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Insider Trading Laws and Stock Markets Around the

World:

An Empirical Contribution to the Theoretical Law and

Economics Debate

Laura Nyantung Beny *

ABSTRACT

The primary goal of this Article is to bring empirical evidence to bear on the
heretofore largely theoretical law and economics debate about insider trading. The Article
first summarizes various agency, market, and contractual (or “Coasian”) theories of
insider trading propounded over the course of this longstanding debate. The Article then
proposes three testable hypotheses regarding the relationship between insider trading
laws and several measures of stock market performance. Exploiting the natural variation
of international data, the Article finds that more stringent insider trading laws are
generally associated with more dispersed equity ownership, greater stock price accuracy
and greater stock market liquidity, controlling for various economic, legal and
institutional factors. These results cast doubt on pure “Coasian” theories of insider
trading and suggest the appropriate locus of academic and policy inquiries about the
efficiency implications of insider trading and its regulation. Further empirical research is
necessary, however, to conclusively resolve the perennial insider trading debate.

*
Assistant Professor of Law, University of Michigan Law School, Research Fellow, William Davidson
Institute, Stephen M. Ross School of Business, University of Michigan, and 2005-2006 National Fellow,
Hoover Institution, Stanford University. I am deeply grateful to Richard Lempert for extensive and invaluable
comments and suggestions. I also thank Lucian Bebchuk, Richard Epstein, Merritt Fox, Sam Gross, Myra Kim,
Howell Jackson, Rafael La Porta, Daria Roithmayr, Andrei Shleifer, Bill Wang, Mark West and participants at
various seminars and workshops for helpful comments and suggestions at different stages of this Article. I am
also grateful to Ron Alquist, Jonathan Ho, Cynthia Kao, Al Lagrone, Jorge Luis Silva Mendez, and Ozvaldo
Vazquez for excellent research and editorial assistance. I gratefully acknowledge financial support from the
John M. Olin Center for Law, Economics and Business at Harvard Law School, the John M. Olin Center for
Law and Economics at Michigan Law School, and the Cook Fund of the University of Michigan Law School.
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238 The Journal of Corporation Law [Winter

I. INTRODUCTION ........................................................................................................ 239

II. THE LAW AND ECONOMICS DEBATE OVER INSIDER TRADING ................................. 241
A. Agency Theories of Insider Trading ................................................................... 241
1. Insider Trading as an Efficient Compensation Mechanism........................... 242
2. Insider Trading as an Agency Cost................................................................ 243
B. Market Theories of Insider Trading.................................................................... 245
1. Insider Trading and Stock Price Accuracy.................................................... 246
a. The Meaning and Economic Significance of Stock Price Accuracy ......... 246
b. The Law and Economics Debate about Insider Trading and Stock
Price Accuracy ...................................................................................... 247
2. Insider Trading and Stock Market Liquidity.................................................. 249
a. The Meaning and Economic Significance of Stock Market Liquidity....... 249
b. The Law and Economics Debate about Insider Trading and Stock
Market Liquidity .................................................................................... 250
c. A “Coasian” Approach to Insider Trading: Private Contracting............ 252
III. TESTABLE HYPOTHESES .......................................................................................... 256
A. Insider Trading Law and Ownership Concentration.......................................... 256
B. Insider Trading Law and the Information Content of Stock Prices .................... 258
C. Insider Trading Law and Liquidity..................................................................... 261
IV. DESCRIPTION OF THE DATA ..................................................................................... 263
A. Data Sources ...................................................................................................... 263
1. The Dependent Variables .............................................................................. 263
2. Insider Trading Regulation and Enforcement ............................................... 264
a. Insider Trading Law Variables ................................................................ 264
b. Enforcement Environment ........................................................................ 266
3. Additional Economic, Legal and Institutional Variables............................... 268
B. Descriptive Statistics .......................................................................................... 270
V. REGRESSION ANALYSIS OF INSIDER TRADING LAW AND THE STOCK MARKET........ 273
A. Insider Trading Law and Corporate Ownership ................................................ 273
B. Insider Trading Law and Stock Price Informativeness....................................... 275
C. Insider Trading Law and Stock Market Liquidity............................................... 277
D. Interaction of Sanctions and Public Enforcement Power .................................. 278
E. Summary and Discussion of Results ................................................................... 279
VI. CONCLUSION AND IMPLICATIONS FOR THE THEORETICAL LAW AND ECONOMICS
DEBATE ................................................................................................................. 280
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2007] Insider Trading Laws and Stock Markets Around the World 239

I. INTRODUCTION

The law and economics debate about the desirability of prohibiting insider trading—
trading by corporate insiders on material, non-public information—is both long-standing
and unresolved. The early legal debate centered on whether insider trading is unfair to
public investors who are not privy to private corporate information. 1 However, the
fairness inquiry was malleable, lacked a rigorous theoretical framework, and therefore
did not yield coherent or practical policy prescriptions. 2 Professor Henry Manne abruptly
shifted the debate to an efficiency inquiry with his now classic 1966 book, Insider
Trading and the Stock Market. In Insider Trading and the Stock Market, Manne argued
that, contrary to the prevailing legal and moral opinion of the time, insider trading is
desirable because it is economically efficient. 3 Professor Manne’s controversial thesis
abruptly shifted the focus from fairness to the economics of insider trading and
precipitated an intense debate in the law and economics literature about the efficiency
implications of insider trading. 4 The central question in the law and economics debate is
whether insider trading is economically inefficient and thus ought to be subject to
government regulation or, conversely, whether it is economically efficient and thus ought
not to be regulated. Law and economics scholars sit on both sides of the fence. Some
even straddle the fence, for example, by arguing that even if insider trading might be
inefficient (bad) for some firms, it might be efficient (good) for other firms, and therefore
the law should enable corporations and shareholders to address insider trading via private
contract on a case by case basis. Without question, the law and economics approach has
advanced the legal policy debate about insider trading, but it has not achieved consensus
on fundamental questions.
The law and economics literature on insider trading is plagued by a few significant
shortcomings. Like the fairness inquiry, the efficiency inquiry is rather elusive, as no
single locus of efficiency focuses the scholarly debate. Rather, the investigations vary
from examinations of the narrow effects of insider trading on efficiency at the firm level
(agency theories of insider trading) to work studying the broader effects of insider trading
on stock market efficiency (market theories of insider trading). 5 It is possible, for

1. See, e.g., Roy A. Schotland, Unsafe at Any Price: A Reply to Manne, Insider Trading and the Stock
Market, 53 VA. L. REV. 1425, 1438 (1967) (discussing the fairness of insider trading and its effect on the
public’s confidence in the stock market); see also Victor Brudney, Insiders, Outsiders, and Informational
Advantages Under the Federal Securities Laws, 93 HARV. L. REV. 322, 334 (1979) (stating that “the antifraud
provisions [of U.S. securities laws] are said to serve principally a protective function—to prevent overreaching
of public investors—and only peripherally an efficiency goal”).
2. U.S. insider trading law doctrine demonstrates this confusion and ambiguity. See generally Stephen M.
Bainbridge, Insider Trading, in III ENCYCLOPEDIA OF LAW & ECONOMICS 772, 784-91 (Boudewin Bouckaert
& Gerrit De Geest eds., Edward Elgar Publishing 2000) (attempting to determine if insider trading injures
investors); Stephen M. Bainbridge, The Insider Trading Prohibition: A Legal and Economic Enigma, 38 FLA. L.
REV. 35, 55-61 (1986) (defining fairness in “three principal ways”); Frank H. Easterbrook, Insider Trading,
Secret Agents, Evidentiary Privileges, and the Production of Information, 1981 SUP. CT. REV. 309, 309-39
(using three insider trading cases to discuss policy questions).
3. HENRY G. MANNE, INSIDER TRADING AND THE STOCK MARKET 99-104 (1966).
4. Id. See generally Jonathan R. Macey, From Fairness to Contract: The New Direction of the Rules
Against Insider Trading, 13 HOFSTRA L. REV. 9 (1984) (describing the evolution of U.S. insider trading law
doctrine from a fairness focus to a contractual/property rights focus).
5. See Mark Klock, Mainstream Economics and the Case for Prohibiting Inside Trading, 10 GA. ST. U.
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240 The Journal of Corporation Law [Winter

example, that insider trading may enhance efficiency within the firm, but that markets in
which insider trading is permitted are thereby less efficient in the aggregate. Researchers
who focus their studies at different levels and report different results could be talking past
each other. A second, major deficiency of the law and economics literature on insider
trading is that it is insufficiently grounded in empirical evidence, although, as Professors
Carlton and Fischel note, the “desirability of [regulating] insider trading is ultimately an
empirical question.” 6 Rather, beginning with Professor Manne’s seminal argument, law
and economics scholarship on insider trading has been largely speculative and theoretical.
Finally, until recently, the existing empirical literature on insider trading has been
American-centered. 7 Few scholars have sought to examine the impact of insider trading
rules in a comparative context. This is important because, without variation in insider
trading rules, one cannot test causal hypotheses.
This Article, unlike most of the existing legal scholarship on insider trading, is
empirical and comparative. 8 The main aim is to determine whether insider trading laws
are systematically related to stock market performance across countries. To that end, the
Article formulates three testable hypotheses regarding the relationship between insider
trading laws and equity ownership, the informativeness of stock prices, and stock market
liquidity, respectively. These hypotheses are that countries with more stringent insider
trading laws will have: (a) more widespread equity ownership; (b) more informative
stock prices; and (c) more liquid stock markets, other things equal. To test these
hypotheses, I constructed a unique index of the stringency of insider trading laws for
thirty-three countries as of the mid-1990s. Using multivariable regression analysis, 9 I
find that countries with more stringent insider trading laws have more dispersed equity
ownership; more liquid stock markets; and more informative stock prices, consistent with
the formulated hypotheses. Because of the small number of available cases and the
impossibility of controlling for all potentially relevant variables, these conclusions must
be regarded as tentative, but they are nonetheless significant. If insider trading laws are

L. REV. 297, 299 (1994) (focusing on the “public policy arguments over insider trading”).
6. Dennis W. Carlton & Daniel R. Fischel, The Regulation of Insider Trading, 35 STAN. L. REV. 857, 866
(1983). For early empirical evidence on the effects of insider trading laws in the United States, see Jeffrey F.
Jaffe, The Effect of Regulation Changes on Insider Trading, 5 BELL J. ECON. & MGT. SCI. 93 (1974); H. Nejat
Seyhun, The Effectiveness of Insider-Trading Sanctions, 35 J. LAW. & ECON. 149 (1992).
7. See Jaffee, supra note 6; Seyhun, supra note 6.
8. For some recent comparative studies of insider trading laws, see sources cited infra note 206. The
Article contributes to the large and ever-expanding empirical law and finance literature. See, e.g., Lucian
Bebchuk & Mark Roe, A Theory of Path Dependence in Corporate Governance and Ownership, 52 STAN. L.
REV. 127 (1999); John Coffee, The Future as History: The Prospects for Global Convergence in Corporate
Governance and its Implications, 93 NW. U. L. REV. 641 (1999) [hereinafter Prospects for Global
Convergence]; John C. Coffee, The Rise of Dispersed Ownership: The Roles of Law and the State in the
Separation of Ownership and Control, 111 YALE L.J. 3 (2001) [hereinafter Rise of Dispersed Ownership];
Simeon Djankov, Rafael La Porta, Florencio Lopez-de-Silanes & Andrei Shleifer, The Law and Economics of
Self-Dealing (2006) [hereinafter Djankov et al., Self-Dealing] (unpublished manuscript, on file with author);
Rafael La Porta, Florencio Lopez-de-Silanes, Andrei Shleifer & Robert Vishny, Law and Finance, 106 J. POL.
ECON. 1113 (1998) [hereinafter La Porta et al., Law and Finance]; Rafael La Porta, Florencio Lopes-de-Silanes,
Andrei Shleifer & Robert Vishny, Legal Determinants of External Finance, 52 J. FIN. 1131 (1997) [hereinafter
La Porta et al., Legal Determinants]; Rafael La Porta, Florencio Lopez-de-Silanes & Andrei Shleifer, What
Works in Securities Laws?, 61 J. FIN. 1 (2006) [hereinafter La Porta et al., What Works?].
9. See discussion infra Part V.
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2007] Insider Trading Laws and Stock Markets Around the World 241

detrimental, as Professor Manne and others have posited, the pattern I find would have
been unlikely.
The Article is organized as follows: Part II reviews the theoretical law and
economics debate about the desirability of regulating insider trading, categorizing the
theories of insider trading into two broad groups, agency theories and market theories;
Part III formulates three testable hypotheses that emerge from the theoretical literature;
Part IV describes the data and presents summary statistics; Part V presents and discusses
the results of multivariable regression analysis; and finally, Part VI concludes by
addressing some of the implications of this Article’s findings for the theoretical law and
economics debate about insider trading. In particular, I argue that this Article’s findings
tend to support the arguments of legal scholars who argue that insider trading regulation
has a beneficial impact on stock markets. However, more empirical work is necessary to
conclusively resolve the theoretical debate.

II. THE LAW AND ECONOMICS DEBATE OVER INSIDER TRADING

Law and economics theories about insider trading fall into two main categories:
agency theories and market theories of insider trading. 10 Agency theories of insider
trading analyze its effect on the classic corporate agency problem, the manager-
shareholder conflict of interest. 11 These theories consider whether insider trading
ameliorates or worsens this conflict, and therefore whether it increases or reduces firm-
level efficiency. 12 In contrast, market theories of insider trading address its broader
ramifications for market efficiency. 13 In this Part, I summarize common agency and
market theories for and against insider trading regulation, and I briefly discuss the private
contracting approach that some opponents of insider trading regulation advocate.

A. Agency Theories of Insider Trading

Agency theories of insider trading analyze the effects of insider trading on agency
costs. 14 If insider trading reduces the divergence between shareholders’ and managers’

10. Proponents and opponents of insider trading regulation often defend their arguments on both agency
and market efficiency grounds. However, this categorization of the arguments is a useful organizing tool.
11. See ADOLF A. BERLE & GARDINER C. MEANS, THE MODERN CORPORATION AND PRIVATE PROPERTY
(2005) (exploring effect of manager-shareholder conflict of interest on corporations); Michael C. Jensen &
William H. Meckling, Theory of the Firm: Managerial Behavior, Agency Costs, and Ownership Structure, 3 J.
FIN. ECON. 305 (1976) (explaining the conflict that exists when managers have mixed financial interests in
corporations).
12. Judge Easterbrook was one of the first scholars systematically to explore the agency dimensions of
insider trading. Frank H. Easterbrook, Insider Trading as an Agency Problem, in PRINCIPALS AND AGENTS: THE
STRUCTURE OF BUSINESS 81 (John W. Pratt & Richard J. Zeckhauser eds., 1985).
13. These market features are often referred to collectively as market integrity. See generally Lawrence M.
Ausubel, Insider Trading in a Rational Expectations Economy, 80 AM. ECON. REV. 1022 (1990) (modeling the
effect of insider trading on “investor confidence”); Utpal Bhattacharya, Hazem Daouk, Brian Jorgenson & Carl-
Heinrich Kehr, When an Event is Not an Event: The Curious Case of an Emerging Market, 55 J. FIN. ECON. 69,
72 n. 4 (2000) (“Market integrity refers to the disadvantages [that] outsiders face vis-à-vis insiders when trading
in the market.”).
14. Jensen and Meckling define agency costs as the sum of the shareholders’ monitoring costs, the
managers’ bonding costs, if any, and the residual loss, which is the decrease in shareholders’ welfare caused by
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242 The Journal of Corporation Law [Winter

interests, then it reduces agency costs. Conversely, if insider trading increases this
divergence, then it increases agency costs. Proponents of unregulated insider trading
argue the former is true, while proponents of insider trading regulation opt for the latter.

1. Insider Trading as an Efficient Compensation Mechanism

In Insider Trading and the Stock Market, Professor Manne argues that insider
trading is economically efficient because it motivates entrepreneurial innovation. 15
According to Professor Manne, it is difficult to compensate entrepreneurs because, unlike
capitalists and salaried employees, it is hard to identify entrepreneurs in advance.
Because anyone from regular salaried employees to top executives may generate
profitable innovations, it is difficult to set entrepreneurs’ pay in advance. Moreover, the
value of entrepreneurial activity will be vague at the outset:
True innovation cannot be predicted nor its value known before it has been
thought of and made effective. True innovation cannot be planned and
budgeted in advance. An individual cannot be hired to perform x amount of
entrepreneurial service. 16
Finally, so the argument goes, the dynamic nature of innovation renders it virtually
impossible to contract over in advance. 17
Insider trading is seen as a mechanism to avoid the inefficiencies that these
conditions would otherwise produce. Through insider trading, entrepreneurs can be
rewarded in direct proportion to and contemporaneously with their innovations. 18
Entrepreneurial innovation creates valuable new information (at the most basic level, that
there has been an innovation), and the first person to know about it is the entrepreneur
who produced the innovation. She can profit by buying the company’s shares before the
public learns of the innovation and before their value rises to reflect the positive news.
Even if the entrepreneur is wealth-constrained and thus cannot buy unlimited shares, she
can “sell” this information to others. 19 In this manner, insider trading “readily allows
corporate entrepreneurs to market their innovations,” thus forging a closer link between
entrepreneurial compensation and innovation. 20 Since it maximizes their incentives to
innovate, insider trading is the best way to compensate entrepreneurs, according to
Professor Manne. 21
Professors Carlton and Fischel recast Professor Manne’s efficient compensation
thesis in the language of the economics of agency. 22 They argue that insider trading is
efficient because it reduces agency costs. In their view, relying on capital and product

the divergence between the managers’ decisions and the decisions that would maximize the shareholders’
wealth. Jensen & Meckling, supra note 11, at 308. Judge Easterbrook was one of the first scholars
systematically to explore the agency dimensions of insider trading. See Easterbrook, supra note 12.
15. MANNE, supra note 3.
16. Id. at 133.
17. Id. at 132-38.
18. Id. at 138-41.
19. Id. at 138-39.
20. MANNE, supra note 3, at 138.
21. Id.
22. Carlton & Fischel, supra note 6, at 866.
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markets to properly incentivize managers is insufficient because these markets work

imperfectly, making it relatively difficult to remove poorly performing managers. Ex ante
compensation contracts are inadequate because they would require costly “periodic
renegotiations ex post based on (imperfectly) observed effort and output . . . .” 23 In
contrast, insider trading enables managers continually to update their compensation in
light of new information without incurring renegotiation costs. 24 Insider trading thus
increases mangers’ incentives by linking their “fortunes more closely to those of the
firm.” 25
In addition, Professors Carlton and Fischel claim, insider trading improves the
managerial labor market:
A related advantage of insider trading is that it provides firms with valuable
information concerning prospective managers. It is difficult for firms to
identify those prospective managers who will work hard and not be overly risk
averse in their choice of investment projects. Basing compensation in part on
insider trading is one method for sorting superior from inferior managers.
Because insider trading rewards those managers who create valuable
information and are willing to take risks, managers who most prefer such
compensation schemes may be those who are the least risk averse and the most
capable. 26
Because the ability to engage in insider trading causes the most able managers to self-
select into firms that allow it, insider trading reduces both screening and monitoring
costs. 27 Lower screening and monitoring costs imply lower agency costs, a central
concern of corporate law.

