Manne on insider trading as compensation

Larry Ribstein —  9 June 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.

Larry Ribstein


Professor of Law, University of Illinois College of Law

3 responses to Manne on insider trading as compensation

    north fork investor 9 June 2011 at 10:20 am

    Thank goodness noone will give this idea any consideration since it is based on more than one false premise. It is fairly obvious trading on inside information hurts people other than the information owners (though that may serve as the basis for enforcing insider trading prohibitions.) Like the public’s confidence in the integrety of our markets among other things that has kept our securities markets among the most attractive to investors and issuers around the world.

    The claim that prohibitions of insider trading has negatively affected the long term performance of our public companies is equally ridiculous.

    Have either you or Manne served on or advised as counsel a compensation committee for a public company?


    Stocks trade on forward looking expectations of profits and cash flows. Private knowledge of future innovations is compensatory, if and only if, the future innovation is unexpected (deviates from expectations) and its positive or negative effect on profitability is determinable with a high degree of certainty. For example, Nintendo recently announced a new game system and the market value of the company declined due to market disappointment in the new game systems profitability. Would an insider in the company have correctly anticipated the stock market reaction to the new game system?

    If a company has a successful track record of profitable innovation, the company’s internal compensation and organization are already successfully promoting innovation, and insider trading is an unnecessary additional compensation scheme.

    If the company does not have a successful track record of profitable innovation then insider trading is a risky trade with uncertain profitability.

    Contrast company innovation where there is uncertainty over the stock market reaction with an acquisition of another company for cash and the amount of gain to the insider is more certain. The market reaction in almost all cases is a rise in the target company’s stock price upon announcement or leak of the proposed acquisition offer.

    Given that stocks trade on future company prospects, and include not just current products, but also expectations about reinvestment and future products, it is unclear how insider trading provides an incentive for company innovation above and beyond normal long-term stock ownership in an employer.

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