Effects of Insider Trading to the Aggregate Economy II
Aside from the economic model of Manove that concludes that legalized insider trading would decrease the liquidity of the stock but increase the capital cost of the corporation and at the same time increase the informativesness of the stock price, other economists in their own models partially concurred to Manove’s findings. According to the economic models prepared by Shin in 1996, Dye in 1984, Leland in 1992, Hu and Noe in 1997, among others, agree that the liquidity of the stocks would decrease if insider trading would be permitted as the stock price would respond more to the arbitrary changes in the stock exchange. This responsiveness is due to the perception of the people that these changes were brought about by the trade activity of the insiders. Of course, like every story, other economists refute these findings including Fishman and Hagerty as well as Ausubel.
While the earlier economic model of Manove only takes into consideration the effect of legalized insider trading to the infomativeness of the stock price based on the insider’s trading activity, the model of Shin takes into account the interaction between the insiders and market professionals. As I said in earlier articles, it is not only the insiders that can possess non-public information about the corporation. Even market professionals, who are experts and analysts, can also possess confidential and non-public information. According to Shin, the rivalry between these two key actors can affect the stock price. According to Shin, by not prohibiting insider trading, the information efficiency of stock prices would increase but this does not necessary mean that the liquidity traders would increase their losses. If a proper balance can be stricken between the insiders and the market professionals, legalized insider trading can even lessen the trading losses incurred by liquidity traders.
One of the major criticisms against Shin’s economic model is that it fails to take into account an important factor that is different between the insiders and the market professionals. This is the information cost. Insiders obtain the non-public information about the corporation with virtually no expenses or costs, monetary or otherwise. Market professionals, on the other hand, still have to expend material and human resources to obtain the same non-public information. According to the scholars Fishman and Hagerty, factoring in this important circumstance can in fact make the stock price less efficient in providing information. Because of the added cost to the market professionals, they may be discouraged from obtaining the information and spending much resources. Because of the market professional’s discouragement, the total information that is injected into the stock price would be considerably less thereby reducing the information efficiency of the stock price.
Furthermore, Fishman and Hagerty assert that the better the data that insiders possess, the less efficient the stock price is as the efficiency of the stock increases as the number of market professionals that participate in the stock market increases. Finally, the more evenly distributed the information is to the insiders and the market professionals the more maximized the efficient of the stock price is.