2. Insider Trading as an Agency Cost

Proponents of insider trading regulation emphasize its rent-extraction potential,
suggesting that insider trading might simply be an inefficient private benefit of control
that accrues to managers and other insiders at shareholders’ expense. 28 They argue that
rather than serving as an incentive-alignment device that more closely aligns
shareholders’ and managers’ interests, insider trading can exacerbate agency costs by
distorting the managerial wage-setting process. 29 If they are permitted to trade, managers
might be able, ex post, to undo an efficient ex ante compensation contract and thereby
sabotage performance-based compensation schemes intended to calibrate pay to

23. Id. at 870.

24. Id. at 866.
25. Id. at 877.
26. Id. at 871-872.
27. Carlton & Fischel, supra note 6, at 866.
28. On the problem of private benefits of control, see generally, Sanford J. Grossman and Oliver D. Hart,
Coporate Financial Structure and Managerial Incentives, in THE ECONOMICS OF INFORMATION AND
UNCERTAINTY 125 (J. J. McCall ed., 1982).
29. Reinier Kraakman, The Legal Theory of Insider Trading Regulation in the United States, in
EUROPEAN INSIDER DEALING: LAW AND PRACTICE 47, 52 (Klaus J. Hopt & Eddy Wymeersch eds., 1991);
Klock, supra note 5, at 313-15.
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244 The Journal of Corporation Law [Winter

productivity. 30 As a result, firms might have to monitor managers’ trading ex post,

offsetting its presumed cost-saving to the firm. 31
In addition, some proponents of regulation argue that in practice it is difficult to
ensure that those who produce valuable information (i.e., entrepreneurial innovations) are
the only ones who are able to profit from it. 32 This non-excludability feature of insider
trading benefits could generate a free-rider problem and possibly lead to information
hoarding within the firm as the true entrepreneurs, who are the real innovators in the firm,
would have an incentive to hold their information close to their chests to maintain a
monopoly on insider trading profits. The inability of the firm’s true entrepreneurs to
monopolize the information about their innovations vis-à-vis other insiders might
ultimately reduce the incentive to innovate and therefore negatively affect corporate
performance. In addition, by obstructing the free flow of information through the firm,
such information hoarding could reduce the firm’s overall organizational efficiency. 33
Proponents of insider trading legislation also claim “that allowing managers to trade
on inside information” might give them incentives to take on too much risk or to
undertake value-reducing projects. 34 Since insider trading is more profitable the more
stock price volatility increases, it might encourage managers to engage in excessively
risky investment behavior by undertaking overly risky projects that create private
opportunities for profitable insider trading but that reduce corporate value for the firm. 35
In addition, since managers can profit from insider trading whether the firm is performing

30. Kraakman, supra note 29, at 52.

31. Even Professors Carlton and Fischel, ardent proponents of deregulation, concede that “[b]anning
insider trading would prevent insiders from undoing compensation agreements in this manner.” Carlton &
Fischel, supra note 6, at 873.
32. See, e.g., James D. Cox, Insider Trading and Contracting: A Critical Response to the Chicago School,
1986 DUKE L.J. 628, 653 (1986) (stating that “most [U.S.] insider-trading cases have not involved those whose
entrepreneurial or other managerial efforts have produced the value-increasing event that was traded upon.
Instead, the defendants have been outside directors, professionals, or clerks whose assistance was used to
complete the transaction, not to create it”).
33. Robert J. Haft, The Effect of Insider Trading Rules on the Internal Efficiency of the Large
Corporation, 80 MICH. L. REV. 1051, 1053-67 (1982). This argument is, in my view, an example of the
shortcomings of the abstract theorizing that has characterized both sides of the insider trading debate. If an
innovator held her information completely private, neither she nor her firm would benefit because the
innovation would never be developed. If she were to buy stock in the company before disclosing her idea, her
investment would have to account for the likelihood that she could not sell her innovation within the firm, and
she might be poorly situated to estimate this risk. Realistically, the type of insider trading that regulators have
been concerned with often does not involve innovation at all but knowledge that a person secures because of her
position in the firm, such as knowledge about what the next quarterly report will say. To the extent that
innovation is involved, trading on the inside knowledge is likely to be sufficiently downstream from the original
innovative or entrepreneurial spark so that many who did not contribute to its development will be able to
benefit from it if they are allowed to trade on their inside knowledge.
34. See Klock, supra note 5, at 313-15; Kraakman, supra note 29, at 52 (discussing the role of managers
in insider trading); see also Lucian Arye Bebchuk & Chaim Fershtman, Insider Trading and the Managerial
Choice Among Risky Projects, 29 J. FIN. & QUANT. ANALYSIS 1 (1994) (presenting a formal economic model
of the effect of insider trading on managers’ choice among risky investments).
35. See Kraakman, supra note 29, at 52 (“The option-like character of returns from insider trading rewards
the selection of projects with volatile payouts, regardless of whether they have a positive or negative return on
net.”). In response, opponents of insider trading regulation claim that managers are too risk averse and insider
trading encourages them to bear more risk, which is good for shareholders.
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2007] Insider Trading Laws and Stock Markets Around the World 245

poorly or well, insider trading increases managers’ incentives to under-perform by

making them indifferent as to whether the firm is doing well or poorly. 36
If corporate insiders are permitted to sell the firm’s shares short, the potential
problems of excessive risk-taking and compensation unbundling induced by insider
trading may be exacerbated. 37 Professor Klock gives a colorful and somewhat humorous
example:
A case in point is that of Mr. Albert Wiggin, as told by Professor Malkiel. Mr
Wiggin was,
[t]he head of Chase, the nation’s second largest bank at the time. In July
1929 Mr. Wiggin became apprehensive about the dizzy heights to which stocks
had climbed and no longer felt comfortable speculating on the bull side of the
market. . . . Believing that the prospects of his own bank’s stock were
particularly dim . . . he sold short over 42,000 shares of Chase stock. . . .
Wiggin’s timing was perfect. Immediately after the short sale the price of
Chase stock began to fall, and when the crash came in the fall the stock
dropped precipitously. When the account was closed in November, Mr. Wiggin
had netted a multimillion dollar profit from the operation. . . .
There are two possible interpretations of the Wiggin case. One is that Mr.
Wiggin believed bad news was inevitable and sold short. He then worked
vigorously against his own self interest trying to minimize his profit, and even
trying to lose his personal wealth, but nevertheless managed to make a great
deal of money in spite of his best efforts to the contrary. . . . The alternative
was that there is some self-dealing going on. Readers are left to determine for
themselves the more probable explanation. 38

B. Market Theories of Insider Trading

Insider trading might have efficiency implications that are broader than its effects at
the firm level. 39 Market theories of insider trading address these broader ramifications.
The two measures that are most frequently addressed in the insider trading debate are
stock price accuracy and stock market liquidity. Economists and finance scholars have

36. Kraakman, supra note 29, at 52 (discussing the role of managers in insider trading); Klock, supra note
5, at 313-15; Easterbrook, supra note 12, at 86; Iman Anabtawi, Note, Toward A Definition of Insider Trading,
41 STAN. L. REV. 377, 391-92 (1989).
37. In the U.S., Rule 16(b) prohibits short-selling. U.S. Securities Exchange Act of 1934, 15 U.S.C. §
78p(b) (2006). But see Carlton & Fischel, supra note 6, at 873-74 (arguing that short selling may be beneficial
to the firm, “if it induces managers to invest in a way that maximizes the value of the firm” and that managers
will be sufficiently self-constrained not to seek profits from bad news).
38. Klock, supra note 5, at 314-15 (quoting BURTON G. MALKIEL, A RANDOM WALK DOWN WALL
STREET 186 (1990)) (internal quotations omitted).
39. See generally Zohar Goshen & Giedeon Parchomovsky, On Insider Trading, Markets, and “Negative”
Property Rights in Information, 87 VA. L. REV. 1229 (2001) (discussing the effects of insider trading on market
efficiency); Kimberly D. Krawiec, Fairness, Efficiency, and Insider Trading: Deconstructing the Coin of the
Realm in the Information Age, 95 NW. U. L. REV. 443 (2001) (addressing the efficiency implications of insider
trading for the market for information).
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246 The Journal of Corporation Law [Winter

long noted the importance of both of these characteristics of the stock market to the
efficiency of capital allocation and the cost of capital and therefore ultimately to
economic growth. 40

1. Insider Trading and Stock Price Accuracy

a. The Meaning and Economic Significance of Stock Price Accuracy

There is disagreement about the meaning of accurate stock prices. 41 In this Article, I
refer to accurate stock prices as stock prices that reflect as much firm-specific
information as possible. As Professors Fox, Morck, Yeung, and Durnev point out,
“[s]hare price is relatively ‘accurate’ if it is likely to be relatively close, whether above or
below, to the share’s actual value. When a price has a high expected accuracy, the
deviation of the price from actual value is, on average, relatively small.” 42
Accurate share prices are important to economic efficiency via their effect on capital
allocation:
More accurate prices can increase the amount of value added by firms as they
use society’s scarce resources for the production of goods and services. In a
competitive economy, the increase in value added will generally increase both
the level of firm cash flows . . . and returns to other factors of production . . . by
improving the quality of [capital allocation across] investment projects in the
economy and by improving the operation of existing real assets. 43
In addition to improving the efficiency of capital allocation, accurate stock prices
might reduce agency costs within the firm:
[A]dditional disclosure and increased share price accuracy, by signaling when
there are problems, assist in both the effective exercise of the shareholder
franchise and shareholder enforcement of management’s fiduciary duties.
Additional disclosure and more accurate share prices also increase the threat of

40. On the positive role of share price accuracy, see for example, Merritt B. Fox, Randall Morck, Bernard
Yeung & Artyom Durnev, Law, Share Price Accuracy, and Economic Performance: The New Evidence, 102
MICH. L. REV. 331, 345-46 (2003); Li Jin & Stewart C. Myers, R2 Around the World: New Theory and New
Tests, 79 J. FIN. ECON. 257 (2006); Jeffrey Wurgler, Financial Markets and the Allocation of Capital, 58 J. FIN.
ECON. 187 (2000). On the positive role of stock market liquidity, see for example, Yakov Amihud & Haim
Mendelson, Asset Pricing and the Bid-Ask Spread, 17 J. FIN. ECON. 223 (1986); Michael J. Barclay & Clifford
W. Smith, Jr., Corporate Payout Policy: Cash Dividends versus Open Market Repurchases, 22 J. FIN. ECON. 61
(1988); Michael J. Brennan & Avanidhar Subrahmanyam, Market Microstructure and Assets Pricing: On the
Compensation for Illiquidity in Stock Returns, 41 J. FIN. ECON. 441 (1996); Gady Jacoby, David J. Fowler &
Aron A. Gottesman, The Capital Asset Pricing Model and the Liquidity Effect: A Theoretical Approach, 3 J.
FIN. MARKETS 69 (2000).
41. See John M. R. Chalmers & Gregory B. Kadlec, An Empirical Examination of the Amortized Spread,
48 J. FIN. ECON. 159 (1998); Vinay T. Datar, Narayan Y. Naik & Robert Radcliffe, Liquidity and Stock Returns:
An Alternative Test, 1 J. FIN. MARKETS 203 (1998); Klock, supra note 5, at 299.
42. Fox et al., supra note 40, at 345-46 and corresponding notes.
43. Id. at 338-39 and corresponding notes. For empirical evidence that the efficiency of capital allocation
in the economy is positively correlated with more accurate stock prices (i.e., stock prices that reflect more firm-
specific information), see Wurgler, supra note 40.
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2007] Insider Trading Laws and Stock Markets Around the World 247

hostile takeover when managers engage in non-share-value-maximizing

behavior. 44
“Share price accuracy is a function of two core determinants. One is the amount of
information concerning a firm’s future distributions that exists in the hands of one or
more persons in the world. The other is the extent to which price reflects this
information.” 45 Insider trading potentially impacts both of these determinants of share
price accuracy.

b. The Law and Economics Debate about Insider Trading and Stock Price Accuracy
Firms may directly affect the accuracy of their share prices by regularly disclosing
information. However, although corporate disclosure is beneficial, it is also costly. 46
Disclosure is a public good in that firms bear most of the (private) costs of disclosure, but
do not reap its full benefits, which are dispersed among the firm and the public, which
includes rival firms and investors. 47 In some cases, disclosure might even be detrimental
to the firm’s own investors by revealing too much too soon. Thus, firms might engage in
less than the socially optimal amount of disclosure. 48
In Insider Trading and the Stock Market, Professor Manne argues that insider
trading enables a firm to improve the accuracy of its stock’s price relative to its true value
without incurring the costs associated with premature disclosure of firm-specific
information. 49 Similarly, Professors Carlton and Fischel argue that insider trading is less
costly than traditional disclosure: 50
Through insider trading, a firm can convey information it could not feasibly
announce publicly because an announcement would destroy the value of the

44. Fox et al., supra note 40, at 340 and corresponding notes.
45. Id. at 346 and corresponding notes.
46. See George J. Benston, The Value of the SEC’s Accounting Disclosure Requirements, 44 ACCT. REV.
515 (1969). For a comparative empirical study of the determinants of voluntary corporate disclosure, see Gary
K. Meek, Clare B. Roberts & Sidney J. Gray, Factors Influencing Voluntary Annual Disclosures by U.S., U.K.
and Continental European Multinational Corporations, 26 J. INT’L BUS. STUD. 555 (1995).
47. A public good is a good that is impossible to exclude parties from consuming and that one person’s
consumption of does not decrease the amount that other consumers may consume of such good. HAL R.
VARIAN, MICROECONOMIC ANALYSIS 414 (1992). In general, the government or other public institutions (like
voting) rather than private markets are the most efficient providers of public goods. Id. at 415, 417-28.
Consequently, if stock price accuracy and stock market liquidity are public goods, private contracting might not
yield the optimal amount and regulation might be the best way to attain the optimal amount of these “goods.”
48. See generally Kenneth J. Arrow, Economic Welfare and the Allocation of Resources for Invention, in
THE RATE AND DIRECTION OF INVENTIVE ACTIVITY: ECONOMIC AND SOCIAL FACTORS, NATIONAL BUREAU OF
ECONOMIC RESEARCH CONFERENCE SERIES (1962); John C. Coffee, Jr., Market Failure and the Economic Case
for a Mandatory Disclosure System, 70 VA. L. REV. 717 (1984); Merritt B. Fox, Retaining Mandatory
Securities Disclosure: Why Issuer Choice is Not Investor Empowerment, 85 VA. L. REV. 1335 (1999). The
socially optimal amount of disclosure lies somewhere between no disclosure and complete disclosure. Left to
their own devices, firms would probably disclose less than the socially optimal amount, which presumably
explains why the law compels disclosure through mandatory disclosure rules. Mandatory disclosure
supplements firms’ voluntary disclosure of information that is relevant to the value of their shares.
49. MANNE, supra note 3, at 80-91; Henry G. Manne, Insider Trading: Hayek, Virtual Markets, and the
Dog that Did Not Bark, 31 J. CORP. L. 167, 169 & n.10 (2005).
50. Carlton & Fischel, supra note 6, at 868.
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248 The Journal of Corporation Law [Winter

information, would be too expensive, not believable, or—owing to the

uncertainty of the information—would subject the firm to massive damage
liability if it turned out ex post to be incorrect. 51
When insiders trade on the basis of private information (e.g., a new discovery, an
impending merger, etc.) prices will adjust to reflect the news, but without prematurely
revealing the underlying information to the market. 52 Professor Manne argues that this
mechanism of price adjustment is more efficient than prohibiting insiders from trading
and therefore delaying the incorporation of information (that the firm is unwilling or
unable immediately to disclose) into the stock’s price. 53
In contrast, advocates of insider trading regulation question its utility as a cheap
substitute for traditional disclosure methods on several grounds. First, they argue that
insider trading is likely to distort managers’ incentives to disclose information in a timely
manner. 54 Insiders’ ability to profit from insider trading depends fundamentally on their
superior access to information. The more that they can control the leakage of information,
the more they stand to gain from insider trading. This might include hoarding information
to the detriment of both price accuracy 55 and the firm’s operational efficiency. 56 In the
worst case, insider trading might reduce stock price accuracy by increasing corporate
insiders’ incentives to manipulate information disclosure to maximize their trading
profits. 57
Second, it might be difficult for outsiders to detect insiders’ trades. One reason is
insiders might deliberately hide their trading to “preserve their informational monopolies,
even if their activities were legal.” 58
It will be very costly to detect an insider’s trades, because he can hide his
trading activity. He can buy stock in street names or through nominees
(including trusts and family members); he may route orders through a chain of
brokers to make tracing difficult; the list of evasive devices is long. 59
If insiders are able to hide their trades, insider trading will be difficult to discern. Even if
insiders do not deliberately hide their trades, they might avoid taking large positions due
to risk aversion. If insiders’ trades are insufficiently large, they will be undetectable and
thus might fail to convey new information. 60 In addition, the more “noise” there is

51. Id.
52. Id. at 879.
53. MANNE, supra note 3, at 86-90, Figures 3 and 4 and accompanying text.
54. Kraakman, supra note 29, at 52.
55. Id. at 51.
56. See Haft, supra note 33, at 1054-57.
57. See Kraakman, supra note 29, at 51; Cox, supra note 32, at 648; see also Roland Benabou & Guy
Laroque, Using Privileged Information to Manipulate Markets: Insiders, Gurus, and Credibility, 107 Q.J.
ECON. 921 (1992) (presenting an economic model demonstrating the effect of private information on insiders’
incentives to manipulate the market with deliberately misleading announcements).
58. Kraakman, supra note 29, at 50.
59. Easterbrook, supra note 12, at 91; see also Ronald J. Gilson & Reinier H. Kraakman, The Mechanisms
of Market Efficiency, 70 VA. L. REV. 549, 631-32 (1984) (noting that the extent to which insider trading makes
stock prices more efficient depends on the extent to which uniformed investors are able to discern insider
trading).
60. See generally Gilson & Kraakman, supra note 59, at 574-79 (describing how uninformed investors
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2007] Insider Trading Laws and Stock Markets Around the World 249

surrounding an inside trade, the lower its informational value.61

Finally, proponents of insider trading regulation argue that even if insiders do not
hide their trades or delay disclosure to monopolize insider trading profits, whatever
advantage insider trading might have over traditional disclosure is probably very small.
The argument for insider trading as an alternative means of disclosure is strongest when
the information in question is the kind of information managers have little ability or
incentive to disclose. 62 “Familiar examples include complex or ‘soft’ information that
cannot be communicated effectively, bad news that might embarrass incumbent
managers, and good news that cannot be released directly without aiding an issuer’s
competitors or upsetting ongoing negotiations.” 63
In the case of these kinds of information, allowing insider trading might do more to
update prices than public announcement, as Professors Manne, Carlton and Fischel argue.
However, for most types of information, traditional disclosure seems relatively cheap. 64

2. Insider Trading and Stock Market Liquidity

a. The Meaning and Economic Significance of Stock Market Liquidity

As finance scholar David Lesmond notes, “[l]iquidity, by its very nature, is difficult
to define and even more difficult to estimate.” 65 Similarly, finance scholar Albert Kyle
writes, “liquidity is a slippery and elusive concept.” 66 However, the general view in the
finance literature seems to be that stock market liquidity refers to the transaction costs of
trading—direct or indirect. 67 A liquid stock market has relatively low trading costs, while
an illiquid stock market has relatively high trading costs. Like accurate stock prices, a
liquid stock market is important to efficient capital allocation in the economy. In
addition, theoretical and empirical research suggests that lower liquidity costs (more
liquid stock markets) are associated with a lower cost of capital and higher market
valuation. 68 An important issue in the law and economics debate about insider trading is
whether it has a detrimental effect on stock market liquidity.

might infer the nature of inside information by observing trading volume or price movements due to insider
trading, particularly if they are able to infer the identity of the inside traders).
61. Carlton & Fischel, supra note 6, at 868; Kraakman, supra note 29, at 50.
62. Kraakman, supra note 29, at 50.
63. Id.
64. See Michael Manove, The Harm from Insider Trading and Informed Speculation, 104 Q. J. ECON. 823,
826-27 (1989).
65. David A. Lesmond, Liquidity of Emerging Markets, 77 J. FIN. ECON. 411, 412 (2005).
66. Id. (quoting Albert Kyle, Continuous Actions and Insider Trading, 53 ECONOMETRICA 1315, 1316
(1985)).
67. Id.
68. For theoretical proof of the positive relationship between liquidity costs and the firm’s cost of capital,
see Amihud & Mendelson, supra note 40; Barclay & Smith, supra note 40; Jacoby et al., supra note 40. But see
Amar Bhide, The Hidden Costs of Stock Market Liquidity, 34 J. FIN. ECON. 31 (1993) (arguing that excessive
liquidity could harm corporate performance by reducing dominant shareholders’ incentive to monitor
managers). For empirical evidence that greater liquidity is associated with a lower cost of capital, see Brennan
& Subrahmanyam, supra note 40; John M.R. Chalmers & Gregory B. Kadlec, An Empirical Examination of the
Amortized Spread, 48 J. FIN. ECON. 159 (1998); Datar et al., supra note 41.
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250 The Journal of Corporation Law [Winter

b. The Law and Economics Debate about Insider Trading and Stock Market Liquidity
Insider trading is profitable because of the asymmetry of information between
insiders and outsiders. On average, when an insider sells her firm’s stock, she sells for
more than the stock’s “true” worth and when she buys her firm’s stock, she buys at less
than its “true” value. 69 The difference between the insider’s purchase or sell price and the
“true” value is the premium she receives because of having superior information relative
to outsiders. This premium represents a trading cost to less informed counter-parties. 70
Thus, controlling for other factors, a market characterized by pervasive insider trading
might be less liquid than a market in which insider trading is less severe. 71 If information
asymmetry is extreme, uninformed investors may refrain from trading altogether,
rendering the stock market fully illiquid. 72
Opponents of insider trading regulation dismiss its potential adverse effect on
liquidity. In particular, the fact that uninformed investors trade frequently implies that
they are not hindered by the existence of more informed parties, whether or not the latter
are insiders. 73 That uniformed investors trade in spite of asymmetric information might
suggest that their trading decisions are independent of trading costs. 74 Indeed, some
opponents of insider trading regulation argue uninformed investors might trade precisely
because of informed trading, which increases the accuracy of stock prices: “That trade
occurs suggests that traders either do not believe they are uninformed or realize that
enough informed trading occurs for the prevailing prices to reflect most material
information.” 75 In other words, the benefits of improved price accuracy might offset the
potential costs of trading against better-informed counter-parties.
Opponents of insider trading regulation argue further that some investors will
always be more informed than others. “Smart brokers . . . cause the same problems as
smart insiders. Uninformed traders who know they are uninformed should not trade in

