Henry Manne on Behavioral Finance & Insider Trading
When Henry Manne writes about insider trading, as he does this week in the WSJ op-ed, one can be sure that it is worth reading. The op-ed, which is the first installment of a two part series, offers two central points: (1) the behavioral finance literature does not support the regulation of insider trading, but has pushed usefully pushed economists to think beyond the realm of the “marginal trader” and into a Hayekian theory of price formation, and (2) this “wisdom of crowds” approach to price formation provides a new rationale insider trading regulations. The key paragraph:
“Since such trading clearly makes the market process work more efficiently, it aids capital allocation decisions and informs business executives through market-price feedback of the best predictions about the value of new plans… .
The new approach would suggest that it is undesirable to have laws discouraging stock trading by anyone who has any knowledge relevant to the valuation of a security. Thus, assembly-line workers, administrative assistants, office boys, accountants, lawyers, salespeople, competitors, financial analysts and, of course, corporate executives (government officials are another story) should all be encouraged to buy or sell stocks based on any new information they might have. Only those privately enjoined by contract or other legal duty from trading should be excluded. The “wisdom of crowds” can do far more for the welfare of American investors than all the mandated disclosures and insider trading laws that the SEC and Congress can think up.”
Henry makes a more detailed version of this argument in this paper. Here are some early reactions from Larry Ribstein and Tyler Cowen. One particularly interesting feature of this rationale for insider trading is the fascinating issues it raises with respect to the adoption of corporate prediction markets as the basis for firm decision-making and resource allocation. If one believes that information markets can improve firm decision-making and corporate governance, insider trading laws are a substantial barrier to achieving those efficiencies.