Insider Trading and the Managerial Choice among Risky Projects

Abstract

The concern of this paper is with the effects of insider trading on ex ante managerial behavior. Specifically, the paper focuses on how insider trading affects insiders' choice among investment projects. Other things equal, insider trading leads insiders to choose riskier investment projects, because increased volatility of results enables insiders to make greater trading profits if they learn these results in advance of the market. This effect might be beneficial, however, because insiders' risk aversion pulls them toward a conservative investment policy. Insiders' choices of projects are identified and compared with insider trading and those without such trading. Using these results, the conditions under which insider trading increases or decreases corporate value by affecting the choice of projects with uncertain returns are identified.

Exchange Trading Rules, Surveillance, and Insider Trading

“…Our findings strongly support this prior work 4 See also, e.g., Aggarwal (2001), Aggarwal and Wu (2006), Allen and Gale (1992), Allen and Gorton (1992), Comerton-Forde and Rydge (2006), Daouk et al (2006), DeMarzo et al (2005), Gerard and Nanda (1993), Hillion and Suominen (2004), Jarrow (1992, 1994), La Porta et al (1997, 1999, 2002, 2006), Mahoney (1999, Merrick et al (2005), Ni et al (2005), Peng andRöell (2009), O'Hara andMendiola (2003), Pirrong (1993Pirrong ( , 1995aPirrong ( ,b, 1999Pirrong ( , 2004, Pistor et al (2003), Pistor andXu (2003, 2005), Prichard (2003), Reiffen and Robe (2007), Romano (2001Romano ( , 2002. and extend the literature by highlighting the effect of different yet complementary market manipulation rules and specific direct policy mechanisms directly relevant to insider trading.…”

Exchange Trading Rules, Surveillance, and Insider Trading

“…Our findings strongly support this prior work 4 See also, e.g., Aggarwal (2001), Aggarwal and Wu (2006), Allen and Gale (1992), Allen and Gorton (1992), Comerton-Forde and Rydge (2006), Daouk et al (2006), DeMarzo et al (2005), Gerard and Nanda (1993), Hillion and Suominen (2004), Jarrow (1992, 1994), La Porta et al (1997, 1999, 2002, 2006), Mahoney (1999, Merrick et al (2005), Ni et al (2005), Peng and Röell (2009), O'Hara and Mendiola (2003), Pirrong (1993Pirrong ( , 1995aPirrong ( ,b, 1999Pirrong ( , 2004, Pistor et al (2003), Pistor andXu (2003, 2005), Prichard (2003), Reiffen and Robe (2007), Romano (2001Romano ( , 2002. and extend the literature by highlighting the effect of different yet complementary market manipulation rules and specific direct policy mechanisms directly relevant to insider trading.…”

A Review of the Current Literature on Executive Compensation: New Insights and Understandings

“…Therefore, insiders whose trading is restricted will be less inclined to choose risky projects when compared with insiders with the freedom to trade. So in order to encourage the choice of projects that are in the shareholders' interest, restricted insiders must receive other incentives such as stock options so as to take on risk (Bebchuk and Fershtman, 1994).…”