69. See Manove, supra note 64, at 823-24.

70. See Nicholas L. Georgakopoulos, Insider Trading as a Transactional Cost: A Market Microstructure
Justification and Optimization of Insider Trading Regulation, 26 CONN. L. REV. 1, 17 (1993) (“Informed traders
‘take’ part of the stock market returns from the uninformed traders . . . . This ‘taking’ thus resembles a
transaction cost since it can be avoided by not trading.”); Goshen & Parchomovsky, supra note 39, at 1251-53,
1260-62 and corresponding notes; Kraakman, supra note 29, at 48 (“[I]nsider trading functions as a trading tax
on outsiders.”).
71. Id. Even Professors Carlton and Fischel, staunch opponents of banning insider trading, acknowledge
that “insider trading could be detrimental to the extent it reduces liquidity.” Carlton & Fischel, supra note 6, at
879.
72. Professor Akerlof established the theoretical connection between information asymmetry and market
failure, showing that markets malfunction when there is asymmetric information and may break down entirely
in cases of extreme information asymmetry. George A. Akerlof, The Market for “Lemons”: Quality
Uncertainty and the Market Mechanism, 84 Q.J. ECON. 488 (1970). For evidence that insider trading laws and
enforcement are associated with more liquid stock markets, see Utpal Bhattacharya & Hazem Daouk, The
World Price of Insider Trading, 57 J. FIN. 75, 90-93 (2002) (concluding “that the enforcement of insider trading
laws affects the cost of equity through its positive effect on liquidity”).
73. Carlton & Fischel, supra note 6, at 879-80.
74. See id.; see also David D. Haddock & Jonathan R. Macey, A Coasian Model of Insider Trading, 80
NW. U. L. REV. 1449, 1457 (1987) (observing that uninformed investors “will follow a ‘buy and hold’ strategy
[and] [b]ecause they trade securities infrequently, they will be relatively insensitive to the bid-ask spread
charged by market makers”).
75. Carlton & Fischel, supra note 6, at 880.
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2007] Insider Trading Laws and Stock Markets Around the World 251

either situation.” 76 Insider trading laws cannot eliminate this phenomenon. Rather,
prohibiting insider trading simply redistributes (but does not reduce) the profits from
informed trading from insiders to market professionals and other informed traders. 77 As a
result, banning insider trading will not reduce the cost of trading, opponents of insider
trading regulation argue. 78
However, some proponents of insider trading regulation argue that prohibiting
insider trading will reduce the cost of trading by increasing competition among informed
traders. There are essentially two competing groups of informed traders, corporate
insiders and informed outsiders (e.g., investment analysts, hedge fund and mutual fund
managers, etc.). Insiders have a clear advantage over informed outsiders, since the latter
generally are not privy to non-public corporate information, while insiders are always
privy to such information. If insiders are allowed freely to trade on non-public corporate
information (i.e., if insider trading is legal), they have a virtual monopoly on the profits
from informed trading. 79 This discourages informed outsiders from investing in
information gathering and analysis and there are thus fewer informed outsiders in the
market. Conversely, if insider trading is banned, more informed outsiders will participate
in the market. In turn, because there are more of them, none with monopoly access to
corporate information, the information market will be more competitive. A more
competitive market for information implies lower total profits from informed trading,
relative to a world in which insider trading is legal and insiders have monopolistic access
to information. Greater competition in the information market presumably translates into
lower trading costs 80 and more accurate stock prices. 81
Critics of insider trading regulation respond that if insider trading were harmful to
liquidity, firms would voluntarily prohibit it because greater liquidity is valuable. 82
Therefore, they argue, the fact that firms do not voluntarily proscribe insider trading
suggests that it does not harm liquidity. Yet, there is evidence that, at least in the United
States, firms do proscribe insider trading (albeit in the shadow of the law) and that this

76. Id. at 879-80.

77. David D. Haddock & Jonathan R. Macey, Controlling Insider Trading in Europe and America: The
Economics of the Politics, in LAW AND ECONOMICS AND THE ECONOMICS OF LEGAL REGULATION 149 (J.
Matthias Graf von der Schulenburg & Goran Skogh eds., 1986) [hereinafter Haddock & Macey, CONTROLLING
INSIDER TRADING]; David D. Haddock & Jonathan R. Macey, Regulation on Demand: A Private Interest
Model, with an Application to Insider Trading Regulation, 30 J.L. & ECON. 311 (1987) [hereinafter Haddock &
Macey, Regulation on Demand]. Consistent with this, a recent empirical study finds that analyst following
increases after countries’ initial enforcement of insider trading laws. Robert M. Bushman et al., Insider Trading
Restrictions and Analysts’ Incentives to Follow Firms, 60 J. FIN. 35 (2005).
78. Haddock & Macey, CONTROLLING INSIDER TRADING, supra note 77, at 153. However, uninformed
investors may not know they are uninformed and/or while they may be willing to pay a moderate premium
(brokerage fee) reflecting their information disadvantage relative to more informed traders, they might be
unwilling to pay the very high fees that might result if they are trading against corporate insiders.
79. See Georgakopoulos, supra note 70, at 20-30.
80. See id. at 17.
81. See discussion infra Parts III.B and III.C.
82. Haddock & Macey, CONTROLLING INSIDER TRADING, supra note 77. For empirical evidence that
greater liquidity is associated with a lower cost of capital for the firm, see Brennan & Subrahmanyam, supra
note 40; Chalmers & Kadlec, supra note 68; Vinay T. Datar et al., Liquidity and Stock Returns An Alternative
Test, 1 J. FIN. MARKETS 204 (1998).
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252 The Journal of Corporation Law [Winter

results in lower bid-ask spreads (i.e., greater liquidity). 83

Supporters of insider trading regulation argue that the reason firms and their
shareholders do not pre-commit to ban insider trading is that greater liquidity is a public
good, which firms systematically under-provide:
[E]ven if firms know the true correlation of price and transaction costs, they
may still reduce transaction costs less than is socially desirable if there is a
benefit to society from low transaction costs and market liquidity which firms
do not enjoy (in essence, transaction costs are [a positive] externality). 84
Because firms have insufficient incentives to provide liquidity by banning insider trading
themselves, markets must rely on government regulation, proponents of regulation
argue. 85 The question of whether firms and shareholders would voluntarily prohibit
insider trading if it were harmful is another controversial theme in the law and economics
debate, to which this Article now turns briefly.

c. A “Coasian” Approach to Insider Trading: Private Contracting

In addition to the question whether insider trading is harmful or beneficial and to
whom, another aspect of the law and economics debate about insider trading is the issue
of who should regulate insider trading—the government or private parties? Professors
Carlton and Fischel advocate private negotiations between firms and insiders. They argue
that the question is essentially one about the optimal allocation of the property right in
corporate information, a decision they believe is most efficiently made by private parties:
Whether insider trading is beneficial depends on whether the property right in
information is more valuable to the firm’s managers or to the firm’s investors.
In either case, the parties can engage in a value-maximizing exchange by
allocating the property right in information to its highest-valuing user. If the
critics of insider trading are correct, therefore, both the firm’s investors and the
firm’s insiders could profit by banning insider trading, thereby allocating the
property right in information to the firm’s investors. 86
Two observations about the contractual approach are worth mentioning. First, law
and economics scholars who advocate private contracts over insider trading regulation
confine their investigation of the optimal allocation of the property right in corporate
information to within the boundaries of the firm. 87 The property right is assignable by

83. Many U.S. firms have voluntary insider trading policies that go beyond the requirements of insider
trading regulations. In particular, many U.S. firms specify “black-out” periods, often prior to earnings
announcements, during which insiders are forbidden to trade absent corporate approval. See J.C. Bettis et al.,
Corporate Policies Restricting Trading by Insiders, 57 J. FIN. ECON. 191 (2000). It appears that these policies
result in reduced bid-ask spreads (i.e., greater liquidity) during the “black-out” periods. Id. at 211-14.
84. Georgakopoulos, supra note 70, at 34 n.69 and corresponding text.
85. Id. at 17; see also Goshen & Parchomovsky, supra note 39, at 1261-62 (explaining why private firms
and shareholders will not privately provide sufficient liquidity to the stock market). But see Bettis et al., supra
note 83 (demonstrating that many U.S. firms do voluntarily restrict insider trading, albeit in the shadow of the
law).
86. Carlton & Fischel, supra note 6, at 863.
87. See, e.g., JONATHAN R. MACEY, INSIDER TRADING: ECONOMICS, POLITICS, AND POLICY 4 (1991)
(observing that “the debate about insider trading is really a debate about how to allocate a property right within
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2007] Insider Trading Laws and Stock Markets Around the World 253

contract either to the firm (shareholders) or to insiders, by this approach, which is based
on the notion of the firm as a nexus of contracts. 88 Second, the contractual argument rests
on the applicability of the Coase theorem, which states that, in the absence of transaction
costs, uncertainty, and externalities, private parties will allocate property rights
(resources) to their most efficient uses. 89 Applying the Coase theorem to insider trading,
some law and economics scholars contend that if there were no government regulation,
firms and shareholders would privately negotiate the optimal allocation of the property
right in corporate information. 90 For some firms this would imply permitting insiders to
trade on private information, while for other firms, it would imply prohibiting insiders to
trade on private information. 91 Competitive labor, capital, and product markets would
prevent insiders’ overreaching the terms of insider trading contracts, 92 which may be
either publicly or privately enforced. 93 But the Coase Theorem does not describe the

the firm”); Carlton & Fischel, supra note 6 (investigating whether shareholders or insiders should have the
property right to valuable corporate information); Haddock & Macey, supra note 74 (investigating whether
shareholders or insiders should have the property right to valuable corporate information). For a critique of this
narrow focus, see Goshen & Parchomovsky, supra note 39, at 1233 (arguing “that existing analysis is
misguided as it rests on the erroneous assumption that property rights to inside information must be allocated
within the boundaries of the firm—namely, either to shareholders or to managers” and, for that reason,
overlooks “the possibility of awarding the property right of inside information” to third parties outside the firm,
like market analysts).
88. See Haddock & Macey, supra note 74, at 1449 n.1 (observing “the basic principle of corporate finance
that a firm is a nexus of contractual relationships”).
89. Ronald H. Coase, The Problem of Social Cost, 3 J.L. & ECON. 1, 15 (1960) (noting that “a
rearrangement of rights will always take place if it would lead to an increase in the value of production”).
90. They analogize insider trading to other forms of managerial compensation, which are addressed via
private contract. See, e.g., Carlton & Fischel, supra note 6, at 861-62.
Salaries, bonuses, stock options, office size, vacation leave, secretarial support, and other terms of
employment are all . . . properly left to private negotiation. Nobody would argue seriously that
these terms and conditions of employment should be set by government regulation . . . . Most
would agree that these decisions are better made through negotiations between firms and
managers, given the constraints of capital, product, and labor markets as well as the market for
corporate control.
Id. But see BEBCHUK & FRIED, infra note 107 (discussing the drawbacks of standard executive compensation
contracts).
91. See Carlton & Fischel, supra note 6, at 866.
[T]he allocation of the property right in valuable information to managers might not be optimal in
all circumstances for every firm. But even if some firms would attempt to ban insider trading in
the absence of regulation, other firms should nonetheless be able to opt out of the regulations if
they so desire. No justification exists for precluding firms from contracting around a regulatory
prohibition of insider trading.
Id.; see also Haddock & Macey, supra note 74, at 1467-68 (suggesting that some firms will desire a prohibition
against insider trading, while other firms will not).
92. Carlton & Fischel, supra note 6, at 862-63 (noting that “[g]overnment need not prohibit [hypothetical
compensation schemes whereby managers pay themselves huge salaries regardless of prerequisites] because,
given competitive markets, firms will have a strong incentive to avoid such a scheme.” The identical argument
applies to insider trading: “If it is bad, firms that allow insider trading will be at a competitive disadvantage
compared with firms that curtail insider trading.”).
93. See Carlton & Fischel, supra note 6, at 890 (discussing merits of private versus public enforcement).
But see Easterbrook, supra note 2, at 334-35 (suggesting that public enforcement of private insider trading
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254 The Journal of Corporation Law [Winter

world in which insider trading contracts would be negotiated because, in the real world,
transaction costs exist.
The two main transaction costs are: (1) negotiation costs and (2) enforcement costs.
Advocates of private contracting argue the costs of negotiating insider trading contracts
between firms and insiders would be minimal. 94 Professors Haddock and Macey argue
further that the actual drafting costs would be de minimis, since a firm’s articles of
incorporation represent a preexisting contractual relationship between shareholders and
managers. 95 As a result, it would be simply a matter of dropping a line or two
(prohibiting or allowing insider trading) into the preexisting corporate contract. Critics of
the “Coasian” approach do not see the costs as so slight. 96 One obvious cost is the cost of
overcoming collective action problems among dispersed shareholders; another is the
investment the parties would have to make to learn whether allowing insider trading is in
their interest. Critics also argue the costs of enforcing private prohibitions of insider
trading would be high. Judge Easterbrook, for example, argues it is too easy for insiders
to hide their trading and it is too costly for firms to determine when an inside trade is
based on “material” information. 97 Consequently, “[t]he overwhelming majority of
violations will go undetected.” 98 If private contracts prohibiting insider trading are not
enforceable, firms will not write them in the first place, even if it is in their private (or the
social) interest to do so, 99 or managers will write them for their private gain in the event
shareholders do not recognize their unenforcability. If the contracts are enforceable,
enforcement is itself a cost and, as is evident with shareholder derivative suits, the costs
can be huge.
A second criticism of the “Coasian” approach to insider trading is that the
assumption of zero external effects is unrealistic. The Coase theorem requires that all
affected parties are privy to the negotiations. However, insider trading within the firm
probably has spillover effects on non-shareholders, including other firms and the stock
market generally. 100 In addition, intra-firm negotiations over insider trading exclude

contracts might be better than private enforcement of such contracts); Haddock & Macey, supra note 74, at
1462-63 n.28 (suggesting that stock exchanges might be efficient enforcers of private insider trading contracts
between firms and shareholders).
94. See Carlton & Fischel, supra note 6, at 863 (“[T]he costs of negotiating contracts banning insider
trading in the employer-employee situation appears to be low.”).
95. Haddock & Macey, supra note 74, at 1449, n.1 (“For a publicly held firm, the preexisting contractual
relationship that provides the basis for the privity of contract between shareholders and insiders manifests itself
in the firm’s articles of incorporation.”).
96. See, e.g., Klock, supra note 5, at 315 (“Firms have agency costs, and negotiations between managers
and shareholders are not costless.”).
97. Easterbrook, supra note 12, at 91-93.
98. Id. at 92.
99. Id. at 91 (“No firm has an incentive to suppress trading by its insiders on material information unless
the private gains of doing so exceed the private costs.”). But see Carlton & Fischel, supra note 6, at 865
(arguing that perfect enforcement is not required and that imperfect enforcement will yield gains that exceed the
costs of contracting, if insider trading is detrimental to investors).
100. See generally Goshen & Parchomovsky, supra note 39 (discussing the spillover effects of insider
trading on stock market liquidity and the market for information). For an interesting analysis of the potential
spillover effects of outside trading, see Ian Ayres & Stephen Choi, Internalizing Outsider Trading, 101 MICH.
L. REV. 313, 405 (2002) (arguing that regulators should focus on enabling the market to determine division
between allowable and prohibited information).
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2007] Insider Trading Laws and Stock Markets Around the World 255

future shareholders, upon whom insider trading is also likely to have an impact. 101 Judge
Easterbrook articulates the concern that firms prohibiting insider trading may not be able
to capture the gains of doing so because of free-riding by firms that do not prohibit
insider trading. 102 Professors Goshen and Parchomovsky argue that, in their private
negotiations with insiders, firms will not consider the external benefits of prohibiting
insider trading on market efficiency as reflected in more accurate stock prices and greater
stock market liquidity. 103 Therefore, private contracting will lead to less than the socially
optimal level of curtailment of insider trading among firms. The empirical results in Part
V have important implications for this issue. 104
Third, critics of the private contracting approach argue that uncertainty and
asymmetric information will deter efficient private bargaining in the context of insider
trading. Professor Cox, for example, contends that precisely because of the secret, non-
transparent nature of insider trading, it is impossible for shareholders and insiders to
efficiently contract over whether to allow it or not. This difficultly arises because
efficient contracting requires “that parties know the costs and benefits of their
actions.” 105 Such knowledge seems unattainable in the insider trading context:
[S]tockholders must not only be able to quantify the benefits—such as
increased efficiency and more aggressive entrepreneurial activity—that they
will receive from licensing managers to trade on confidential corporate
information, but they also must know whether and by what amount these
benefits will be accompanied by costs such as abusive insider-trading practices.
[However,] it is difficult to quantify the gains attributable to entrepreneurial
activity generally, let alone the gains attributable to each individual manager’s
contribution toward these benefits.
Moreover, the costs of insider trading are open-ended. . . . [T]he opposite
trader’s insider-trading costs are beyond quantification. Furthermore, hidden
costs associated with various abusive insider-trading practices must also be
taken into account. . . . [T]he existence and magnitude of such costs pose an
insolvable problem, especially in the context of ex ante contracting. 106
In this respect, insider trading profits are distinguishable from other, more transparent
forms of managerial compensation that firms and shareholders regularly contract over. 107

101. See Klock, supra note 5, at 317 (observing that Coase theorem is not applicable because future
shareholders do not participate in the negotiating).
102. Easterbrook, supra note 12, at 94-95. Easterbrook’s concern is that firms that do not ban insider
trading will mimic firms that do and thus the market will be unable to distinguish between the two types of
firms. Such mimicry, if successful, will cause the market to over-discount the shares of the firms that ban
insider trading and under-discount the shares of the firms that do not ban insider trading but pretend that they
do. Id.
103. Goshen & Parchomovsky, supra note 39, at 1264.
104. See discussion infra Part V.
105. Cox, supra note 32, at 653.
106. Id. at 654.
107. But see LUCIAN BEBCHUK & JESSE FRIED, PAY WITHOUT PERFORMANCE: THE UNFULFILLED PROMISE
OF EXECUTIVE COMPENSATION (2004) (arguing that executive compensation methods often obscure the amount
of executive pay and the weak link between executive pay and performance).
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256 The Journal of Corporation Law [Winter

The debate about whether private contracting is more efficient than government
regulation of insider trading is closely related to the debate about whether insider trading
is efficient. If insider trading is solely an agency issue, private contract might be an
efficient way of addressing it within the firm. But, even in this case, public regulation
may be superior to private contract for the reasons discussed above. However, if insider
trading is detrimental to stock markets (that is, if insider trading has effects beyond the
firm level), any argument in favor of private contract is greatly diminished, if not
obliterated, notwithstanding the fact that an individual firm and its shareholders might be
privately satisfied with a contractual approach to insider trading.

III. TESTABLE HYPOTHESES

Until recently, the law and economics debate about the desirability of regulating
insider trading has been largely theoretical. Although scholars interested in insider
trading have articulated highly refined theoretical arguments, these arguments, as we
have seen, are offsetting, and actual knowledge of the effects of insider trading has not
been advanced due to the dearth of empirical evidence. In this Part, I will draw on the
theoretical law and economics literature and scholarship in financial economics, to
formulate three testable hypotheses.

A. Insider Trading Law and Ownership Concentration

Judge Easterbrook notes that there have been few empirical assessments of the
competing agency theories of insider trading. 108 One reason is the indeterminacy of
theoretical agency models. 109 Another reason is that, “even with data the problem may be
insoluble.” 110 Mindful of these limitations, I first propose to indirectly test the agency
implications of insider trading by examining how insider trading laws relate to ownership
concentration. Concentrated corporate ownership has both costs and benefits. On the one
hand, concentrated corporate ownership might improve monitoring and therefore increase
firm value. 111 On the other hand, if ownership is too concentrated, large investors might

108. Easterbrook, supra note 12, at 89-90 (“There must be some effort to verify that the models’
predictions describe the world. Efforts to verify the assessments provided by the agency models have been few
and unsatisfactory.”) (citations omitted).
109. Id. at 89 (noting “the theoretical work is indeterminate”). Judge Easterbrook suggests the following
tests of the agency theories: “look at the relation between insiders’ trading and other forms of compensation” or,
more promising, “search for substitution between insider trading and other agency-cost-control devices,” “look
for price changes at times of changes in approaches to insider trading,” examine “[w]hat happens when insider
trading is detected at a given firm and prosecuted[.]” Id. at 96-97. Easterbrook cautions, however, that “[i]t
would be foolish to put too much confidence in these tests.” Id. at 97.
110. Id.
111. See generally Bhide, supra note 68 (stressing the positive role of large shareholders in corporate
governance); Harold Demsetz, Corporate Control, Insider Trading, and Rates of Return, 76 AM. ECON. REV.
313 (1986) (arguing that large shareholders play an important role in corporate monitoring); Jensen & Meckling,
supra note 11, at 343-49 (discussing the incentive effects of managerial (inside) ownership); Andrei Shleifer &
Robert W. Vishny, Large Shareholders and Corporate Control, 94 J. POL. ECON. 461 (1986) (presenting a
theoretical model showing that large shareholders may sometimes monitor managers and thereby increase firm
value).
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2007] Insider Trading Laws and Stock Markets Around the World 257

be insufficiently diversified and firms might find it difficult to raise equity finance. 112
Professor Maug presents a formal model in which insider trading might increase
ownership concentration and agency costs. He shows that, under some circumstances,
countries with more lax insider trading laws will have more concentrated corporate
ownership. 113 In his mathematical model, there are three relevant parties: managers,
large/dominant shareholders, and small shareholders. Large shareholders have two
choices: (1) they may monitor managers and thereby mitigate agency costs, which
benefits minority shareholders and increases corporate value, or (2) they may collude
with managers and expropriate private benefits at the expense of the minority
shareholders and corporate value. Insider trading law comes into play in the model in the
following way. Large shareholders are more likely to monitor managers and company
performance (option 1) when insider trading is illegal. In this manner, banning insider
trading aligns the interests of dominant and minority shareholders. In contrast, when
insider trading is not illegal, managers may bribe large shareholders not to monitor them
by sharing inside information on which large shareholders may profitably trade (option
2). Thus, when insider trading is legal, insider trading profits are an opportunity cost of
monitoring for large shareholders. If these profits are sufficiently high, dominant
shareholders will forego monitoring altogether and collude with managers “to conceal
adverse information and protect managers’ private benefits of control” as well as their
own trading profits. 114 As a result, minority investors will be more reluctant to invest in
corporate shares when insider trading legislation is weak because the risk of
expropriation by managers and dominant shareholders is high and therefore equity
ownership will be more concentrated. 115
In cross-country comparisons, Professors La Porta et al. find that countries with
weaker investor legal protections tend to have more concentrated corporate ownership.116
Professors La Porta et al. propose two reasons for this finding:
First, large, or even dominant, shareholders who monitor the managers might
need to own more capital, ceteris paribus, to exercise their control rights and
thus to avoid being expropriated by the managers. . . . Second, when they are
poorly protected, small investors might be willing to buy corporate shares only
at such low prices that make it unattractive for corporations to issue new shares
to the public. Such low demand for corporate shares by minority investors

