Momentum Stock Picks

On the other side of the insider trading debate are those scholars and economists that advocate for the continued prohibition and banning  of insider trading. In previous articles I have discussed the theories that are proposed by this school of thought. In this article I will tackle the results of their economic models and their own opinion on how the prohibition of insider trading would affect the aggregate economy. Like in the previous economic models, the same economic variables and agents are used by the following economic models.

Unlike other scholars that assert that legalizing insider trading would increase the informativeness of the stock price and stock efficiency, Ausubel believes that totally banning insider trading would actually increase the informativeness and efficiency of the stock price. Ausubel asserts that if insider trading is unlawful then insiders have no reason to keep the information about the company and therefore, this may even lead to the revelation of that information. As we know, the more information available about a particular corporation or its stocks, the more informative the stock price is, the better it is for investors and investment in these stocks in general.

Ausubel also looks into the level of investment of the corporation. According to him, legalizing of insider trading actually decreases the level of investment that is going into the corporation. With the declaration of a lawful insider trading, there would be an expectation from the investors that inside traders would take advantage of the information that they know. Investors would have to necessarily take into account this circumstance in buying the corporation’s stocks. This may thus lead in a decrease of investment that goes into the corporation through the investors.

Because of the decrease in the investors and the investment capital that is going into the company, even the insiders themselves would have to be forced to reduce the shares of stocks that they are buying as they would know that once the investment capital of a corporation lowers, the corporation would have a difficult time in growing and expanding. According to Ausubel, the complete prohibition of insider trading would provide an opportunity for increased investment flow into the corporation thereby attracting more investors into the corporation. The greater the investment, even the insiders would have to increase their investment in the corporation.

Manove focuses on two effects of insider trading to the investment level of the corporation in general. He says that, like Ausubel, legalized insider trading may lower the investments that are coming into the corporation but at the same time, legalized insider trading may also result in increased investment as he thinks investors would increasingly invest to make up for the uncertainty of the stock. Leland also agrees with Manove that the investment level of a corporation may rise of insider trading will be legalized. The increased investment would have a beneficial effect to the corporation. As you can see, even with economic models, both sides can still justify either banning or legalizing insider trading. Both show convincing arguments for both sides.

This entry was posted on Thursday, October 7th, 2010 at 6:38 am and is filed under Other . You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.