Insider Trading and the Problem of Corporate Agency

WP 95-2

Posted: 5 Jul 1998

See all articles by Thomas H. Noe

Thomas H. Noe

University of Oxford - Said Business School; University of Oxford - Balliol College; Bank of Finland; European Corporate Governance Institute

Date Written: January 3, 1996

Abstract

This paper models an economy in which managers, whose efforts affect firm performance, are able to make "inside" trades on claims whose value is also dependent on firm performance. Managers are able to trade only on "good news," that is, on returns above market expectations. Further, managers cannot trade at all unless permission for such trading is granted by shareholders. Insider trading is in derivative securities and thus does not adversely affect the firm's cost of raising funds. In this setting, it is shown that a prohibition on insider trading may still generate welfare improvement over a regime that allows shareholders to determine insider trading policy. This result obtains because insider trading, although improving managerial effort incentives for any fixed compensation level, also improves the bargaining position of shareholders relative to managers. This reduces the willingness of shareholders to provide expensive effort-assuring managerial compensation packages.

JEL Classification: D82, K2

Suggested Citation

Noe, Thomas H., Insider Trading and the Problem of Corporate Agency (January 3, 1996). WP 95-2, Available at SSRN: https://ssrn.com/abstract=7318

Thomas H. Noe (Contact Author)

University of Oxford - Said Business School ( email )

Park End Street
Oxford, OX1 3BJ
United Kingdom

University of Oxford - Balliol College ( email )

Broad St
Oxford, OX1 3BJ
United Kingdom

Bank of Finland ( email )

P.O. Box 160
FIN-00101 Helsinki
Finland

European Corporate Governance Institute ( email )

c/o the Royal Academies of Belgium
Rue Ducale 1 Hertogsstraat
1000 Brussels
Belgium

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