112. La Porta et al., Law and Finance, supra note 8, at 1151.

113. Ernst Maug, Insider Trading Legislation and Corporate Governance, 46 EUR. ECON. REV. 1569
(2002).
114. Id. at 1585. Another condition is that the stock market is sufficiently liquid. Id. at 1583.
115. Professor Maug argues that insider trading legislation is “a prerequisite for dispersed ownership and
liquid public markets.” Id. at 1588; see also Ausubel, supra note 13, at 1023 (presenting a theoretical model in
which insider trading might reduce outsiders’ willingness to participate in the stock market and showing that a
“disclose or abstain rule” increases investor confidence, defined as “the rational belief . . . that their return on
investment is not being diluted by insiders’ trading”). But see Brian R. Cheffins, Does Law Matter?: The
Separation of Ownership and Control in the United Kingdom, 30 J. LEGAL STUD. 459, 460 (2001) (arguing that
“a highly specific set of laws governing companies and financial markets does not need to be in place for
[dispersed equity ownership] to become predominant,” as long as “alternative institutional structures can
perform the function the ‘law matters’ thesis implies the legal system needs to play”).
116. La Porta et al., Law and Finance, supra note 8, at 1152.
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258 The Journal of Corporation Law [Winter

would indirectly stimulate ownership concentration. . . . [W]ith poor investor

protection, ownership concentration becomes a substitute for legal protection,
because only large shareholders can hope to receive a return on their
investment. 117
The fact that countries with weaker investor protection tend to have more
concentrated ownership alone does not imply that agency costs are greater in countries
with weaker investor protections or that agency costs are lower in countries with stronger
investor protections, since ownership structure might be an efficient and/or endogenous
adaptation to the legal environment. 118 However, it is at least consistent with such an
interpretation.
Synthesizing Professor La Porta et al.’s findings with Professor Maug’s theorizing
suggests that if prohibiting insider trading is a form of investor protection and, in
particular, if ownership concentration is a way of dealing with agency costs, ceteris
paribus, ownership will tend to be more concentrated in countries with relatively lax
insider trading laws, if insider trading increases agency costs. This is the first testable
hypothesis.
Hypothesis 1 (H1): Countries with tougher insider trading laws have more
outside ownership (greater ownership dispersion). Conversely, countries with
weaker insider trading laws have more concentrated ownership.
But, as with Professor La Porta et al.’s results, even if the evidence strongly supports
the hypothesis, there will be some ambiguity of interpretation. In particular, finding an
inverse relationship between insider trading laws and ownership concentration does not
necessarily imply that insider trading is costly to the firm. Concentrated ownership may
be an endogenous mechanism for controlling agency costs and insider trading profits
might be a way to compensate large investors for assuming undiversified positions and
engaging in valuable corporate monitoring. 119

B. Insider Trading Law and the Information Content of Stock Prices

One’s view of how the market for corporate information works is likely to influence
one’s perspective on the effect of insider trading on stock price accuracy. Thus,
opponents and proponents of insider trading regulation seem to have conflicting
understandings of how the market for corporate information works (or should work).
Opponents of insider trading laws tend to focus on intra-firm information markets, while
proponents of regulation tend to look beyond the firm to the broader market context.120
The relevant policy inquiry for the first group is whether the property right in corporate
information should be assigned to insiders or to the firm (shareholders). 121 In contrast,

117. Id. at 1145.

118. Id.
119. See Bhide, supra note 68, at 43; Demsetz, supra note 111, at 315.
120. Goshen & Parchomovsky, supra note 39, at 1232 (arguing that some “Law and Economics scholars
have limited the list of potential entitlement holders to two: the managers and the shareholders . . . . [T]he scope
of the inquiry has been restricted to the boundaries of the firm”). They contrast “insider-based information
market” with “analyst-based information market.” Id. at 1237.
121. As we have seen, opponents of insider trading regulation favor either assigning this property right to
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2007] Insider Trading Laws and Stock Markets Around the World 259

the second group takes a more comprehensive view of the market for corporate
information and sees strong public good features in corporate information. 122
Professors Goshen and Parkomovsky, proponents of insider trading regulation, posit
four types of participants in the capital market: insiders, information traders (or analysts),
liquidity traders, and noise traders, which they define as follows:
Insiders have access to inside information due to their proximity to the firm.
They also have the knowledge and ability to evaluate this information and to
price it.
Information traders, the second group, lack access to inside information, but
are willing and able to devote resources to gathering and analyzing information
as a basis for their trading. . . .
[L]iquidity traders, [do] not collect and evaluate information; rather, their
investment reflects their individual allocation of resources between savings and
consumption. . . . [I]f rational, [they] will follow a strategy of buying and
holding a portfolio of shares.
Finally, noise traders . . . act irrationally, following different methods of
investment either as individuals or as a group. Noise traders often believe that
they are in possession of valuable information and invest as if they are
information traders. In such cases, other market participants cannot separate
noise traders from true information traders. 123
Only trading by insiders and information traders (stock market analysts) is likely to
enhance stock price accuracy. Both of these groups utilize the information that they have
in order to profit from a divergence between a stock’s true value and its current market
price. 124 They buy when the stock is undervalued, causing its price to rise, and they sell
when the stock is overvalued, causing its price to fall. 125 In this manner, both insiders
and information traders improve stock price accuracy.
It should be fairly obvious why insiders’ trading might enhance stock price
accuracy. They are privy to firm-specific information before it is disclosed to the public.
When they have material firm-specific information that nobody else has, they are the first
to perceive and to trade on such information. Their trading moves the stock price in the
correct direction, as other market participants infer the existence of new information by
observing trading volume and price movements. 126 Information traders, who compete
with inside traders, also enhance stock price accuracy. Unlike insiders, however, they are

insiders or relegating allocation of this right to private contract, with such allocation to be determined on a firm
by firm basis.
122. See, e.g., Goshen & Parchomovsky, supra note 39, at 1258 (describing the public good attributes of
corporate information).
123. Id. at 1237-38.
124. Id. at 1238-39.
125. Id. at 1239.
126. See Gilson & Kraakman, supra note 59, at 572-79 (describing how investors might infer the nature of
the inside information by observing trading volume or price movements, particularly if they are able to infer the
identity of the inside traders). See generally MANNE, supra note 3, at 86-90 (describing how insider trading
moves the stock price in the “correct” direction).
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260 The Journal of Corporation Law [Winter

not privy to firm-specific information before it is publicly disclosed. Instead, they invest
time and resources in discovering and analyzing general market information and firm-
specific information. 127 Their analysis of this information enables them to value a stock
and to determine whether its current market price diverges from their estimated
valuation. 128 The profits that informed traders earn from trading against less informed
parties give them the incentive to conduct research and analysis. 129
When insider trading is legal, informed traders are at a clear disadvantage relative to
insiders, who will systematically beat them. 130 The amount of trading by informed
traders is, according to Professors Goshen and Parchomovsky’s model, therefore,
inversely related to the amount of insider trading. When insider trading is legal,
information traders will reap a lower return on their investment in information gathering
and analysis and therefore conduct less of both. Thus, Professors Goshen and
Parchomovsky expect insider trading to stifle the development of an analyst market. 131 In
contrast, if “insider trading is illegal, ‘a competitive analysts’ market will form,”
according to Professors Goshen and Parchomovsky. 132 “This substitution effect between
insiders and analysts is the key to understanding the ban on insider trading.” 133 The
policy question that naturally emerges is whether the government should favor one group
(analysts versus insiders) over the other in setting insider trading policy. For Professors
Goshen and Parchomovsky, this inquiry essentially boils down to: “[W]hich group—
insiders or analysts—is better able to” promote price accuracy? 134
Some proponents of insider trading regulation, including Professors Goshen and
Parchomovsky, argue that analyst trading yields more efficient stock prices than insider
trading, since informed traders are more adept than insiders at pricing both firm-specific
and general market information. 135 There is considerable support for this position in the
finance literature. Finance scholars have long noted the superiority of (non-insider)
informed traders relative to insiders in promoting efficient stock prices. 136 Presumably,

127. Goshen & Parchomovsky, supra note 39, at 1237-38.

128. Id.
129. See Michael J. Fishman & Kathleen M. Hagerty, Insider Trading and the Efficiency of Stock Prices,
23 RAND J. ECON. 106 (1992) (presenting a formal model of the effect of insider trading on informed traders’
incentives to acquire information and trade); see also Jhinyoung Shin, The Optimal Regulation of Insider
Trading, 5 J. FIN. INTERMEDIATION 49, 59-61 (1996) (showing the effect of insider trading on market
professionals’ trading profits).
130. Goshen & Parchomovsky, supra note 39, at 1240-41.
131. Id. at 1241-42.
132. Id. at 1243; see also Fishman & Hagerty, supra note 129 (presenting an economic model of the effect
of insider trading on the degree of competition in the market for information, where the competitive parties are
insiders and informed outsiders); Shin, supra note 129, at 53-55 (modeling the role of insider trading regulation
in promoting competition between market professionals (informed traders) and insiders). For empirical
evidence that supports this proposition, see Bushman et al., supra note 77 (finding, using cross-country data,
that analyst participation increases after countries initially enforce their insider trading laws).
133. Goshen & Parchomovsky, supra note 39, at 1243.
134. Id. at 1243.
135. See, e.g., id. at 1246-51.
136. See, e.g., Kenneth R. French & Richard Roll, Stock Return Variances: The Arrival of Information and
the Reaction of Trades, 17 J. FIN. ECON. 5 (1986); Sanford Grossman, On the Efficiency of Competitive Stock
Markets Where Traders Have Diverse Information, 31 J. FIN. 573 (1976); Randall Morck et al., The Information
Content of Stock Markets: Why Do Emerging Markets Have Synchronous Stock Price Movements?, 58 J. FIN.
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2007] Insider Trading Laws and Stock Markets Around the World 261

informed investors’ trading generates more informative stock prices than insiders’
trading, because the external market for information is more competitive than the internal
information market. 137 If it is true that analyst (informed) trading yields more efficient
price discovery than insider trading, stock prices will be less informative when insider
trading is legal, since there will be less informed trading when insiders may freely trade
on the basis of private information. This leads to the second testable hypothesis.
Hypothesis 2 (H2): Countries with more stringent insider trading laws have
more accurate stock prices. Conversely, countries with more lax insider trading
laws have less accurate stock prices.

C. Insider Trading Law and Liquidity

Opponents of insider trading regulation believe either that insider trading is not
detrimental to stock market liquidity or that any harmful impact that it might have on
liquidity is offset by other benefits. In contrast, proponents of insider trading regulation
believe insider trading compromises stock market liquidity, without offering sufficient
offsetting benefits, if any. Insider trading might adversely affect liquidity through at least
two channels: (1) by raising the transaction costs of trading, and (2) by reducing the
number of informed traders, who provide liquidity to the stock market.
The first way in which insider trading might reduce stock market liquidity is by
raising the transaction costs of trading. Some market microstructure studies in the finance
literature show that a high degree of asymmetric information among traders can lead to
greater transaction costs in trading, thus compromising market liquidity. 138 Market
makers generally subsidize their trading losses to better informed traders by increasing
the bid-ask spread, which is the difference between the price at which they are willing to
sell (offer) and the price at which they are willing to buy (bid) a stock. 139 The greater the
degree of asymmetric information, the greater the bid-ask spread. This increase in the
bid-ask spread means that transaction costs of trading are higher, and therefore stock
market liquidity is lower. 140 Since insider trading is the most extreme form of firm-
specific asymmetric information, this logic suggests that it should have a greater adverse
effect on stock market liquidity than other types of informed trading, 141 because market

ECON. 215 (2000); Richard Roll, R2, 43 J. FIN. 541 (1988).

137. Goshen & Parchomovsky, supra note 39, at 1250-51 and corresponding notes.
138. See, e.g., Thomas E. Copeland & Dan Galai, Information Effects on the Bid-Ask Spread, 38 J. FIN
1457 (1983); Lawrence R. Glosten & Lawrence E. Harris, Estimating the Components of the Bid/Ask Spread, 21
J. FIN. ECON. 123 (1988); Hayne Leland, Insider Trading: Should it be Prohibited?, 100 J. POL. ECON. 859
(1992); H. Nejat Seyhun, Insiders’ Profits, Costs of Trading, and Market Efficiency, 16 J. FIN. ECON. 189
(1986). This work builds on Akerlof’s original insight that markets malfunction in the presence of asymmetric
information and, in extreme cases, may break down entirely. Akerlof, supra note 72.
139. See sources cited supra note 138.
140. See, e.g., Hans R. Stoll, Inferring the Components of the Bid-Ask Spread: Theory and Empirical Tests,
44 J. FIN. 115, 132 (1989) (finding that forty-three percent of the bid-ask spread of NASDAQ/National Market
System stocks is due to adverse information costs).
141. See, e.g., Goshen & Parchomovsky, supra note 39, at 1252.
The uninformed market maker faces the problem of asymmetric information when trading either
against analysts or against insiders; both groups have an information edge. However, trading by
insiders imposes much greater risk on the uninformed market maker. Insiders, due to their
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262 The Journal of Corporation Law [Winter

makers will raise bid-ask spreads to reflect the possibility that they are trading against
more informed corporate insiders. 142
The second way insider trading might reduce stock market liquidity is by reducing
competition in the market for information. As discussed above, allowing insiders to trade
on private information gives them a short-term monopoly over an important class of
valuable information and, therefore, a monopoly over the trading profits enabled by that
information. 143 The inability to compete successfully in the market for relevant
information causes informed traders (analysts) to exit the market, leading to lower trading
volume, since informed traders provide liquidity to the market. 144 Informed traders are
not expected to exit the market entirely because they do have an informational advantage
relative to market makers, but this advantage is smaller than the insiders’ informational
advantage relative to market makers. Consequently, informed trading in a stock market in
which insider trading is illegal yields lower transaction costs than insider trading in a
stock market in which insider trading is legal. 145 Hence follows the third testable
hypothesis.
Hypothesis 3 (H3): Countries with more stringent insider trading laws have
more liquid stock markets. Conversely, countries with more lax insider trading
laws have less liquid stock markets.
Thus Part V will examine empirically the following three hypotheses.

Hypothesis 1 (H1) Equity ownership is more dispersed (i.e., less concentrated)

when insider trading laws are more stringent.
Hypothesis 2 (H2) Stock prices are more informative when insider trading laws
are more stringent.
Hypothesis 3 (H3) The stock market is more liquid when insider trading laws are
more stringent.

But before I turn to the empirical tests in the next Part, I describe the data.

exclusivity over inside information, can manipulate the timing and volume of their trades, a fact
which increases the risk of the uninformed market maker trading against them.
Id.
142. See supra note 138 and accompanying text.
143. See Fishman & Hagerty, supra note 129; Georgakopoulos, supra note 70; Goshen & Parchomovksy,
supra note 39, at 1260.
144. Bushman et al., supra note 77, at 36; Georgakopoulos, supra note 70; Goshen & Parchomovksy, supra
note 39.
145. See, e.g., Goshen & Parchomovsky, supra note 39, at 1252.
[A]nalysts, even when enjoying an informational advantage, will always hold diverging opinions
as to the exact impact of the information on stock prices, and their trade orders will therefore
diverge from one another. This, in turn, reduces the risk faced by the uninformed market maker.
In addition, because analysts face competition from other analysts, they cannot manipulate or time
their orders. Thus, trading by analysts presents the uninformed market maker with a much lower
risk relative to trading by insiders.
Id.
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2007] Insider Trading Laws and Stock Markets Around the World 263

IV. DESCRIPTION OF THE DATA

My sample consists of stock market and other economic data from a cross-section of
thirty-three countries. The countries vary along several important dimensions, including
the efficiency, transparency and regulation of their stock markets, their corporate laws
and corporate governance structures, their legal traditions, and the quality of their law
enforcement and other institutions. The stock markets in the sample range from long-
established and highly developed stock markets to newly emerging stock markets. Some
of the markets have relatively strong securities (that is, disclosure and antifraud) laws,
and others have relatively lax securities laws. They also vary in the strength of their
insider trading laws and enforcement mechanisms.

A. Data Sources

1. The Dependent Variables

Testing the three hypotheses requires measures of ownership dispersion, stock price
informativeness, and stock market liquidity. These measures come from several sources.
First, the ownership data come from Professors La Porta et al. 146 They define ownership
concentration as the average ownership concentration of the three largest shareholders in
the ten largest private non-financial firms in the economy as of the mid-1990s. 147 I define
ownership dispersion as one minus Professors La Porta et al.’s ownership concentration
measure. Thus defined, ownership dispersion is the average fraction of shares owned by
all shareholders in the ten largest private, non-financial firms in the economy, excluding
the three largest shareholders in each of these firms. This ownership dispersion measure
is admittedly problematic. I use Professors La Porta et al.’s ownership measure because
there is no better comparative measure available. Nevertheless, I recognize its serious
flaws. The use of only ten companies from the tail of the distribution to characterize
ownership concentration in the economy at large is questionable, and the decision to
determine concentration within those companies by looking at the holdings of three
shareholders is somewhat arbitrary. On the other hand, in many countries the ten largest
companies constitute the bulk of stock market capitalization (value). Moreover, in many
countries outside the United States, three or fewer shareholders hold most of a company’s
outstanding shares. Nevertheless, for these reasons, as well as the ambiguity of
hypothesis-consistent results pointed out above, the test of H1 is necessarily a weak test.
Second, Professors Morck, Yeung, and Yu’s measure of stock-price synchronicity is
a proxy for stock price informativeness. 148 This variable measures the degree to which
the stock prices of different firms moved together in an average week in 1995. Greater
synchronicity (co-movement) of stock returns implies that a larger proportion of stock
return variation is explained by market-wide than by firm-specific factors, suggesting that
stock prices are less informative of firm-specific strengths and weaknesses.
Information on stock market liquidity comes from the International Finance

146. La Porta et al., Law and Finance, supra note 8, at 1145-51.

147. Id. at 1145-46.
148. Morck et al., supra note 136.
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264 The Journal of Corporation Law [Winter

Corporation’s (IFC) 1996 Emerging Stock Markets Factbook. 149 The IFC reports stock
market turnover, a common measure of liquidity, which is the ratio of the total value
traded to total stock market capitalization. 150 For each country in the sample, I use the
average turnover ratio from 1991 through 1995. Illustration 4 describes the dependent
variables.

