Manne on insider trading as compensation

Cite this Article
Larry Ribstein, Manne on insider trading as compensation, Truth on the Market (June 09, 2011),

Henry Manne has a new version of the arguments he’s been making for years for insider trading as an efficient compensation mechanism. It’s Entrepreneurship, Compensation, and the Corporation.  Here’s the abstract:

This paper revisits the concept of entrepreneurship, which is frequently neglected in mainstream economics, and discusses the importance of defining and isolating this concept in the context of large, publicly held companies. Compensating for entrepreneurial services in such companies, ex ante or ex post, is problematic – almost by definition – despite the availability of devices such as stock and stock options. It is argued that insider trading can serve as a unique compensation device and encourage a culture of innovation.

And more from the article (footnote omitted):

Today, with the regulation, criminalization, and vilification of insider trading, many, probably most, corporate employees—particularly the entrepreneurial ones who would be the easiest for regulators to spot—would not try to profit from an innovation by trading in their companies’ securities before the innovation’s value is reflected in the stock price as a result of public disclosure. But along with that hesitation to trade undoubtedly goes a loss of incentive for developing new ideas and certainly the loss of a culture that could encourage entrepreneurship. It is highly doubtful that the outlawing of insider trading in the United States has not had a significant deleterious effect on the long-term performance of our publicly held companies.

Henry notes that laws against insider trading may not have completely stopped this activity, though the SEC and Justice are trying very hard to do so by increasingly wide-ranging criminal prosecutions. Indeed, Todd Henderson has shown evidence that insider trading is actually used as compensation and (with Jagolinzer and Muller) that the SEC’s Rule 10b5-1 increases opportunities for insider trading.

While many have criticized Henry’s theory over the years, nobody in the meantime has produced a perfect compensation system, or much evidence that insider trading hurts anybody other than information owners who ought to be able to license their employees to use it.   Maybe it’s time to give the idea some serious consideration.