Law and Economic Literature :: Economic Environment, Trading Regulations

Law and economic literature on insider trading can be categorized into two categories- agency theories and market theories of insider trading. Agency theories of insider trading deal with the impact of insider trading on firm-level efficiency and corporate value (Jensen and Meckling, 1976). On other hand, Market theories of insider trading analyze the implication of insider trading on market performance (Bhattacharya and Daouk, 2000) e.g. the cost of capital, liquidity and market efficacy etc., for example, Manna (1966) suggests that the insider trading allows stock markets to be more efficiency. Surprisingly, most of the debates on insider trading are concentrated on U.S markets (Beny, 2005).La Porta et al (1998) claim that law and its level of enforcement vary according to countries’ infrastructures, and differences in law and its enforcement may explain variations in market structures and stock market practices among different countries. Moreover, Maug (2002) presents a mat hematical model in which a dominate owner has information advantage over small shareholders where insider trading regulations are not properly enforced. Besides, Leland (1992) argues that if the insider trading is allowed, stock prices reflect better information at the cost of less liquidity that magnitude depends on economic environment. Baiman and Verrecchia (1996) argue that the level of insider trading varies with level of financial disclosure, the culture, and the economics of different countries. Therefore, it can be expected that the impact of insider trading activities on the stock market varies country to country. Bhattacharya and Daouk (2002) address the effect of insider trading regulation and its enforcement on the cost of capital by taking 51 countries over more than 20 years, and they summaries that insider trading regulation and its enforcement of different countries help in reducing the cost of capital of firms. Even though, the magnitude of effect varies with the level of enforcement of a country. Moreover, Beny (2005) does an attempt to find whether insider trading law matter on Ownership dispersion, stock price informativeness and stock liquidity. In empirical results, he finds that Ownership dispersion, stock price informativeness and stock liquidity are greater where insider trading law and its enforcement are more restricted. Moreover, the most important aspect of the formal law is penalties or criminal sanctions that are imposed on who violates insider trading law. Fernandes and Ferreira (2009) argue that insider trading regulation and its enforcement improve the informativeness of stock prices, but this improvement is concentrated in developed markets.