2. Insider Trading Regulation and Enforcement

a. Insider Trading Law Variables

Since most countries with stock exchanges (and all of the countries in the sample)
forbid corporate insiders to trade on the basis of price-sensitive, private information, I do
not code this common/basic prohibition. 151 I code four elements of countries’ insider
trading laws as they existed as of the mid-1990s on the basis of a priori reasoning about
which elements of insider trading laws are substantively (or, doctrinally) significant, with
an emphasis on deterrence. 152 Taken together, these four elements of each country’s

149. INTERNATIONAL FINANCE CORP., EMERGING STOCK MARKETS FACTBOOK (1996) [hereinafter
EMERGING MARKETS FACTBOOK].
150. For other common measures of stock market liquidity, see generally David A. Lesmond, Liquidity of
Emerging Markets, 77 J. FIN. ECON. 411 (2005) (comparing price-based liquidity measures to volume-based
liquidity measures); Geert Bekaert, Campbell R. Harvey & Christian Lundblad, Liquidity and Expected
Returns: Lessons from Emerging Markets (Nat’l Bureau of Econ. Research, Working Paper No. W11413, 2005)
(using transformation of the proportion of zero daily firm returns).
151. Price-sensitive information is generally defined as information that would significantly affect the
stock’s price. The standards for determining whether information is price-sensitive vary across countries and
contexts, as Euronext, the pan-European Exchange, notes:
Whether or not information is price sensitive depends on factors specific to each individual
company, such as its size, recent history and sector of activity. Market sentiment can also have a
marked effect on price sensitivity. Given these considerations, it is not possible to produce one
definition of price sensitivity that takes all of these factors into account. For the same reason, it is
impossible to indicate what percentage increase or decrease in a share price qualifies as a
‘significant impact’ on prices.
EURONEXT AMSTERDAM, PRICE-SENSITIVE INFORMATION 9 (2003),
http://www.euronext.com/vgn/images/portal/cit_53424/55/32/66175905901789_OA1_Price-sens.pdf. .
Consequently, I do not code price-sensitivity (materiality) standards because doing so would introduce
excessive subjectivity into my measure of insider trading law. I do not code scienter requirements and fiduciary
standards for the same reason. At any rate, the requirement of a fiduciary nexus between the source of the
information and the person engaging in insider trading is virtually unique to common law countries, and
particularly the United States. See, e.g., Dirks v. SEC, 463 U.S. 646, 654 (1983); Chirarella v. United States,
445 U.S. 222, 232 (1980). Finally, I also do not code the misappropriation theory of liability for insider trading.
See United States v. O’Hagan, 521 U.S. 642 (1997). However, one study does code misappropriation liability in
addition to my insider trading law index. Duncan Herrington, Insider Trading Enforcement and Market
Performance (May 3, 2004) (unpublished manuscript, on file with author).
152. See, e.g., STEPHEN M. BAINBRIDGE, SECURITIES LAW: INSIDER TRADING (1999); ROBERT CLARK,
CORPORATE LAW (1986); WILLIAM H. PAINTER, FEDERAL REGULATION OF INSIDER TRADING (1968); WILLIAM
K.S. WANG & MARC I. STEINBERG, INSIDER TRADING (1997); Brudney, supra note 1; Reinier Kraakman, The
Legal Theory of Insider Trading Regulation in the United States, in EUROPEAN INSIDER DEALING 47, 50 (Klaus
J. Hopt & Eddy. Wymeersch eds., 1991). My sources of information about countries’ insider trading laws are
INSIDER TRADING: THE LAWS OF EUROPE, THE UNITED STATES, AND JAPAN (Emmanuel Gaillard ed., 1992) and
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insider trading law constitute the overall insider trading law measure for that country.
The first element, Tipping, equals one if a corporate insider is liable for giving price-
sensitive, private information to an outsider (so-called “tippee” 153 ) and encouraging her
to trade, and zero otherwise. Forbidding a corporate insider to trade on inside
information, while at the same time allowing her to tip outsiders who subsequently trade,
is equivalent to allowing the insider to trade on her own behalf. 154 In some countries,
insiders are liable for tipping outsiders, while those whom they have tipped are not liable
for their subsequent trading on such information. 155 A prohibition on trading by insiders
is arguably less meaningful if insiders can tip outsiders with impunity. Most countries
that prohibit insider trading also prohibit insiders’ tipping of outsiders. 156
A tippee is a third person (a corporate outsider) who has been tipped about material,
non-public information by an insider (a director, manager, employee, etc.). The second
element, Tippee, equals one if tippees, like corporate insiders, are forbidden to trade on
price-sensitive, private information, and zero otherwise. 157
The third element, Damages, equals one if the potential monetary penalty for
violating a country’s insider trading law is greater than the illicit insider trading profits,
and zero otherwise. If the potential monetary penalty is less than the expected profits
from insider trading, the insider trading law’s deterrent effect is weaker, holding constant
the probability of detection. 158
The fourth and final element, Criminal, equals one if insider trading is a criminal
offense in the country, and zero otherwise. In some cases, criminal sanctions might yield
more efficient deterrence than monetary sanctions. 159 One case is where the likelihood of
detection is very low and the optimal monetary penalty is thus greater than the violator’s
net wealth. In such a case, criminal prosecution leading to imprisonment or other non-
monetary sanctions might yield optimal deterrence. 160 Criminal sanctions might also
have the opposite effect, however, since in most jurisdictions criminal prosecution
requires a higher standard of proof. A higher burden of proof reduces the probability of
successful prosecution and increases enforcement costs. This should make finding a

INTERNATIONAL INSIDER DEALING (Mark Stamp & Carson Welsh eds., 1996).
153. A tippee is an outsider who has received a “heads-up” (or tip) about price-sensitive, private
information by a corporate insider (a director, manager, employee, advisor, etc.).
154. As Professor Brudney notes, “[T]he insider, by giving the information out selectively, is in effect
selling the information to its recipient for cash, reciprocal information, or other things of value for himself,
including possibly prestige or status or the like.” Brudney, supra note 1, at 348.
155. See infra Illustration 4.
156. See infra Illustration 4.
157. “[R]eceipt of the information by one who is such a selected beneficiary taints the recipient so that he
should no more be entitled to use it in trading than was the donor.” Brudney, supra note 1, at 348.
158. Of course, the probability of detection is not constant; some countries have better detection technology
than others. When the probability of detection is very low, the monetary penalty must be greater than the
insider’s expected gain to yield the efficient level of deterrence. Michael P. Dooley, Enforcement of Insider
Trading Restrictions, 66 VA. L. REV. 1, 26 (1980); Easterbrook, supra note 12, at 93-94. See generally A.
Mitchell Polinsky & Steven Shavell, The Economic Theory of Public Enforcement of Law, 38 J. ECON. LIT. 45
(2000) (modeling mechanisms for efficient public enforcement of laws). In fact, very high monetary sanctions
might be desirable if they accommodate low detection probabilities and thus economize on enforcement costs.
Id.
159. Polinsky & Shavell, supra note 158.
160. Easterbrook, supra note 12, at 94.
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266 The Journal of Corporation Law [Winter

statistically significant coefficient on Criminal unlikely. The preceding analysis is true

only if criminal sanctions displace civil sanctions. However, if criminal sanctions are
imposed in conjunction with civil sanctions, unless they are never used, they should have
a deterrent effect, if only because the cost of defending a criminal prosecution is a
sanction whether or not the crime is proven. Insider trading is both a criminal and a civil
offense in several jurisdictions.
A country’s insider trading prohibition can be characterized along two broad
(although not exhaustive) dimensions: the scope of the activities that it prohibits and the
sanctions for violating it. I thus create two sub-indices of insider trading law, which
correspond roughly to these separate aspects. The first sub-index, Scope, is the sum of
Tipping and Tippee. The insider trading prohibition is broader if it prohibits insiders both
from trading and from tipping third parties. It is broader still if it also forbids tippees to
trade. The second sub-index, Sanction, is the sum of Damages and Criminal and is a
rough proxy for the expected cost of violating a country’s insider trading laws. Potential
violators are assumed to compare the expected benefits to the expected costs of breaking
the law, a reasonable assumption, particularly when the motivation for the crime is
financial gain. 161 Holding constant the expected benefit, the greater the expected cost, the
greater the law’s deterrent effect. Since I do not have data on the expected benefits of
violating insider trading laws, my analysis implicitly assumes that they are constant
within and across countries. This assumption is less reasonable than the deterrence
assumption because the incidence of and profits from insider trading may vary
systematically with legal and institutional differences across the countries and contexts
within which such trading occurs. 162 It is expected, though not guaranteed, that the
failure of this assumption will add noise to the analysis rather than systematically bias it.
I also create an aggregate insider trading law index, IT Law, which is the sum of the
two sub-indices, Scope and Sanction. Abstracting from enforcement, an IT Law score of
zero represents the most lax insider trading regime, while an IT Law score of four
represents the most prohibitive insider trading regime. Illustration 4 describes the insider
trading law variables in detail.

b. Enforcement Environment
In addition to the potential criminal or monetary sanctions for violating insider
trading laws, their deterrent effect also depends on the probability (actual or perceived)
that they will be enforced. 163 In this regard, two dimensions of enforcement are relevant:
actual (or past) enforcement and enforcement power (or potential), both of which
potential violators should consider in deciding whether to risk violating the law.

161. See Gary S. Becker, Crime and Punishment: An Economic Approach, 76 J. POL. ECON. 169 (1968)
(using an economic analysis to develop policies on crime); Polinsky & Shavell, supra note 158.
162. See, e.g., Arturo Bris, Do Insider Trading Laws Work?, 11 EUR. FIN. MGMT. 267 (2005) (measuring
the profitability of insider trading across countries); Abraham Ackerman & Ernst Maug, Insider Trading
Legislation and Acquisition Announcements: Do Laws Matter? (2005) (unpublished manuscript, on file with
author) (also measuring the profitability of insider trading across countries).
163. See, e.g., FRANKLIN E. ZIMRING & GORDON J. HAWKINS, DETERRENCE: THE LEGAL THREAT IN CRIME
CONTROL 160-63 (University of Chicago Press 1973) (explaining that as the risk of being caught goes up, the
rate of crime goes down).
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2007] Insider Trading Laws and Stock Markets Around the World 267

Although there is little systematic information on actual enforcement or enforcement

power across countries, a few rough proxies exist. For actual enforcement, I use
information on countries’ enforcement histories from Professors Bhattacharya and
Daouk. 164 Their enforcement information consists of the year in which a country
enforced its insider trading rules for the first time. I convert this information into the
variable Enforced by 1994, which equals one if a country had enforced its insider trading
rules for the first time by 1994 and zero otherwise. I choose 1994 as the cut-off date
because the dependent variables (ownership dispersion, stock price synchronicity, and
stock market turnover) come from the mid-1990s and because the insider trading law
indices are based on the sample countries’ insider trading rules as they existed around
that time. 165
For enforcement power, I construct two separate measures: public enforcement
power and private enforcement power. My division of enforcement power into public and
private dimensions is inspired by the theoretical inquiry about who should enforce a
particular public law. 166 To construct public enforcement power, I rely on securities
regulatory information compiled by Professors La Porta et al. based on a survey of
domestic lawyers concerning, among other things, the attributes and investigative powers
of the securities market supervisor. 167 The supervisor’s attributes include four elements
that address the supervisor’s independence, focus and power: (1) supervisor appointment
process; (2) supervisor tenure; (3) focus of supervisor’s activities; and (4) supervisor’s
rulemaking authority. Professors La Porta et al. compute the supervisor characteristics
index as the mean of these four attributes. 168 A higher mean signifies that the securities
market supervisor is more independent of the political process and has greater authority.
Professors La Porta et al. also construct an index of the supervisor’s investigative powers,
which equals the mean of the supervisor’s power to command documents and to

164. Bhattacharya & Daouk, supra note 72.

165. Both the content and the enforcement of these laws might have changed in many of these countries
since 1994. See Herrington, supra note 151, for more recent measures of insider trading rules that build upon
my original insider trading law index and enforcement across countries. Herrington’s results confirm my
original findings.
166. See, e.g., JAMES M. LANDIS, THE ADMINISTRATIVE PROCESS (Yale University Press 1938); Edward
Glaeser et al., Coase versus the Coasians, 116 Q.J. ECON. 853 (2001); Jonathan R. Hay & Andrei Shleifer,
Private Enforcement of Public Laws: A Theory of Legal Reform, 88 AM. ECON. REV. 398 (1998); La Porta et
al., What Works?, supra note 8; Shavell & Polinsky, supra note 158. La Porta et al. address the relative
advantages and disadvantages of private and public enforcement of securities laws. Under their public
enforcement hypothesis,
[p]ublic enforcement might work because the enforcer is independent and focused and thus can
regulate markets free from political interference, because the enforcer can introduce regulations
of market participants, because it can secure information from issuers and market participants—
through subpoena, discovery, or other means—more effectively than private plaintiffs, or because
it can impose sanctions.
La Porta et al., What Works?, supra note 8, at 3. Under their private enforcement hypothesis, the main
advantage of securities laws is to reduce the costs of private contracting by mandating disclosure and
delineating standards of liability for issuers and intermediaries. Id. at 2.
167. La Porta et al., What Works?, supra note 8. I am implicitly assuming that the sample countries’
relative rankings in terms of these measures have not changed significantly between the mid-1990s and the time
when La Porta et al. conducted their survey, which was around 2002-2003.
168. La Porta et al., What Works?, supra note 8.
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268 The Journal of Corporation Law [Winter

subpoena the testimony of witnesses during investigations of violations of the country’s

securities laws. 169 Using these two measures, I create the variable Public Enforcement
Power as the mean of Professors La Porta et al.’s supervisor characteristics and
investigative powers indices. 170 Illustration 4 describes Public Enforcement Power and
its components in greater detail.
To construct a measure of private enforcement power, I first consider whether
(“injured” 171 ) investors may bring private suits against alleged transgressors of the
country’s insider trading laws. A private right of action gives particular investors (usually
those who traded contemporaneously with the insider) or the corporation access to the
courts to sue insiders for trading on inside information. For example, some jurisdictions
give individual investors the right to sue for monetary compensation for their alleged
trading losses because they have traded at the opposite end of an insider transaction.
Private rights to sue might increase investors’ incentives to enforce the country’s insider
trading laws independent of any action taken by the relevant regulatory authority. 172
Therefore, holding constant the reliability and efficiency of the court system, the
availability of a private right of action might render the law more effective by giving
private parties an incentive to enforce it. The variable Private Right equals one if such a
right exists, and zero otherwise. Private litigation is meaningful only to the extent that the
judicial system is reliable and efficient, however. 173 Thus, I construct an index , Private
Enforcement Power, as the product of an index of the efficiency of the judiciary 174 and
Private Right. As Professor Merritt Fox notes, however, “countries that have a private
right of action to support rules against insider trading probably have a quite different kind
of legal system in other broader regards.” 175 I address this issue by controlling for the
legal system in the regressions in Part V. Illustration 4 describes Private Enforcement
Power and its components in greater detail.

3. Additional Economic, Legal and Institutional Variables

To isolate the relationship between insider trading regulation and the dependent
variables, in the regression analyses below, I control for several additional factors that
prior research suggests are also relevant to financial market structure and performance.

169. Id.
170. Id. at 15-16.
171. There is some theoretical debate about whether individual investors are “harmed” by insider trading in
public stock markets. Some scholars argue that it is practically impossible to identify individuals or groups
harmed by insider trading, since any cost of trading against better informed insiders is distributed across all
investors. See, e.g., William Carney, Signaling and Causation in Insider Trading, 36 CATH. U. L. REV. 863
(1987) (stating the above proposition); William Wang, Trading on Material Nonpublic Information on
Impersonal Stock Markets: Who is Harmed, and Who Can Sue Whom Under SEC Rule 10b-5?, 54 S. CAL. L.
REV. 1217 (1981) (same). At any rate, in the United States, “it has long been clear that persons who traded
contemporaneously with an inside trader have a private cause of action.” STEPHEN M. BAINBRIDGE, SECURITIES
LAW: INSIDER TRADING 123 (1999).
172. Of course, private enforcement might be abusive or insufficient. See, e.g., Dooley, supra note 158, at
15-17 (1980); Polinsky & Shavell, supra note 158, at 45 (2000). Nevertheless, this does not change the analysis.
It merely goes to the issue of the optimal level of regulation, which is beyond the scope of this Article.
173. See, e.g., Glaeser et al., supra note 166; Hay & Shleifer, supra note 166.
174. La Porta et al., What Works?, supra note 8, at 10.
175. Private conversation with Professor Merritt Fox.
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2007] Insider Trading Laws and Stock Markets Around the World 269

First, since economic development is generally associated with greater financial market
development and better institutions and law enforcement capabilities, 176 I control for the
logarithm of per capita gross domestic product (GDP). 177 Second, since stock market
liquidity is positively associated with economic growth, 178 I control for the growth of
GDP per capita. Third, I control for anti-director rights, 179 and legal origin, 180 since prior
research demonstrates that these measures of the quality of investor legal protections
have an important bearing upon financial development. 181 In particular, prior studies find
that countries with common law legal origins tend to have greater legal protections for
investors and that both factors—common law legal origin and greater anti-director
rights—are positively associated with stock market development.
Finally, I control for disclosure, since better disclosure is associated with greater
stock market development. 182 In addition, timelier and higher quality information
disclosure should reduce insiders’ opportunity to trade profitably relative to the rest of the
market, thereby reducing their incentive to violate the law. 183 I use two measures of
disclosure quality. The first is a measure of legal disclosure requirements from Professors
La Porta et al. 184 This index, Disclosure, is an arithmetic average of five categories of
information that firms are required to include in their offering prospectuses: (1)
compensation; (2) ownership structure; (3) inside ownership; (4) irregular contracts; and
(5) related party transactions. The second measure is the quality of accounting standards,
Accounting, which ranks countries on the basis of the quality of their corporate disclosure
practices as of 1990. 185 Disclosure is a rough proxy for the strength of the involuntary
disclosure regime at the initial offering stage, while Accounting is a rough proxy for the

176. See, e.g., DOUGLAS NORTH, STRUCTURE AND CHANGE IN ECONOMIC HISTORY (1981); Rafael La
Porta et al., The Quality of Government, 15 J.L. ECON. & ORG. 222, 225-26 (1999).
177. Also, wealthier countries should have (access to) more advanced surveillance technologies to detect
insider trading violations.
178. See Raymond Atje & Boyan Jovanovic, Stock Markets and Development, 37 EUR. ECON. REV. 632
(1993); Ross Levine & Sara Zervos, Stock Markets, Banks, and Economic Growth, 88 AM. ECON. REV. 537,
546 (1998).
179. Djankov et al., Self-Dealing, supra note 8, at 28-29.
180. La Porta et al., Legal Determinants, supra note 8, at 1131-32.
181. Id. at 1149; La Porta et al., Law and Finance, supra note 8, at 1115-16.
182. See Jere R. Francis et al., The Role of Accounting and Auditing in Corporate Governance and the
Development of Financial Markets Around the World, 10 ASIA-PAC. J. ACCT. & ECON. 1 (2004); La Porta et al.,
Law and Finance, supra note 8; La Porta et al., Legal Determinants, supra note 8; La Porta et al., What Works?,
supra note 8, at 5-11.
183. Academics and lawmakers have long noted the close relationship between disclosure rules and insider
trading laws. Indeed, an important pillar of U.S. insider trading legislation is the “disclose or abstain” rule,
which requires that insiders either disclose material nonpublic information or refrain from trading on the basis
of such information. See generally Stanley Baiman & Robert E. Verrecchia, The Relation Among Capital
Markets, Financial Disclosure, Production Efficiency, and Insider Trading, 343 J. ACCT. RES. 1, 9-12 (1996)
(showing that greater voluntary disclosure reduces the extent of insider trading in a firm’s shares); Maug, supra
note 113, at 1581 n.18; Jesse M. Fried, Reducing the Profitability of Corporate Insider Trading Through
Pretrading Disclosure, 71 S. CAL. L. REV. 303 (1997) (arguing that a rule that would require insiders to disclose
their identities and intentions to trade prior to trading would reduce considerably, and perhaps even eliminate,
insider trading profits); Shin, supra note 129 (demonstrating that some restriction of insider trading combined
with minimal disclosure requirements is the optimal approach to regulating insider trading).
184. La Porta et al., Legal Determinants, supra note 8.
185. La Porta et al., Law and Finance, supra note 8.
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270 The Journal of Corporation Law [Winter

quality of periodic (post-offering) disclosure and measures firms’ actual disclosure

practices rather than legal disclosure requirements per se. 186 Illustration 4 describes all of
the control variables in detail.

B. Descriptive Statistics
Illustration 5 presents the insider trading laws and enforcement measures for the
sample countries, according to their legal origins: English common law or European civil
law. 187 Illustration 5 also presents the average of each insider trading law and
enforcement measure for each of the four legal origin groups and for all civil law
countries and all the common law countries. I present the insider trading variables for the
sample countries by their legal origins because previous research shows that corporate
and securities laws differ significantly among countries according to their legal
origins. 188 In particular, common law countries tend to have stronger investor protection
laws, especially rules prohibiting self-dealing by corporate insiders. 189 To gauge whether
this is also true for insider trading laws and enforcement, Illustration 5 computes t-test
statistics that indicate whether the average values of the insider trading law and
enforcement measures differ significantly between the civil and common law countries in
the sample.
As Illustration 5 shows, for the full sample, the overall average of the aggregate
insider trading law index, IT Law, is 2.73. The average value of IT Law is 2.91 for the
common law countries and 2.64 for the civil law countries, but this result is not
statistically significant. Looking at the components of this index, we see the average
scope of insider trading bans (Scope) is almost identical for the two groups of countries,
but there is a small difference in mean sanction threat (common law Sanction = 1.18,
while civil law Sanction = 0.86), which is significant at the 10% level. In other words, the
common law countries are somewhat more likely to be able to impose criminal sanctions
and/or multiple monetary penalties upon those who violate the country’s insider trading
laws than are the civil law countries, suggesting somewhat greater deterrence in common
law countries. This difference is, however, attributable to the fact that four civil law
countries and zero common law countries have insider trading laws with none of the
measured sanctions. The large majority of the civil law countries have sanction threats
like those of the common law countries. Thus, it would be a mistake to conclude that civil
law origin necessarily implies that the sanctions attaching to insider trading laws will be
weaker than those in common law countries. There is a similarly small, and in this case

186. In the regressions below, I report results using only Disclosure. The results do not differ if I use
Accounting rather than Disclosure.
187. The average year of enactment for the countries in the sample is 1983, which suggests that insider
trading regulation is a relatively recent phenomenon. In fact, the majority of the countries in the sample did not
have an insider trading law prior to 1988. The United States was the first country in the world to prohibit insider
trading, with an effective prohibition occurring in 1961. The next country to prohibit insider trading was
Canada, which enacted its insider trading law in 1966. The average year of the first enforcement is 1989,
roughly six years after the average year of enactment.
188. Djankov et al., Self-Dealing, supra note 8; La Porta et al., Law and Finance, supra note 8, at 1130-31;
La Porta et al., Legal Determinants, supra note 8, at 1138-39; La Porta et al., What Works?, supra note 8, at 15-
16.
189. See sources cited supra note 188.
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2007] Insider Trading Laws and Stock Markets Around the World 271

statistically insignificant, difference in the fractions of civil and common law countries
that had enforced their insider trading laws by 1994.
Turning to enforcement power, a different picture emerges. The average value of
Public (or Regulatory) Enforcement Power is 0.69 for the common law countries and
0.41 for the civil law countries, a difference that is statistically significant at the 1% level.
The average value of Private (Investor) Enforcement Power is 5.73 for the common law
countries and 1.44 for the civil law countries, which is also significant at the 1% level.
Thus, despite substantial similarity in the formal dimensions of insider trading laws, we
find, consistent with the work of Professors La Porta et al., that investors in common law
countries can expect somewhat greater protection against insider trading (and other
securities law violations) than investors in civil law countries. 190
Illustration 6 reports the averages, medians and standard deviations of the variables
that will be used in our analyses, both overall and by common law and civil law origin.
Interestingly, the average values of the three dependent variables, ownership dispersion,
stock price synchronicity, and average stock market turnover do not differ significantly
between the common law and civil law countries of the sample. There is similarly no
difference between common law and civil law countries on our two measures of
economic well-being (average wealth and average economic growth). However, the other
three control variables, anti-director rights, disclosure rules, and accounting standards do
tend to be more stringent for the common law countries in my sample than for the civil
law countries. 191
Illustration 7 presents the pair wise correlation coefficients among the variables that
are relevant to an empirical assessment of Hypotheses 1-3 (H1-H3); i.e., the dependent
variables, outside ownership, stock price synchronicity, and average stock market
turnover, and the insider trading law and enforcement measures. H1 predicts that
countries with more restrictive insider trading laws have greater ownership dispersion,
other things equal. Consistent with H1, Illustration 7 indicates that ownership dispersion
is positively and significantly correlated with the aggregate IT Law index, the sub-index
Sanction, and Enforced by 1994. The correlation coefficients range between 0.41 for IT
Law and 0.53 for Sanction. These correlations are not huge, but neither are they tiny. In
contrast, ownership dispersion is not significantly correlated with the Scope sub-
component of IT Law or with either of the enforcement power variables, Public
Enforcement Power or Private Enforcement Power. The three insignificant coefficients
are, however, of the predicted (positive) sign. Illustration 1 presents average ownership
concentration graphed against IT Law and indicates that average ownership concentration
steadily declines as IT Law increases, consistent with H1.
H2 predicts that stock prices are more informative, in that they contain a higher
degree of firm-specific information, when insider trading laws are more stringent. The
implication is that stock prices should be less synchronous (i.e., move together to a lesser
extent) in countries with stricter insider trading laws and enforcement. Thus, a negative

