On Insider Trading, Markets, and 'Negative' Property Rights in Information

Abstract

In this Essay, we present a brand new efficiency-based justification for the ban on insider trading. Adopting a broad-market approach to the problem enables us to transform conventional theorizing - which suggests that property rights in inside information must be allocated within the firm, either to shareholders or to managers - and present a third, superior option: allocating the property right to market analysts. This new conceptualization of the problem enables one to see that the crucial issue underlying insider trading policy is: which group-insiders or market analysts can best provide efficiency and liquidity to financial markets?We argue, contrary to the accepted lore, that market analysts are superior to insiders in providing efficiency and liquidity to financial markets. Although insiders have ready access to inside information, they are isolated from external competition, and thus, if allowed to exploit this information through trade, they would seek to preserve and exploit their market power over inside information. Analysts, on the other hand, operate in a fiercely competitive environment, and, thus, process new information to the market as expeditiously as possible. Furthermore, because analysts possess greater financial resources, are able to diversify their investments, and frequently diverge in assessing stock prices, they also provide superior liquidity to financial markets.Moreover, we show, for the first time, that competition among analysts generates a myriad of positive externalities for the economy. Competition among analysts is responsible for the burgeoning market for financial information, and the welter of financial media to which we are exposed. In addition, the analysts' market creates economies of scale for the investment banking industry as a result of continuous monitoring and pricing of stocks, attracting many foreign companies to list their shares on U.S. capital markets. None of this would occur if insiders were allowed to trade. Because of their ready access to inside information, insiders would consistently beat analysts when competing against them, eventually driving analysts out of the market. Given the substantial benefits derived from competition among analysts, we submit that insiders should be banned from appropriating inside information; or as we suggest, they should be assigned, what we call, a negative property right in inside information to allow a competitive information market to develop. We believe that the novel theorizing we develop presents a compelling economic case for retaining the prohibition on insider trading.Finally, our broad market analysis provides a comprehensive analytic framework for analyzing the efficiency tradeoffs implicated by two unresolved aspects of insider trading: selective disclosure and warehousing.