    • Handle: RePEc:nwu:cmsems:889
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    1. Lucian Arye Bebchuk & Chaim Fershtman, 1990. "The Effects of Insider Trading on Insiders' Choice Among Risky Investment Projects," Discussion Papers 897, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
    2. Laffont, Jean-Jacques & Maskin, Eric S, 1990. "The Efficient Market Hypothesis and Insider Trading on the Stock Market," Journal of Political Economy, University of Chicago Press, vol. 98(1), pages 70-93, February.
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    5. Glosten, Lawrence R. & Milgrom, Paul R., 1985. "Bid, ask and transaction prices in a specialist market with heterogeneously informed traders," Journal of Financial Economics, Elsevier, vol. 14(1), pages 71-100, March.
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    8. Dye, Ronald A, 1984. "Inside Trading and Incentives," The Journal of Business, University of Chicago Press, vol. 57(3), pages 295-313, July.
    9. Kyle, Albert S, 1985. "Continuous Auctions and Insider Trading," Econometrica, Econometric Society, vol. 53(6), pages 1315-1335, November.
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    Cited by:

    1. Chen, Zhihong & Huang, Yuan & Kusnadi, Yuanto & John Wei, K.C., 2017. "The real effect of the initial enforcement of insider trading laws," Journal of Corporate Finance, Elsevier, vol. 45(C), pages 687-709.
    2. Laura Nyantung Beny, 2005. "Do Insider Trading Laws Matter? Some Preliminary Comparative Evidence," William Davidson Institute Working Papers Series wp741, William Davidson Institute at the University of Michigan.
    3. Lucian Arye Bebchuk & Chaim Fershtman, 1990. "The Effects of Insider Trading on Insiders' Choice Among Risky Investment Projects," Discussion Papers 897, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
    4. Kusnadi, Yuanto, 2015. "Insider trading restrictions and corporate risk-taking," Pacific-Basin Finance Journal, Elsevier, vol. 35(PA), pages 125-142.

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