190. La Porta et al., Law and Finance, supra note 8; La Porta et al., Legal Determinants, supra note 8.
191. The similarity of the dependent variables between common law and civil law countries is not what the
work of La Porta et al. would lead one to expect. The significant difference on the three control variables is
consistent with their results. La Porta et al., Law and Finance, supra note 8; La Porta et al., Legal Determinants,
supra note 8.
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272 The Journal of Corporation Law [Winter

correlation between stock price synchronicity and the various insider trading law and
enforcement measures is expected. 192 Consistent with H2, Illustration 7 shows that stock
price synchronicity is negatively and significantly correlated with the aggregate IT Law
index and with its sub-indices Sanction and Scope. However, stock price synchronicity is
not significantly correlated with any of the enforcement measures, Enforced by 1994,
Public Enforcement Power or Private Enforcement Power, although these coefficients
are all of the expected (negative) sign. Illustration 2 plots average stock price
synchronicity against IT Law and shows, consistent with H2, albeit weakly, that average
stock price synchronicity is higher in countries with lower IT Law values.
Finally, H3 predicts that stock markets are more liquid in countries that have more
restrictive insider trading laws. In Illustration 7, we see that average stock market
turnover, a proxy for stock market liquidity, is positively and significantly correlated with
the sub-index Scope. However, average stock market turnover is not significantly
correlated with Sanction, the aggregate IT Law index, or with any of the three
enforcement measures, Enforced by 1994, Public Enforcement Power and Private
Enforcement Power. Moreover, the correlations between the latter two enforcement
variables and average stock market turnover are, contrary to H3, negative. Illustration 3
plots average stock market turnover against IT Law and shows that average stock market
turnover is greater in countries with higher IT Law values, consistent with H3.
Illustration 7 also reveals other relationships of interest, although they are not
directly relevant to H1-H3. In particular, it appears that countries whose formal insider
trading laws penalize insider trading more harshly, in the form of criminal or monetary
penalties, tend to allocate greater enforcement powers to both public and private
enforcers and are more likely to have actually enforced their insider trading laws by
1994. The correlation coefficients between IT Law and Enforced by 1994, Public
Enforcement Power and Private Enforcement Power, respectively, are positive and
significant at the 10% level or above. Likewise, the correlation coefficients between the
IT Law sub-index Sanction and Enforced by 1994, Public Enforcement Power and
Private Enforcement Power, respectively, are positive and significant at the 10% level or
above. Furthermore, countries that allocate greater public enforcement power also tend to
have greater private enforcement potential. The correlation coefficient between Public
Enforcement Power and Private Enforcement Power is 0.33 and is significant at the 10%
level in Illustration 7.
Finally, although Table 4 does not report correlations between the level of economic
development and the various dependent variables and insider trading law and
enforcement measures, they are noteworthy. The wealthier economies (where wealth is
measured by the log of GDP per capita) in the sample have significantly larger stock
markets (as measured by stock market capitalization). The wealthier countries also have
more diffuse equity ownership; the correlation between the log of GDP per capita and
outside ownership is 0.35 and is significant at the 5% level. In addition, the correlation
coefficient between stock price synchronicity and the log of GNP is -0.44 and is
significant at the 1% level, which means that stock prices tend to reflect more firm-
specific information in wealthier countries. In contrast, the wealthier countries in the

192. H2 predicts a negative correlation between the stringency of insider trading laws and synchronicity
because lower synchronicity implies that stock prices are more informative. See illustration supra p. 262.
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2007] Insider Trading Laws and Stock Markets Around the World 273

sample do not have significantly more liquid stock markets. Finally, the richer countries
have significantly more stringent insider trading laws by all three measures (Scope,
Sanction, and IT Law) and are more likely to have enforced those laws by 1994. 193 For
these reasons, we cannot consider H1-H3 supported without conducting a more
controlled analysis, and in the regressions below I control for wealth (log of GDP per
capita) and various additional variables.

V. REGRESSION ANALYSIS OF INSIDER TRADING LAW AND THE STOCK MARKET

Although the empirical results presented in Part IV.B are generally consistent with
the predictions of H1-H3, those results present only a partial story, for they do not control
for factors, other than the insider trading laws, which might explain the dependent
variables. It may be, for example, that if we looked at two countries with identical wealth
and accounting rules, the relationships between more stringent insider trading bans and
stock market characteristics would disappear (i.e., become statistically insignificant) or
even reverse (i.e., be significant but in the opposite direction of the Illustration 7 results).
Multivariable regression analysis is a way of controlling for this possibility. 194 The
multivariable regression model we shall use is
Y = BO + BNXN + BMXM + e
where Y is the dependent variable of interest, XN represents the various independent
variables (i.e., measures of insider trading laws and their enforcement) and XM represents
the various control variables. In the regressions below, I consider a coefficient to be
statistically significant if it is at least significant at the 10% level.

A. Insider Trading Law and Corporate Ownership

H1 predicts that countries with more stringent insider trading laws have more
dispersed equity ownership. Due to limited data availability on corporate ownership
patterns across countries, I test this hypothesis using the degree of ownership dispersion
in a country’s ten largest non-financial firms as the dependent variable in several
different multivariable regression models. The independent variables in these regressions
are measures of insider trading laws and enforcement. The insider trading law variables,
Scope and Sanction, are centered about their means to address multicollinearity. I also
include an interaction term, Scope*Sanction, which is the product of (mean-centered)
Scope and (mean-centered) Sanction. The control variables include disclosure quality,
legal origin, an index of anti-director rights, the log of GDP per capita, and the growth of
GDP per capita.
Illustration 8 reports three regression models for ownership dispersion. In Model 1,
the coefficient on Scope is positive, which is consistent with H1, but it is not statistically

193. However, public and private enforcement measures are not greater for the wealthier countries and, in
fact, Public Enforcement Power is, paradoxically, negatively correlated with the log of GDP per capita at the
5% level of significance.
194. Multiple regression is by now so familiar in the law review literature that I shall not explain it. The
reader who wants to learn more about this statistical technique may wish to consult Daniel L. Rubinfeld,
Reference Guide on Multiple Regression, in REFERENCE MANUAL ON SCIENTIFIC EVIDENCE 179-227 (2d ed.
2000), available at http://air.fjc.gov/public/pdf.nsf/lookup/sciman00.pdf$file/sciman00.pdf.
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274 The Journal of Corporation Law [Winter

significant. Thus, we cannot conclude on the basis of Model 1 that the scope of the
insider trading prohibition is associated with wider ownership dispersion. In contrast, in
Model 1, the coefficient on Sanction is 0.15 and it is statistically significant at the 1%
level and of the predicted sign, suggesting that stiffer sanctions for insider trading are
associated with less concentrated equity ownership, at least in a country’s ten largest non-
financial firms. In Model 1, the coefficients on the control variables are all
insignificant. 195
Model 1 looks only at the law on the books. If the law has not been enforced or has
been enforced only recently, regardless of what the law stipulates, it may have had little
influence on behavior. 196 Ideally, we would be able to measure the activities of the
agencies charged with enforcing insider trading laws, but I was unable to acquire such
measures for all the countries in my sample. The only measure currently available is the
relatively crude measure of whether a country’s insider trading law is a mere formality,
as indexed by whether the law was ever enforced by 1994. Thus Model 2 adds the
variable, Enforced by 1994 (described above), to the control variables of Model 1.
We see from Model 2 in Illustration 8 that a history of enforcement has effects
consistent with H1, for the coefficient on Enforced by 1994 is positive, as predicted, and
significant. Including this variable in the ownership dispersion regression does not
dampen the effect of the Sanction measure of insider trading law. Rather, the magnitude
and significance of the coefficient on Sanction is the same in Models 1 and 2. Moreover,
Model 2 explains a greater proportion of the variance of ownership dispersion among
large firms than Model 1 explains (R2 increases from 58% to 65% between Model 1 and

195. In regressions that I do not report in the Article, I regress ownership dispersion on the alternative
disclosure measures and the control variables, excluding the insider trading law indices. The coefficient on
Disclosure is positive and significant at the five-percent level. This result is consistent with what La Porta et al.
found. La Porta et al., What Works?, supra note 8, at 16. In contrast, although the coefficient on Accounting is
also positive, it is insignificant. The finding of this Article that the relationship between insider trading laws and
the dependent variables is generally stronger than the relationship between the dependent variables and
disclosure is consistent with the finding of another empirical study that disclosure is of secondary importance to
the legal rules protecting investors. Francis et al., supra note 182. But see Djankov et al., Self-Dealing, supra
note 8 (finding that disclosure rules are positively associated with stock market development across countries);
La Porta et al., What Works?, supra note 8 (same).
196. In discussing the limitations of the laws on the books as predictors of financial market development in
transition economies, Professors Gelfer, Pistor, and Raiser stress:
For the law on the books to affect financial market development . . . law enforcement must be
credible. Past experience with legal reforms suggests that where new laws were forced upon a
judicial system unfamiliar with the underlying legal tradition and were not adapted to fit the
specific local context, the effectiveness of the law suffered . . . . Trust in the law remained low
and reliable enforcement by the state’s legal institutions could not be guaranteed . . . . [T]he
quality of law enforcement is at least of equal importance to the extensiveness of the law.
Stanislaw Gelfer et al., Law and Finance in Transition Economies, 8 ECON. OF TRANSITION 325, 328 (2000)
(emphasis added). In their empirical investigation, Gelfer et al. find that the effectiveness of legal institutions is
more important to the development of financial markets in transition economies than the formal written laws.
Id. at 351-55. Thus, it is necessary to consider not only countries’ formal written laws but also the
characteristics of the institutional environment that pertain to the credibility of such laws. In the present context,
the relevant inquiry is twofold: (1) whether a country has an established history of enforcing its insider-trading
law and (2) insider trading enforcement history aside, the quality of the available mechanisms for enforcement
of the country’s insider trading and securities laws.
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2007] Insider Trading Laws and Stock Markets Around the World 275

Model 2).
Finally, Model 3 adds controls for two potential enforcement measures, Public
Enforcement Power and Private Enforcement Power. 197 These variables have somewhat
different meanings. Public Enforcement Power relates to the independence and authority
of the stock market supervisory official(s) and is not limited to the authority to proceed
against insider trading violations. Hence, it may be seen as an indicator of the general
regulatory climate regarding financial markets. The Private Enforcement Power variable
reflects the capacity of private parties to seek redress for violations of insider trading
laws—hence it can be seen both as an aspect of the stringency of the insider trading
regulatory regime and as a more general indicator of the seriousness with which insider
trading violations are taken by the country’s lawmakers. We see from Model 3 in
Illustration 8 that controlling for Private Enforcement Power and Public Enforcement
Power does not fundamentally change the results of Models 1 and 2. However, Model 3
does slightly increase the proportion of variance explained relative to Model 2. The
results in Illustration 8 are robust to dropping one country at a time from each regression;
that is, no single country drives the results.
To summarize, the regressions in Illustration 8 suggest that outside ownership in a
country’s largest non-financial firms is positively related to the existence of criminal or
monetary sanctions for violating the country’s insider trading laws, other things equal. If
such a relationship exists, it is not trivial. For instance, Model 3 suggests that a 0.32 point
increase in the Sanction score is associated with about a 5 percentage point increase in
average ownership dispersion. 198 This 5 percentage point increase is approximately the
difference in average ownership concentration between common law (59%) and civil law
countries (54%) and about 9% of the average ownership dispersion for the sample. This
finding is consistent with H1 and suggests that a country’s largest public corporations
tend to have greater ownership dispersion where insider trading laws are enforceable
through civil, criminal, or civil and criminal sanctions and, conversely, it appears that
ownership concentration is greater in countries whose insider trading laws include
weaker sanctions for insider trading violations.

B. Insider Trading Law and Stock Price Informativeness

H2 predicts that stock prices are more informative in countries that have more
stringent insider trading laws. Lower synchronicity implies more informative stock prices
for reasons explained above. Thus, H2 predicts negative coefficients on the insider
trading law variables in regressions where stock price synchronicity is the dependent
variable. Illustration 9 reports three regressions that test this hypothesis. Models 1
through 3 in Illustration 9 include the same independent and control variables as the three
corresponding regressions for ownership dispersion reported in Illustration 8.
As with ownership dispersion, Model 1 of Illustration 9 shows that the coefficients

197. As a brief reminder, recall that the variable Public Enforcement Power is the arithmetic mean of an
index of the securities market supervisor’s characteristics and an index of the securities market supervisor’s
investigative powers, and Private Enforcement Power is the product of the existence of a private right of action
pursuant to a country’s insider trading law and the efficiency of the judiciary. See infra Illustration 4.
198. The difference in the average value of Sanction between the common law and civil law countries in
my sample is 0.32. See infra Illustration 5.
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276 The Journal of Corporation Law [Winter

on Scope and the interaction term, Scope*Sanction, are statistically insignificant,

although they are negative as predicted by H2. Model 1 also shows that the coefficient on
Sanction is negative (-5.39), and it is significant at the 1% level. This result is consistent
with H2 and suggests that more stringent insider trading laws are associated with more
informative (i.e., less synchronous) stock prices. The availability of civil, criminal, or
criminal and civil sanctions again appears to be driving the relationship. That is, stock
prices appear to be more informative about firm-specific developments in the sample
countries in which those who violate the country’s insider trading laws face greater
potential criminal and monetary sanctions. Models 2 and 3 in Illustration 9 control for
various aspects of the enforcement environment that might be driving this result, since
Sanction is positively and significantly correlated with the enforcement variables (as
demonstrated in Illustration 7).
Model 2 adds the control variable Enforced by 1994 to the regressors in Model 1.
The coefficient on Enforced by 1994 is insignificant, but it is in the direction (negative)
predicted by H2. Importantly, controlling for enforcement history does not dampen the
relationship between the Sanction index and stock price synchronicity relative to Model
1. Rather, the coefficient on Sanction increases in absolute magnitude, and it remains
significant at the 1% level. The coefficient on Model 2 also explains a greater proportion
of the variance in stock price synchronicity relative to Model 1.
Model 3 adds to Model 2 the two additional enforcement measures, Public
Enforcement Power and Private Enforcement Power. 199 Model 3, reported in Illustration
9, indicates that the coefficient on Public Enforcement Power is negative and significant
at the 1% level. This result implies that countries whose securities regulatory authorities
have greater enforcement power have more informative stock prices, other things equal.
Model 3 also shows that controlling for Private Enforcement Power and Public
Enforcement Power does not change the basic results relative to Models 1 and 2.
Although the absolute magnitude of the coefficient on Sanction falls somewhat in Model
3, it is still significant at the 1% level as in Models 1 and 2. Also, the coefficient on the
interaction term, Scope*Sanction, becomes significant at the 10% level in Model 3. In
addition, Model 3 does not change the magnitude or significance of the coefficient on
Enforced by 1994 relative to Model 2. Finally, Model 3 increases the proportion of
variance explained relative to Models 1 and 2. The results in Illustration 9 are robust to
dropping one country at a time from each regression; that is, no single country is driving
the results.
In summary, the regressions in Illustration 9 suggest that, other things equal, stock
prices are less synchronous (presumably more informative) in countries with greater
potential criminal or monetary sanctions for insider trading law violations. To concretize
this basic result, Model 3 in Illustration 9 suggests that a 0.32 point increase in the
Sanction score is associated with roughly a 1.7 percentage point decrease in average
stock price synchronicity, or slightly more than twice the difference in average stock
price synchronicity between civil law countries (66.52%) and common law countries
(65.76%) and about 2.6% of average stock price synchronicity for the full sample
(66.25%). Also note that Models 1-3 suggest that stock prices are more synchronous (less
informative) in civil law countries than in common law countries (the omitted dummy

199. See infra Illustration 4 for an explanation of the meaning of these enforcement measures.
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2007] Insider Trading Laws and Stock Markets Around the World 277

variable). 200

C. Insider Trading Law and Stock Market Liquidity

H3 predicts that stock markets are more liquid in countries that have more stringent
insider trading laws for the reasons given above. Thus, H3 predicts positive coefficients
on the insider trading law variables in regressions where stock market turnover is the
dependent variable. Illustration 10 reports three regressions that test this hypothesis; the
dependent variable is the log of the average stock market turnover between 1991 and
1995. The regressions in Illustration 10 include the same independent and control
variables as in Illustrations 8 and 9 for ownership dispersion and stock price
synchronicity, respectively.
In Model 1, the coefficient on Scope is positive as predicted by H3; however, it is
only marginally significant at the 11% level. The coefficient on Sanction in Model 1 is
positive, consistent with H3, but it is statistically insignificant. In contrast, the coefficient
on the interaction between (mean-centered) Scope and (mean-centered) Sanction is
positive and significant at the 1% level in Model 1. This result is consistent with H3 and
suggests that simultaneously broader and more punitive insider trading laws are
associated with greater stock market liquidity.
Model 2 in Illustration 10 supplements Model 1 by controlling for Enforced by
1994. The coefficient on Enforced by 1994 is insignificant, but it is positive as predicted
by H3. Note that controlling for past enforcement in this manner does not affect the
relationship between average stock market turnover and the interaction between (mean-
centered) Scope and (mean-centered) Sanction. In addition, Model 2 explains a greater
proportion of the variance in average stock market turnover relative to Model 1.
Model 3 adds the two potential enforcement measures, Public Enforcement Power
and Private Enforcement Power to the control variables in Model 2. 201 Neither of these
variables is statistically significant in Model 3. However, in Model 3 the coefficient on
the interaction between (mean-centered) Scope and (mean-centered) Sanction increases in
magnitude relative to both Models 1 and 2 and in statistical significance relative to Model
2. In addition, Model 3 increases the proportion of variance explained relative to Models
1 and 2. 202
To summarize, the results in Illustration 10 are consistent with H3, which posits that
countries with more prohibitive insider trading laws have more liquid stock markets,
other things equal. However, the results in Illustration 10 are somewhat sensitive to the
inclusion of particular countries in the regressions, so they must be interpreted with
caution. The small size of my sample might explain why the results in Illustration 10 are

200. In regressions that I do not report in the Article, I regress stock price synchronicity on the alternative
disclosure measures and the control variables, without the insider trading law indices. The coefficient on
Disclosure is positive but insignificant, while the coefficient on Accounting is positive and significant at the 5%
level.
201. See infra Illustration 4 for an explanation of the meaning of these enforcement measures.
202. In regressions that I do not report in the Article, I regress stock market turnover on each of the
alternative disclosure quality measures and the other control variables, excluding the insider trading law
variables. The coefficients on Disclosure and Accounting are both positive but insignificant.
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278 The Journal of Corporation Law [Winter

sensitive to particular countries. 203 Using a much larger time series for 103 countries,
Professors Bhattacharya and Daouk find that stock market liquidity does indeed tend to
increase after a country first enacts insider trading regulation. This provides some
consolation that my results regarding stock market liquidity are not spurious.

D. Interaction of Sanctions and Public Enforcement Power

There is sound reason to expect that both insider trading laws and public
enforcement mechanisms affect investors’ expectations and hence stock market
performance. 204 However, in the regressions above, with the exception of ownership (see
Model 3 in Illustration 8), the coefficients on these separate variables are never
simultaneously significant. A potential reason for this is multicollinearity between the
insider trading law variables and Public Enforcement Power (see Illustration 7). I thus
pursue a common approach to multicollinearity, which is to combine collinear variables
into a single variable in light of their inseparable influence on the dependent variable. I
create a new variable, Public Enforcement Power*Sanction, which is the product of
Public Enforcement Power and Sanction. I then run the regressions for each of the three
dependent variables using this new variable, Public Enforcement Power*Sanction.
Illustration 11 reports the results. Columns 1, 3, and 5 present regressions in which
the insider trading law variables are Scope and Public Enforcement Power*Sanction for
the dependent variables ownership, synchronicity, and liquidity, respectively. The results
are consistent with H1-H3. In particular, the coefficient on Public Enforcement
Power*Sanction is of the predicted sign and is statistically significant in each of the
regressions in columns 1, 3, and 5. Regressions 1, 3 and 5 in Illustration 11 are also
robust to dropping one country at a time; that is, no single country dominates the results.
However, note the relatively low R-squared statistics of regressions 1, 3, and 5 relative to
Model 3 in Illustrations 8, 9, and 10, respectively. Thus, I also report the regressions in
columns 2, 4, and 6 of Illustration 11. The latter regressions constitute Model 4 for each
of the dependent variables, since they simply add the variable Public Enforcement
Power*Sanction to Model 3 for each dependent variable. In contrast to the results in
columns 1, 3, 5, in columns 2, 4, and 6 (Model 4), the coefficients on Public Enforcement
Power*Sanction are insignificant. This might be due to multicollinearity among the
independent variables, even though in columns 2, 4, and 6, all of the insider trading law
variables and Public Enforcement Power are centered about their means to mitigate the
effect of multicollinearity. Nevertheless, the results in columns 2, 4, and 6 are still largely
consistent with H1, H2, and H3, respectively.

