Theories for Legalizing Insider Trading II
As can be remembered, Manne’s second argument for legalizing insider trading asserts that insider trading can be beneficial to both the investor and the insider. If the insider is allowed to trade the company’s stocks using private information, the insider himself would profit if the prices of the company’s stocks would increase thereby the insider would have more incentive in doing a good job because as the company prospers the insider also prospers. However, a major criticism in this argument attacks the assumption that insiders can only profit and earn if the company’s prices are increasing. In the real world, insiders can also profit when the company’s stock prices are decreasing. This is done by shorting the company’s stocks and having other short positions. This further means that the insider has more incentive in not doing his job so that the stock prices can deflate and the insider can earn more. Manne answers by saying that nearly all non-trade related incentives, such as the insider’s compensation and his and the company’s reputation, would push the insider to favor and work for the success of his company. To further bolster the second argument of Manne, Macey defends that even if insiders can trade on the failures of the company, regulations and laws can be put to make short trading illegal for insiders. The government can make it a policy to allow insiders to trade only on �good news’ about a company and prohibit any trading on �bad news’.
Another argument of Manne that relates to the incentives of the insider that can also benefit the corporation states that allowing insider trading can increase the risk taking attitude of the managers. In the past, as it is now, managers are scared to take on risks for the benefit of the corporation as they are interested in keeping their jobs and avoid any possible termination. Being able to trade would decrease the fear of the manager in losing his job as he has a different source of income thereby making him bolder in making management choices and entering into riskier but more profitable projects for the corporation.
It is not unknown to many corporations that in hiring important employees, especially managers and officers, it is very difficult to asses their talents, skill and abilities as well as their propensity to take risks. As of now, there is no clear test that the corporations can use to gauge an applicant’s capability. Proponents of legalizing insider trading suggest that legal insider trading can be a way for the corporation to gauge and test the potential employee’s ability to take on risks. According to these economists, corporations can use insider trading contracts in exchange for higher compensation and salary for the managers. This means that the corporation can test the manager’s risk tolerance by offering him a lower salary yet more opportunities to trade the company’s stocks by using non-public information of the corporation. If the applicant accepts then this means that he has a higher risk tolerance, as he would forgo a stable yet fixed compensation for a riskier and less certain way to earn through insider trading.