Apr 28, 2010
Q&A
Some economists argue that prohibiting insider trading does more harm than good by reducing the flow of useful information. Do you agree?

EFF/KRF: No. It is difficult to run a company to generate value for shareholders, but it is easy for senior managers to reduce their company's value so they can profit personally from a short sale. Thus, there is a big moral hazard problem if insiders are allowed to short sell. What about purchases on positive inside information? A firm's managers are supposed to act in the interests of shareholders. A manager who buys stock based on positive inside information is disadvantaging the seller — an existing shareholder. Moreover, the presumption that allowing insider trading increases the flow of information to the market is tenuous since managers then have an incentive to delay disclosure of information. In short, allowing insider trading creates big moral hazard problems, with lots of negative consequences. This is the logic behind disclosure laws (or at least idealized versions of them), which seek to make all value-relevant information available to all market participants on the same terms.

 
ABOUT FAMA AND FRENCH
Eugene F. Fama
The Robert R. McCormick Distinguished Service Professor of Finance at the University of Chicago Booth School of Business
Kenneth R. French
The Roth Family Distinguished Professor of Finance at the Tuck School of Business at Dartmouth College
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Eugene Fama and Ken French are members of the Board of Directors for and provide consulting services to Dimensional Fund Advisors LP.