203. Bhattacharya & Daouk, supra note 72. Unlike this study, though, their study does not distinguish
countries by the stringency of their insider trading laws.
204. Ackerman & Maug note:
market participants anticipate future enforcement actions by regulatory authorities [and] this
effect is concentrated in countries with high quality legal systems [where] investors change their
behavior after insider trading laws have been enacted and . . . before they have been enforced
[while i]n countries with less effective legal systems laws may have no impact as investors
anticipate that they will not be enforced.
Ackerman & Maug, supra note 162, at 2-3.
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2007] Insider Trading Laws and Stock Markets Around the World 279

E. Summary and Discussion of Results

The regression analyses yield three basic results. The first result is that a country’s
large public corporations tend to have less concentrated ownership, where concentration
is defined as the proportion of a company’s stock held by the company’s three largest
shareholders, when a country has tougher insider trading laws and enforcement. This
finding is consistent with H1. The availability of criminal or monetary sanctions for
violating the insider trading laws and a willingness to enforce them seem particularly
important. Since concentrated ownership is a mechanism for addressing agency problems
and because outside investors are reluctant to invest when agency costs are high, this
result supports theories that see insider trading as an agency cost. However, the result is
also consistent with the view that insider trading reduces agency costs, meaning that
ownership concentration may be endogenous to insider trading. Thus, the first set of
models we examined (in Illustration 8) provide only a weak test of the implications of
prohibitions against insider trading because our ownership dispersion measure is limited
to ten companies per country and the results are indeterminate in any event. 205
Nevertheless, the failure to find that more stringent insider trading laws are associated
with greater ownership concentration is some evidence that prohibiting insider trading
does not have one kind of detrimental effect that might occur if the laws were
counterproductive. Moreover, the ownership results suggest that countries that wish to
encourage more widespread equity ownership might want to consider strengthening their
insider trading laws.
The results of the second set of regression models (Illustration 9) indicate that stock
prices tend to be less synchronous (i.e., contain more firm-specific information) in
countries with more stringent insider trading laws, consistent with H2. This finding is
consistent with the claim that insider trading undermines stock price accuracy because it
discourages arbitrage traders by increasing the risk of expropriation and/or by stifling
competition in the market for information, and/or it increases insiders’ incentives to
manipulate information disclosure. These results are not what one would expect if the
claim of opponents of insider trading legislation that insider trading is an effective and
less costly alternative to traditional disclosure were true.
The results from the third set of models indicate that countries with tougher insider
trading laws tend to have more liquid stock markets, consistent with H3. Support for H3

205. See supra Part III for a review of the conflicting accounts of Professors Demsetz and Bhide, on the
one hand, and Professor Maug, on the other hand, regarding the impact of insider trading on agency costs. In
another study, I conduct a more direct test of the agency cost implications of insider trading laws by examining
the relationship between insider trading laws at the country-level and corporate valuation at the firm level.
Laura Beny, Do Shareholders Value Insider Trading Laws? International Evidence (August 2006) (unpublished
manuscript, on file with author), available at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=296111. In
that study, I find a positive and statistically significant relationship between corporate valuation and insider
trading law and enforcement among firms in common law countries but not among firms in civil law countries.
Id. Judge Easterbrook suggests a few additional tests of the agency implications of insider trading, including
investigation of the empirical “relation between insiders’ trading and other forms of compensation;”
“substitution between insider trading and other agency-cost control devices;” and various tests of the stock
market’s reaction to changes in insider trading regulation or to firm-specific incidences of prosecution for
insider trading violations. Easterbrook, supra note 12, at 96-97. However, Judge Easterbrook notes that “even
with data the [agency question] may be insoluble.” Id. at 97.
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280 The Journal of Corporation Law [Winter

is consistent with theoretical and empirical research in market microstructure that finds a
detrimental effect of information asymmetry on trading costs and with the notion that
allowing insiders to trade on information known only to them harms liquidity (increases
transaction costs) by reducing competition among informed traders. The results therefore
support those who advocate insider trading regulation on the ground that it promotes
liquid stock markets.
All three basic results are robust to controlling for the enforcement environment.
Furthermore, the regressions strongly suggest that the possibility of stringent criminal or
monetary sanctions, rather than the breadth of the prohibition, is the more salient feature
of countries’ insider trading laws. Sanctions are more frequently significant than the
scope of the insider trading prohibition in the regressions reported in this Article.

VI. CONCLUSION AND IMPLICATIONS FOR THE THEORETICAL LAW AND ECONOMICS
DEBATE

This Article began by summarizing the longstanding and unresolved theoretical law
and economics debate about the efficiency implications of insider trading, reviewing
some of the most prominent agency and market theories of insider trading on both sides
of the debate. Next, the Article presented the equally perennial debate about whether
insider trading ought to be regulated or left to private contracting. The main contribution
of this Article, however, is that it moves the law and economics debate away from the
purely theoretical to the empirical realm. In doing so, it provides some evidence that
seems to favor proponents of insider trading regulation and enforcement. Recent
empirical studies of insider trading laws seem to point in the same direction. 206
The results are consistent with (but do not prove) the claim that insider trading laws
generate positive market externalities. In particular, the findings that such laws are
associated with more liquid stock markets and more informative stock prices support
those who oppose private contracting on the ground that insider trading has external
effects on the stock market. More liquid stock markets and more accurate stock prices
reduce the overall cost of equity capital 207 and improve the efficiency of capital
allocation, 208 respectively. Private parties are unlikely to give adequate consideration to

206. See, e.g., Bhattacharya & Daouk, supra note 72 (finding that stock market liquidity increases after the
enactment of insider trading laws and the cost of equity falls significantly after a country prosecutes its insider
trading law for the first time); Bushman et al., supra note 77 (finding that analyst following increases after
countries’ initial enforcement of insider trading laws, where analyst activity is assumed to be beneficial to stock
market efficiency); Herrington, supra note 151 (confirming the findings in this Article, using more recent
country data and insider trading law indices that are based upon and extend my indices). For recent evidence
that is more ambiguous about the benefits of insider trading law and regulation, see Beny, supra note 205
(finding that more stringent insider trading laws are associated with greater corporate valuation in common law
countries, but lower corporate valuation in civil law countries); Bris, supra note 162 (finding that insider trading
profits prior to tender offer announcements decrease in the stringency of the law, but increase after the first
enforcement); Art Durnev & Amrita Nain, The Effectiveness of Insider Trading Regulation Around the Globe
(unpublished manuscript, on file with the author) (2005), available at http://ssrn.com/abstract=682281 (finding
that insider trading laws may have perverse effects in civil law countries). None of the recent evidence supports
any firm policy prescription, however, since evidence about the costs of insider trading regulation and
enforcement is not available yet. See infra note 212.
207. Amihud & Mendelson, supra note 40.
208. Wurgler, supra note 40.
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2007] Insider Trading Laws and Stock Markets Around the World 281

these external benefits in their private negotiations. Thus, these two findings bolster the
case for public regulation and correspondingly weaken the case for a “Coasian” approach
to insider trading. 209 Furthermore, to the extent that insider trading regulation promotes
more accurate stock prices and greater stock market liquidity, regulation might indirectly
ameliorate corporate agency problems, as more accurate stock prices and greater liquidity
facilitate improved corporate governance and the market for corporate control. 210 In
contrast, less accurate prices and lower liquidity reduce shareholders’ incentives to
monitor and hence increase corporate insiders’ ability and incentives to expropriate
outside investors. 211 Thus, enacting or strengthening insider trading laws and their
enforcement is something that countries interested in increasing the viability of their
stock markets should probably consider. 212
It is premature, however, to claim that such a strategy will surely succeed or that the
debate between proponents and opponents of insider trading laws has now been
empirically resolved. The results of this study must be viewed cautiously for several
reasons. One is the crude nature of the available variables. Ownership concentration
ratios in a country’s midsize and smaller firms might, for example, be very different from
what they are in a relatively small number of the country’s very largest firms. And, we
would like to know how regularly a country’s insider trading laws have been enforced
and not merely whether they have been enforced once before 1994. 213 Also, the sample
of available countries is quite small and there may be differences among them in data
reliability. It is also possible that some countries enacted insider trading laws merely in
response to external pressure, 214 resulting in rote transplantation of foreign insider
trading laws unrelated to such countries’ financial, legal, and institutional
characteristics. 215 It is some consolation that these concerns would ordinarily be expected

209. See Cox, supra note 32; Goshen & Parchomovsky, supra note 39. See generally Glaeser et al., supra
note 166.
210. The literature on mandatory securities disclosure enumerates several economic benefits of accurate
stock prices, including their role in improving corporate governance and reducing agency costs. See, e.g., Fox et
al., supra note 40. In addition, using a mathematical model, Professor Maug shows that liquid stock markets are
beneficial because they improve corporate governance by improving large shareholders’ incentives to monitor.
Ernst Maug, Large Shareholders as Monitors: Is There a Trade-off Between Liquidity and Control? 53 J. FIN.
65 (1998).
211. See Maug, supra note 210; Fox et al., supra note 40.
212. Even if strong insider trading laws and enforcement are associated with greater public participation in
the stock market, more liquid stock markets, and more accurate stock prices, however, policymakers need to
assess whether they are worth their costs. Such costs include the cost of legislative enactment and subsequent
market supervision and enforcement and various additional direct and indirect costs of the regulatory scheme.
See, e.g., Howell E. Jackson, Variation in the Intensity of Financial Regulation: Preliminary Evidence and
Potential Implications (John M. Olin Ctr. for Law, Econ., and Bus., Working Paper No. 521, 2005), available at
http://ssrn.com/sbstract=839250 (discussing the direct and indirect costs of financial regulation). So far, there
have been no empirical studies, much less comparative empirical studies, of the relative costs and benefits of
insider trading regulation. Id. at 32 (“[W]e don’t have evidence that the benefits of enforcing insider trading law
exceeds the costs of enforcing those laws.”).
213. Even if we knew the frequency of enforcement, there would be serious endogeneity problems because
a country with the most effective insider trading regime might have occasion to engage in relatively low
enforcement efforts precisely because the law is so restrictive. Ideally, we would be able to test a time series
model.
214. See Haddock & Macey, Controlling Insider Trading, supra note 77.
215. See generally Katharina Pistor, The Standardization of Law and Its Effect on Developing Economies,
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282 The Journal of Corporation Law [Winter

to reduce the likelihood of finding significant relationships but they nonetheless caution
against relying too heavily on these results. An additional concern is that the relationship
between insider trading laws/enforcement and measures of stock market performance
might be context and culture dependent. A relationship that holds across the sample as a
whole may not hold for a particular country with its own business traditions at a
particular stage of economic development.
Finally, although this Article’s empirical results demonstrate a significant
relationship between insider trading laws and various measures of stock market
performance, they do not prove causality. More developed stock markets may simply
have stronger insider trading laws and enforcement because they have the necessary
influential constituencies to demand a tough approach to insider trading. The public
choice claim that certain stakeholders in the financial system cause insider trading laws to
be adopted suggests that causality might run from the financial system to insider trading
laws, rather than the reverse. 216
The appropriate conclusion to reach from this research is not that the arguments of
proponents of insider trading regulation have been proven sounder than the arguments of
those who criticize such regulation, but rather that there is somewhat more reason to
believe in their soundness than there was before this study was conducted. While I would
like to be able to reach a stronger conclusion, it is essential to avoid the undue
confidence, combined with an inordinate haste to make policy recommendations that too
often have characterized the insider trading debate. If we err at all, we should err on the
side of excessive care in assessing what we know, at least if our aim is to influence
policy.
At the same time, I do not want to sell short what I think we can learn from the
analysis in this Article. Substantively, the consistent support for the hypotheses that favor
the regulation of insider trading at a minimum places on those who advocate the
deregulation of insider trading the burden of presenting persuasive empirical evidence
that refutes this Article’s findings (and the findings of other recent studies) and/or
supports the deregulatory position. My results also suggest that the assumptions made by
theorists who see on balance benefits to insider trading regulation are closer to the mark
than the assumptions that undergird the conclusions of those who oppose such regulation.

50 AM. J. COMP. L. 97 (2002) (noting difficulties in adopting standard laws to domestic legal cultures in
developing countries). This suggests that careful study of the political economy of countries’ (especially
emerging markets’) adoption of insider trading laws is desirable. For a start, see Laura N. Beny, The Political
Economy of Insider Trading Legislation and Enforcement: International Evidence (John M. Olin Ctr. for Law,
Econ., and Bus., Working Paper No. 348, 2002), available at http://ssrn.com/abstract=304383. In addition, I
have conducted a survey of stock market regulators and stock market exchanges around the world about the
motivating circumstances of their countries’ adoption and initial enforcement of insider trading laws. The
results of my analysis of these data will be available shortly (contact author for details).
216. See, e.g., Haddock & Macey, Regulation on Demand, supra note 77 (arguing that insider trading laws
are adopted for political reasons, not necessarily to improve efficiency); see also Beny, supra note 215; see also
Haddock & Macey, supra note 74, at 1451 (“While the SEC’s present rules banning insider trading may well be
supportable under certain theoretical conditions, the SEC’s refusal to permit firms to opt out of its rules suggests
to us that the ban is motivated by political rent seeking rather than a quest for economic efficiency.”). See
generally Coffee, Rise of Dispersed Ownership, supra note 8, at 81 (noting that in several countries, securities
“law appears to be responding to changes in the market [i.e., the emergence of influential investor
constituencies], not consciously leading it”).
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2007] Insider Trading Laws and Stock Markets Around the World 283

In particular, many scholars acknowledge that the “pure” Coasian assumptions are
unrealistic. It appears that their unreality might matter in some contexts, including the
present context, i.e., the insider trading debate.
Methodologically, this Article suggests that cross-country data and a comparative
analysis can shed empirical light on the implications of regulatory regimes that frustrate
single country investigation due to insufficient variance. Undoubtedly there is a need for
further empirical research on this issue, including the assembly of more adequate cross-
sectional and time series data sets. This Article is but an early step. It can help resolve the
theoretical conflict (and perhaps contribute to the articulation of a more coherent insider
trading doctrine in the United States) only if consistent empirical work follows.
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284 The Journal of Corporation Law [Winter

ILLUSTRATION 1: AVERAGE OWNERSHIP CONCENTRATION PLOTTED AGAINST IT LAW

0.5

0.4
Average Ownership Concentration

0.3

0.2

0.1

0
0 1 2 3 4 5
IT Law
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ILLUSTRATION 2: AVERAGE STOCK PRICE SYNCHRONICITY PLOTTED AGAINST IT

LAW

80
Average Stock Price Synchronicity

60

40

20

0
0 1 2 3 4 5
IT Law
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286 The Journal of Corporation Law [Winter

ILLUSTRATION 3: AVERAGE STOCK MARKET TURNOVER (1991-1995) PLOTTED

AGAINST IT LAW

80
Average Stock Market Turnover (1991-1995)

60

40

20

0
0 1 2 3 4 5
IT Law
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ILLUSTRATION 4: DESCRIPTION OF THE VARIABLES

Description
Dependent Variables
Ownership One minus the average fraction of common stock owned by
Dispersion the three largest shareholders of each of the ten largest non-
financial firms in the country as of the mid-1990s. La Porta et al.,
Law and Finance, supra note 8, at 1125.
Average Stock The total value traded divided by stock market capitalization,
Market averaged across 1991-1995. EMERGING MARKETS FACTBOOK,
Turnover supra note 149.
Stock Price The fraction (%) of stocks whose prices moved in the same
Synchronicity direction in an average week in 1995. Fox et al., supra note 40.
Insider Trading Law Variables
Tipping Tipping equals one if corporate insiders are prohibited from
tipping outsiders (tippees) about material non-public information
and/or encouraging them to trade on such information for personal
gain; equals zero otherwise. INSIDER TRADING: THE LAWS OF
EUROPE, THE UNITED STATES AND JAPAN, supra note 152;
INTERNATIONAL INSIDER DEALING, supra note 152.
Tippee Tippee equals one if tippees, like corporate insiders, are
prohibited from trading on material non-public information that
they have received from corporate insiders; equals zero otherwise.
INSIDER TRADING: THE LAWS OF EUROPE, THE UNITED STATES AND
JAPAN, supra note 152; INTERNATIONAL INSIDER DEALING, supra
note 152.
Damages Damages equals one if potential monetary penalties for
violating insider trading laws are proportional to insiders’ trading
profits; equals zero otherwise. INSIDER TRADING: THE LAWS OF
EUROPE, THE UNITED STATES AND JAPAN, supra note 152;
INTERNATIONAL INSIDER DEALING, supra note 152.
Criminal Criminal equals one if violation of insider trading laws is a
potential criminal offense; equals zero otherwise. INSIDER
TRADING: THE LAWS OF EUROPE, THE UNITED STATES AND JAPAN,
supra note 152; INTERNATIONAL INSIDER DEALING, supra note 152.
Scope Scope is a sub-index of insider trading law. Scope measures
the breadth of the insider trading prohibition. It is the sum of
Tipping and Tippee. Scope ranges from 0 to 2, with 0 representing
the most permissive insider trading prohibition and 2 representing
the most restrictive insider trading prohibition.
Sanction Sanction is a sub-index of insider trading law. Sanction is a
proxy for the expected criminal and monetary sanctions for
violating a country’s insider trading laws. It is the sum of Damages
and Criminal. Sanction ranges from 0 to 2, with 0 representing the
lowest expected sanctions and 2 representing the highest expected
sanctions.
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288 The Journal of Corporation Law [Winter

IT Law The aggregate IT Law index equals the sum of (1) Tipping; (2)
Tippee; (3) Damages; and (4) Criminal; or, equivalently, the sum of
Scope and Sanction. IT Law ranges from 0 to 4, with 0 representing
the most lax insider trading legal regime and 4 representing the
most restrictive insider trading legal regime.
Enforcement Variables
Enforced by A proxy for actual enforcement, “Enforced by 1994” is an
1994 indicator variable that equals one if the country’s insider trading
law has been enforced for the first time by the end of 1994.
Bhattacharya & Daouk, supra note 72, tbl. 1 (this is the column that
the authors have mistakenly labeled “IT Laws Existence” (column
8), rather than “IT Laws Enforcement”).
Public The public enforcement index is the arithmetic mean of an
Enforcement index of the securities market supervisor’s characteristics and an
Power index of the securities market supervisor’s investigative powers.
The securities market supervisor’s characteristics index equals
the arithmetic mean of the four components: (1) Appointment—
“[e]quals one if a majority of the members of the Supervisor are not
unilaterally appointed by the Executive branch of government; and
equals zero otherwise,” La Porta et al., What Works?, supra note 8,
at 7; (2) Tenure—“[e]quals one if members of the Supervisor
cannot be dismissed at the will of the appointing authority; and
equals zero otherwise,” id.; (3) Focus—“[e]quals one if separate
government agencies or official authorities are in charge of
supervising commercial banks and stock exchanges; and equals
zero otherwise,” id.; (4) Rule-making authority—
[e]quals one if the Supervisor can generally issue
regulations regarding primary offerings and/or listing
rules on stock exchanges without prior approval of other
governmental authorities. Equals one half if the
Supervisor can generally issue regulations regarding
primary offerings and/or listing rules on stock exchanges
only with the prior approval of other governmental
authorities. Equals zero otherwise.
Id.
The supervisor’s investigative powers index equals the
arithmetic mean of two factors: (1) Document—
[a]n index of the power of the Supervisor to command
documents when investigating a violation of securities
laws. Equals one if the Supervisor can generally issue an
administrative order commanding all persons to turn over
documents; equals one half if the Supervisor can
generally issue an administrative order commanding
publicly traded corporations and/or their directors to turn
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2007] Insider Trading Laws and Stock Markets Around the World 289

over documents; and equals zero otherwise

id. at 8; (2) Witness—
[a]n index of the power of the Supervisor to subpoena the
testimony of witnesses when investigating a violation of
securities laws. Equals one if the Supervisor can
generally subpoena all persons to give testimony; equals
one half if the Supervisor can generally subpoena the
directors of publicly traded corporations to give
testimony; and equals zero otherwise.
La Porta et al., What Works?, supra note 8, at 8.
Private Right Private right equals one if private parties have a private right
of action against parties that have violated the country’s insider
trading laws. INSIDER TRADING: THE LAWS OF EUROPE, THE
UNITED STATES AND JAPAN, supra note 152; INTERNATIONAL
INSIDER DEALING, supra note 152.
Efficiency of Efficiency of the judiciary is a measure of the “efficiency and
the Judiciary integrity of the legal environment as it affects business, particularly
foreign firms.” La Porta et al., Law and Finance, supra note 8, at
1124. It is recorded as the arithmetic average between 1980 and
1983.
Private The product of Private Right and Efficiency of the Judiciary.
Enforcement
Power
Control Variables
Log of GDP Logarithm of per capita gross domestic product in 1995,
measured in constant 1995 U. S. dollars. World Bank, World
Development Report CD-Rom (2003).
GDP Growth Average annual percentage growth rate of per capita GDP for
the years 1970-1993. World Bank, World Development Report
(1995).
Anti-director Aggregate index of minority shareholder rights. The index is
Rights the sum of “(1) [ability to] vote by mail; (2) shares not blocked or
deposited; (3) cumulative voting; (4) oppressed minority [rights];
(5) pre-emptive rights; and (6) capital [required to call a meeting].”
Djankov et al., Self-Dealing, supra note 8, tbl. XI. The index ranges
from zero to six, where six signifies the strongest anti-director
rights.
Legal Origin An indicator variable that signifies the legal origin of the
country’s Company Law or Commercial Code. Legal origin may be
English common law, French civil law, German civil law or
Scandinavian civil law. La Porta et al., Law and Finance, supra
note 8.
Disclosure The Disclosure index equals the arithmetic average of six
separate indices of information that firms are legally required to
include in their prospectuses: (1) Compensation; (2) Shareholders;
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290 The Journal of Corporation Law [Winter

