Why do insiders trade illegally?

Larry Ribstein —  17 November 2011

Not, as economic theory would predict, because they need the money, according to Bhattacharya and Marshall, Do They Do it for the Money?  Here’s the abstract:

Using a sample of all top management who were indicted for illegal insider trading in the United States for trades during the period 1989-2002, we explore the economic rationality of this white-collar crime. If this crime is an economically rational activity in the sense of Becker (1968), where a crime is committed if its expected benefits exceed its expected costs, “poorer” top management should be doing the most illegal insider trading. This is because the “poor” have less to lose (present value of foregone future compensation if caught is lower for them.) We find in the data, however, that indictments are concentrated in the “richer” strata after we control for firm size, industry, firm growth opportunities, executive age, the opportunity to commit illegal insider trading, and the possibility that regulators target the “richer” strata. We thus rule out the economic motive for this white-collar crime, and leave open the possibility of other motives.

One hypothesis:  the need for more money is not necessarily perfectly correlated with how much you have.  Insider traders are rich because they really want to be rich (some would call this “greed”). The higher demand for money offsets the risks. This doesn’t mean you can “rule out the economic motive” for insider trading. 

There may be broader implications here for executive compensation, executive misconduct generally, and for reconciling this data with evidence of executives’ willingness to trade off insider trading and other compensation.

Larry Ribstein


Professor of Law, University of Illinois College of Law

One response to Why do insiders trade illegally?


    From Henry Manne:

    Just a very quick perusal of this article makes me very suspect of their findings (as I am of so many of this kind of empirical studies). First of all, though they say that all the corporations represented in their data (locus of IT prosecutions) are the same as all corporations generally, it is clear that they have not distinguished those companies with very high variability of stock price, the companies most likely to provide meat for IT. Even more important, it is clear that they have confounded the companies that the SEC targets with all companies, assuming that the SEC is an unbiased prosecutor of IT. Nothing could be farther from the truth. The SEC goes after the easy pickings, and the availability of whistle blowing, wiring or wire tapping tells us much more about the SEC’s choices than where IT actually occurs. I did not read past the second page, as I am sure that the list of problems with their econometrics goes on and on. But I am concerned that there is so little skepticism about studies of this sort. It certainly is no wonder that the mass of empirical work in the IT field leaves us with no clear answers; if the studies are full or errors, then the aggregate result is bound to be a random number. I pursued this particular study, as I have lately realized something very peculiar about SEC IT prosecutions (though this is hunch and not empirics) and that is that very few cases in recent years have involved the classic “insiders.” It is almost always someone outside the company, and that is exactly what I would anticipate, since the trading by top insiders is so easy to trace, and they have so much to lose compared to the possible gain (the Becker point these guys don’t think works). Thus, since the rewards from IT are very high, we would anticipate that the “crime” will be committed now by people who have less to lose (and obviously much less to contribute to social welfare from their trading), just as happened with Prohibition.