I present an economic model of insider trading building upon Haddock & Macey’s classic analysis of trading by the manager of a Coasian firm (i.e., a firm in which agency costs do not exist). Due to current shareholders’ status as expected sellers of shares, Coasian insider trading allows shareholders to expropriate outsiders via the managerial proxy and any signaling value of insider trading is eliminated by shareholders’ biased incentives. Adverse selection results. If a system of credible disclosure exists, an insider trading ban results in more disclosure, more efficient prices, and lower illiquidity costs. While the case for insider trading in the Coasian firm may be weak, insider trading can provide positive social benefits where some form of agency cost exists. Insights from the Coasian model include that shareholder incentives may lead to undesirable capital markets activity, greater agency costs may result in preferable social outcomes, and deterrent penalties must take into account shareholder incentives.
James C. Spindler,
The Coasian Firm and Insider Trading, Revisited,
SMU L. Rev.