(3) Inside Ownership; (4) Irregular contracts; (5) Transactions. La

Porta et al., What Works?, supra note 8.
(1) Compensation is
[a]n index of prospectus disclosure requirements
regarding the compensation of the Issuer’s directors and
key officers. Equals one if the law or the listing rules
require that the compensation of each director and key
officer be reported in the prospectus of a newly listed
firm; equals one half if only the aggregate compensation
of directors and key officers must be reported in the
prospectus of a newly-listed firm; and equals zero when
there is no requirement to disclose the compensation of
directors and key officers in the prospectus for a newly
listed firm.
Id. at 6.
(2) Shareholders are
[a]n index of disclosure requirements regarding the
Issuer’s equity ownership structure. Equals one if the law
or the listing rules require disclosing the name and
ownership stake of each shareholder who, directly or
indirectly, controls 10% or more of the Issuer’s voting
securities; equals one half if reporting requirements for
the Issuer’s 10% shareholders do not include indirect
ownership or if only their aggregate ownership needs to
be disclosed; and equals zero when the law does not
require disclosing the name and ownership stake of the
Issuer’s 10% shareholders. [The index includes both]
large shareholder reporting requirements imposed on
firms and those imposed [directly] on large shareholders.
Id.
(3) Inside Ownership is
[a]n index of prospectus disclosure requirements
regarding the equity ownership of the Issuer’s shares by
its directors and key officers. Equals one if the law or the
listing rules require that the ownership of the Issuer’s
shares by each of its directors and key officers be
disclosed in the prospectus; equals one half if only the
aggregate number of the Issuer’s shares owned by its
directors and key officers must be disclosed in the
prospectus; and equals zero when the ownership of
Issuer’s shares by its directors and key officers need not
be disclosed in the prospectus.
Id.
(4) Irregular contracts are
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2007] Insider Trading Laws and Stock Markets Around the World 291

[a]n index of prospectus disclosure requirements

regarding the Issuer’s contracts outside the ordinary
course of business. Equals one if the law or the listing
rules require that the terms of material contracts made by
the Issuer outside the ordinary course of its business be
disclosed in the prospectus; equals one half if the terms of
only some material contracts made outside the ordinary
course of business must be disclosed; and equals zero
otherwise.
Id.
(5) Transactions are
[a]n index of the prospectus disclosure requirements
regarding transaction[s] between the Issuer and its
directors, officers, and/or large shareholders (i.e., “related
parties”). Equals one if the law or the listing rules require
that all transactions in which related parties have, or will
have, an interest be disclosed in the prospectus; equals
one half if only some transactions between the Issuer and
related parties must be disclosed in the prospectus; and
equals zero if transactions between the Issuer and related
parties need not be disclosed in the prospectus.
La Porta et al., What Works?, supra note 8, at 6.
Accounting The accounting index is a measure of the quality of accounting
standards. The accounting index assigns a rating to companies’
1990 annual reports on the basis of their inclusion or exclusion of
ninety items. The ninety items are divided into seven categories
(general information, income statements, balance sheets, funds flow
statement, accounting standards, stock data and special items). For
each country, the index is based on examination of a minimum of
three companies. The companies represent a cross-section of
various industries. Seventy percent are industrial companies, while
the remaining thirty percent are financial companies. La Porta et al.,
Law and Finance, supra note 8.
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292 The Journal of Corporation Law [Winter

ILLUSTRATION 5: INSIDER TRADING LAW AND ENFORCEABILITY

This Table presents the insider trading law and enforcement measures for the sample
countries, grouped by their legal origins: English common law versus European civil law.
The columns contain the following variables: (1) Scope equals the sum of Tipping and
Tippee; (2) Sanction equals the sum of Damages and Criminal; (3) the aggregate IT Law
index is the sum of Scope and Sanction; (4) Enforced by 1994 equals one if the insider
trading prohibition was enforced by 1994, and zero otherwise; (5) Public Enforcement
Power is the mean of the indices of the securities market supervisor’s characteristics and
investigative powers; and (6) Private Enforcement Power is the product of Private Right
and the efficiency of the judiciary. All variables are described in detail in Illustration 4.
The superscripts a, b, and c denote statistical significance at the 1%, 5%, and 10% levels,
respectively. N/A signifies that the relevant information is not available for the country in
question.
Scope Sanction IT Enforced Public Private
Law by 1994 Enforcement Enforcement
Power Power
(1) (2) (3) (4) (5) (6)
Common
Law
Countries
Australia 2. 00 1. 00 3. 00 0 0. 88 10. 00
Canada 2. 00 2. 00 4. 00 1 0. 81 9. 25
Hong Kong 2. 00 1. 00 3. 00 1 0. 75 0. 00
India 1. 00 1. 00 2. 00 0 0. 69 0. 00
Ireland 2. 00 1. 00 3. 00 0 0. 13 8. 75
Malaysia 1. 00 1. 00 2. 00 0 0. 69 9. 00
Singapore 2. 00 1. 00 3. 00 1 0. 75 10. 00
South Africa 1. 00 1. 00 2. 00 0 0. 38 6. 00
Thailand 2. 00 1. 00 3. 00 1 0. 88 0. 00
UK 2. 00 1. 00 3. 00 1 0. 63 0. 00
USA 2. 00 2. 00 4. 00 1 1. 00 10. 00
Common
Law
Average 1. 73 1. 18 2. 91 0. 54 0. 69 5. 73
Civil Law
Countries
Austria 2. 00 0. 00 2. 00 0 0. 13 0. 00
Belgium 2. 00 1. 00 3. 00 1 0. 13 0. 00
Brazil 2. 00 0. 00 2. 00 1 0. 50 5. 75
Denmark 2. 00 1. 00 3. 00 0 0. 38 0. 00
Finland 2. 00 1. 00 3. 00 1 0. 38 0. 00
France 2. 00 2. 00 4. 00 1 0. 94 0. 00
Germany 2. 00 1. 00 3. 00 0 0. 25 0. 00
Greece 2. 00 0. 00 2. 00 0 0. 38 0. 00
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2007] Insider Trading Laws and Stock Markets Around the World 293

Scope Sanction IT Enforced Public Private

Law by 1994 Enforcement Enforcement
Power Power
(1) (2) (3) (4) (5) (6)
Indonesia 1. 00 1. 00 2. 00 0 0. 75 0. 00
Italy 2. 00 1. 00 3. 00 0 0. 50 0. 00
Japan 1. 00 1. 00 2. 00 1 0. 00 0. 00
Luxembourg 2. 00 1.00 3. 00 0 N/A 0. 00
Mexico 1. 00 0. 00 1. 00 0 0. 25 0. 00
Netherlands 2. 00 1. 00 3. 00 1 0. 50 0. 00
Norway 1. 00 0. 00 1. 00 1 0. 13 0. 00
Philippines 1. 00 1. 00 2. 00 0 0. 88 0. 00
Portugal 2. 00 1. 00 3. 00 0 0. 88 5. 50
South Korea 2. 00 2. 00 4. 00 1 0. 38 6. 00
Spain 2. 00 1. 00 3. 00 0 0. 50 6. 25
Sweden 2. 00 1. 00 3. 00 1 0. 25 0. 00
Switzerland 2. 00 1. 00 3. 00 0 0. 25 0. 00
Taiwan 2. 00 1. 00 3. 00 1 0. 38 6. 75
Civil Law 1. 77 0. 86 2. 64 0. 45 0. 41 1. 44
Average
Overall 1. 76 0. 97 2. 73 0. 48 0. 51 2. 91
Average
T-Test of
Difference
in Means
(Common
Law vs.
Civil Law) -0. 28 1. 67c 0. 97 0. 48 2. 86a 3. 33a
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294 The Journal of Corporation Law [Winter

ILLUSTRATION 6: SUMMARY STATISTICS

This Table presents the averages, medians and standard deviations of the three
dependent variables (Ownership Dispersion, Stock Price Synchronicity and Average
Stock Market Turnover) and the control variables (Log of GDP Per Capita, GDP Growth
Per Capita, Anti-Director Rights, Disclosure, and Accounting Standards). All variables
are described in detail in Illustration 4. The superscripts a and b denote statistical
significance at the 1% and 5% levels, respectively.
Avg. Median Standard Common Civil Law T-Test
Deviation Law Avg. Avg. Statistic
Dependent
Variables
Ownership
Dispersion 57. 00 54. 00 13. 90 59. 80 55. 50 -0. 82
Stock Price
Synchronicity 66. 25 66. 60 4. 34 65. 76 66. 52 0. 46
Average
Stock Market
Turnover 58. 90 44. 85 46. 22 44. 54 63. 49 1. 12
Control
Variables
Log of GDP
per capita 9. 31 9. 89 1. 32 9. 13 9. 63 1. 12
GDP Growth
per capita 3. 94 3. 06 2. 54 4. 67 3. 56 -1. 18
Anti-director
Rights 3. 50 3. 50 1. 12 4. 45 3. 11 -4. 24a
Disclosure 0. 66 0. 67 0. 21 0. 88 0. 55 -5. 91a
Accounting 65. 80 65. 00 9. 47 71. 20 63. 10 -2. 38b
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ILLUSTRATION 7: CORRELATION MATRIX

This Table presents pair wise correlation coefficients for the dependent variables,
the substantive insider trading law measures and the enforcement measures. All variables
are described in detail in Illustration 4. The numbers in parentheses are the probability
levels (p-values) at which the null hypothesis of zero correlation can be rejected in two-
tailed tests. The superscripts a, b, and c denote statistical significance at the 1%, 5%, and
10% levels, respectively.

Average Stock Market Turnover

Stock Price Synchronicity

Private Enforc’t Power

Ownership Dispersion

Public Enforc’t Power

Enforced by 1994
Sanction

IT Law
Scope
(1)

(2)

(3)

(4)

(5)

(6)

(7)

(8)

(9)
Dependent
Variables

(1) Ownership 1. 00
Dispersion
(2) Stock Price -0. 19 1. 00
Synchronicity (0. 31)
(3) Average 0. 39b -0. 15 1. 00
stock market (0. 03) (0. 42)
turnover
Insider
Trading Law
Measures
(4) Scope 0. 13 -0. 39b 0. 37b 1. 00
(0. 47) (0. 03) (0. 03)
(5) Sanction 0. 53a -0. 37b 0. 16 0. 32c 1. 00
(0. 00) (0. 04) (0. 38) (0. 06)
(6) IT Law 0. 41b -0. 36b 0. 24 0. 69a 0. 79a 1. 00
(0. 02) (0. 05) (0. 17) (0. 00) (0. 00)
Enforcement
Measures
(7) Enforced by 0. 52a -0. 11 0. 19 0. 29c 0. 35b 0. 33b 1. 00
1994 (0. 00) (0. 55) (0. 28) (0. 09) (0. 04) (0. 05)
(8) Public 0. 01 -0. 28 -0. 09 0. 08 0. 47a 0. 41b 0. 06 1. 00
Enforcement (0. 96) (0. 13) (0. 60) (0. 66) (0. 00) (0. 02) (0. 76)
Power
(9) Private 0. 19 -0. 05 -0. 01 0. 15 0. 34c 0. 70a 0. 02 0. 33c 1. 00
Enforcement (0. 28) (0. 78) (0. 96) (0. 40) (0. 06) (0. 00) (0. 92) (0. 07)
Power
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296 The Journal of Corporation Law [Winter

ILLUSTRATION 8: OWNERSHIP DISPERSION

This Table presents ordinary least squares regressions for the dependent variable
ownership dispersion. The variables Scope and Sanction are centered about their means
to address multicollinearity. The variable Scope*Sanction is the product of mean-
centered Scope and mean-centered Sanction. Illustration 4 describes all of the variables in
detail. Robust standard errors are reported in parentheses. The superscripts a, b, and c
denote statistical significance at the 1%, 5%, and 10% levels, respectively.
Independent and Control Model 1 Model 2 Model 3
Variables
Scope -0. 06 -0. 08 -0. 10c
(0. 08) (0. 06) (0. 07)
Sanction 0. 15a 0. 15a 0. 16b
(0. 05) (0. 05) (0. 06)
Scope* 0. 08 0. 06 0. 06
Sanction (0. 11) (0. 09) (0. 10)
Disclosure -0. 13 -0. 23 -0. 26
(0. 19) (0. 20) (0. 24)
Anti-Director Rights 0. 03 0. 02 0. 02
(0. 02) (0. 02) (0. 02)
French Civil Law -0. 10 -0. 13 -0. 14
(0. 08) (0. 09) (0. 10)
German Civil Law 0. 03 0. 01 0. 01
(0. 08) (0. 09) (0. 10)
Scandina-vian Civil Law 0. 02 -0. 02 -0. 03
(0. 10) (0. 09) (0. 12)
Log of GDP per capita 0. 02 0. 01 0. 01
(0. 03) (0. 02) (0. 03)
GDP Growth per capita -0. 01 -0. 01 -0. 01
(0. 01) (0. 01) (0. 01)
Enforced by 1994 0. 09b 0. 09b
(0. 04) (0. 04)
Public Enforcement Power 0. 02
(0. 12)
Private Enforcement Power -0. 00
(0. 01)
Constant 0. 39 0. 61b 0. 58
(0. 39) (0. 32) (0. 38)
No. of Obs. 31 31 31
R2 0. 58 0. 65 0. 67
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2007] Insider Trading Laws and Stock Markets Around the World 297

ILLUSTRATION 9: STOCK PRICE SYNCHRONICITY

This Table presents ordinary least squares regressions for the dependent variable
stock price synchronicity. The variables Scope and Sanction are centered about their
means to address multicollinearity. The variable Scope*Sanction is the product of mean-
centered Scope and mean-centered Sanction. Illustration 4 describes all of the variables in
detail. Robust standard errors are reported in parentheses. The superscripts a, b, and c
denote statistical significance at the 1%, 5%, and 10% levels, respectively.
Independent and Control Model 1 Model 2 Model 3
Variables
Scope 0. 27 0. 58 2. 49
(2. 58) (2. 47) (2. 39)
Sanction -5. 39a -5. 44a -5. 28a
(1. 54) (1. 52) (1. 37)
Scope*Sanction -4. 55 -4. 30 -5. 48c
(3. 30) (3. 20) (3. 02)
Disclosure 16. 53a 17. 56a 24. 14a
(5. 84) (6. 25) (5. 51)
Anti-Director Rights 0. 04 0. 11 0. 23
(0. 90) (0. 85) (0. 64)
French Civil Law 5. 30b 5. 66b 7. 61a
(2. 13) (2. 14) (1. 93)
German Civil Law 5. 16 5. 47c 5. 52b
(3. 15) (3. 20) (2. 39)
Scandinavian Civil Law 6. 29b 6. 72b 8. 09a
(2. 61) (2. 92) (2. 57)
Log of GDP per Capita -0. 52 -0. 41 -1. 35c
(0. 72) (0. 77) (0. 76)
Growth of GDP 0. 78b 0. 81b 0. 75b
(0. 33) (0. 34) (0. 29)
Enforced by 1994 -0. 78 -0. 44
(1. 56) (1. 58)
Public Enforcement Power -7. 30a
(1. 90)
Private Enforcement Power 0. 25
(0. 18)
Constant 53. 82a 51. 93a 59. 85a
(8. 27) (9. 42) (9. 14)
No. of Obs. 30 30 30
R2 0. 62 0. 63 0. 74
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298 The Journal of Corporation Law [Winter

ILLUSTRATION 10: STOCK MARKET TURNOVER

This Table presents ordinary least squares regressions for the dependent variable log
of average stock market turnover between 1991 and 1995. The variables Scope and
Sanction are centered about their means to address multicollinearity. The variable
Scope*Sanction is the product of mean-centered Scope and mean-centered Sanction.
Illustration 4 describes all of the variables in detail. Robust standard errors are reported in
parentheses. The superscripts a, b, and c denote statistical significance at the 1%, 5%, and
10% levels, respectively.
Independent and Control Model 1 Model 2 Model 3
Variables
Scope 0. 87 * 0. 84c 0. 58
(0. 40) (0. 42) (0. 36)
Sanction 0. 01 0. 01 -0. 06
(0. 25) (0. 26) (0. 29)
Scope*Sanction 1. 26a 1. 24b 1. 33a
(0. 48) (0. 49) (0. 48)
Disclosure 0. 09 -0. 02 -0. 77
(0. 94) (1. 04) (1. 03)
Anti-Director Rights 0. 08 0. 07 0. 09
(0. 14) (0. 15) (0. 14)
French Civil Law 0. 10 0. 06 -0. 12
(0. 39) (0. 40) (0. 41)
German Civil Law 0. 94c 0. 92c 1. 03c
(0. 47) (0. 50) (0. 59)
Scandinavian Civil Law 0. 14 0. 09 0. 04
(0. 36) (0. 41) (0. 52)
Log of GDP per Capita 0. 00 -0. 01 0. 10
(0. 14) (0. 14) (0. 14)
Growth of GDP -0. 06 -0. 06 -0. 05
(0. 05) (0. 05) (0. 05)
Enforced by 1994 0. 10 0. 08
(0. 25) (0. 23)
Public Enforcement Power 1. 04
(0. 93)
Private Enforcement Power -0. 02
(0. 03)
Constant 3. 35b 3. 57b 2. 43
(1. 62) (1. 84) (2. 16)
No. of Obs. 31 31 31
R2 0. 60 0. 60 0. 66

*
Significant at the 11% level only.
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2007] Insider Trading Laws and Stock Markets Around the World 299

ILLUSTRATION 11: INTERACTION OF SANCTIONS AND PUBLIC ENFORCEMENT

This Table presents ordinary least squares regressions for the dependent variables:
ownership dispersion, stock price synchronicity, and the log of average stock market
turnover. In columns 1, 3, and 5, the insider trading law variables are only Scope and
Public Enforcement Power*Sanction. The regressions in columns 2, 4 and 6 contain the
same independent variables as Model 3 presented in Illustrations 8-10, respectively, and
Public Enforcement Power*Sanction. In columns 2, 4 and 6, the insider trading law
variables and Public Enforcement Power are centered around their means to address
multicollinearity. All variables are described in detail in Illustration 4. Robust standard
errors are reported in parentheses. The superscripts a, b, and c denote statistical
significance at the 1%, 5%, and 10% levels, respectively.
Independent Ownership Ownership Stock Stock Log of Log of
and Control Dispersion Dispersion Price Price Average Average
Variables Synchro- Synchro- Stock Stock
nicity nicity Market Market
Turnover Turnover
(1) (2) (3) (4) (5) (6)
Scope -0. 03 -0. 12 1. 02 2. 02 0. 45 0. 69 ±
(0. 07) (0. 07) (2. 06) (2. 54) (0. 36) (0. 44)
Sanction 0. 15b -5. 35a -0. 05
(0. 06) (1. 38) (0. 29)
Scope* 0. 12 -4. 43 1. 09 ¥
Sanction (0. 13) (3. 37) (0. 64)
Disclosure 0. 07 -0. 35 14. 35a 22. 74a -0. 27 -0. 43
(0. 20) (0. 29) (4. 90) (5. 69) (0. 70) (1. 41)
Anti-Director 0. 02 0. 01 -0. 04 -0. 36 0. 05 0. 12
Rights (0. 02) (0. 02) (0. 68) (0. 71) (0. 14) (0. 16)
French Civil -0. 03 -0. 18 3. 78b 6. 98a 0. 13 0. 03
Law (0. 09) (0. 12) 1. 83 (2. 11) (0. 34) (0. 56)
German Civil 0. 11 -0. 01 2. 20 5. 17b 0. 95b 1. 12c
Law (0. 09) (0. 11) (2. 18) (2. 41) (0. 43) (0. 62)
Scandinavian 0. 10 -0. 07 3. 32 7. 47a 0. 39 0. 19
Civil Law (0. 10) (0. 14) 2. 26 (2. 49) (0. 38) (0. 64)
Log of GDP 0. 03 0. 02 -1. 20b -1. 23 0. 12 0. 08
per Capita (0. 03) (0. 03) (0. 52) (0. 80) (0. 13) (0. 15)
Growth of -0. 00 -0. 02 0. 46 0. 70b -0. 03 -0. 04
GDP (0. 01) (0. 01) (0. 28) (0. 31) (0. 04) (0. 06)
Enforced by 0. 10b -0. 30 0. 04
1994 (0. 04) (1. 61) (0. 24)
Public 0. 09 -6. 22b 0. 79
Enforcement (0. 16) (2. 54) (1. 05)
Power

±
Significant at the 13% level only.
¥
Significant at the 11% level only.
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300 The Journal of Corporation Law [Winter

Private -0. 00 0. 25 -0. 02

Enforcement (0. 01) (0. 18) (0. 03)
Power
Public 0. 11b -0. 16 -6. 66a -2. 74 0. 52c 0. 64
Enforcement (0. 05) (0. 19) (1. 06) (3. 66) (0. 26) (0. 97)
Power*
Sanction
Constant 0. 09 0. 61 66. 07a 60. 23a 1. 42 2. 33
(0. 34) (0. 40) (6. 65) (9. 37) (1. 27) (2. 25)
No. of Obs. 31 31 30 30 31 31
R2 0. 49 0. 68 0. 68 0. 74 0. 57 0. 67