The Placebo Effect of Insider Dealing Regulation

Abstract

Insiders can profit from material non-public information pertaining to their own firm by trading in the shares of their own company (traditional insider trading) or in the shares of other companies whose stock prices may also be affected by such information (shadow trading). We show that traditional insider trading and shadow trading have the same consequences for financial markets and corporate governance, but only the former is pursued aggressively by regulators in the European Union, the UK and the United States. Drawing on a variety of evidence, including a survey of 200 retail investors, we suggest that, rather than protecting unsuspecting outside investors, such an arrangement enables insiders to profit at their expense. The ban on the more salient practice of traditional insider dealing regulation lulls outside investors into a false sense of security, thus effectively operating as a placebo, whilst insiders can still profit by engaging in shadow trading. We further argue that, ironically, this arrangement may nonetheless be efficient.