More Insiders, More Insider Trading: Evidence from Private Equity Buyouts

Abstract

This paper studies how insider trading intensity is affected by the joint effects of competition and regulation. Prior theoretical research has found that, in the absence of regulation, more insiders leads to more insider trading. We show that optimal regulation, however, features detection and punishment policies that get stricter as the number of insiders increases, giving rise to lower insider trading in equilibrium. We construct measures of the likelihood of insider activity prior to bid announcements of private equity buyouts during the period 2000-2006 and relate these to the number of financing participants. We find that suspicious stock and options activity is associated with more equity participants, while suspicious activity in bond and CDS markets is associated with more debt participants. These results may be consistent with models of limited competition among insiders, but are inconsistent with our model of optimal regulation.

Keywords: asymmetric information, LBO, private equity, regulation

JEL Classification: D82, G14, K42