Does insider trading contribute to market efficiency?

PRO (yes)

Robert W. McGee, PhD, JD, DSc, MST, Professor of Accounting in the Andreas School of Business at Barry University, in his Jan. 2008 Journal of Business Ethics article, "Applying Ethics to Insider Trading," wrote:

"...Insider trading serves as a means of communicating market information, which makes markets more efficient...

...Even if the insider is anonymous, an increase (or decrease) in demand for a particular stock will be noticed by the market, and the price will move accordingly..."

Jan. 2008 - Robert W. McGee, PhD, JD, DSc, MST 

Henry G. Manne, SJD, Dean Emeritus at George Mason University, in his Winter 1985 Cato Journal article, "Insider Trading and Property Rights in New Information," wrote:

"...[I]nsider trading will always push stock prices in the 'correct direction'. That is, the effect of insider trading will always be to move a share's price towards the level correctly reflecting all the real facts about the company...

...The direction is 'correct' simply because it reflects more valid information..."

Winter 1985 - Henry G. Manne, SJD 

Peter-Jan Engelen, PhD, Professor of Economics as Utrecht University, and Luc Van Liedekerke, PhD, Associate Professor at the Institute of Philosophy at Katholieke Universiteit Leuven, in their Sep. 2007 Journal of Business Ethics article, "The Ethics of Insider Trading Revisited," wrote:

"...If a security market is informational efficient, security prices instantaneously and fully reflect all relevant available data.

...Since security prices in this case reflect all publicly available information, but not the non-public information, the transactions of insiders will reveal the private information component to the market. Precisely due to the transactions of insiders security prices will better and faster reflect the real fundamental value by incorporating the private information. Hence, allowing insider trading increases the allocation-efficiency of the security market..."

Sep. 2007 - Luc Van Liedekerke, MSc, PhD  
Peter-Jan Engelen, PhD 

Jack L. Treynor, MBA, President of Treynor Capital Management, Inc., and Dean LeBaron, MBA, President of Virtualquest and Chairman of Woodworks Inc., in their May/June 2004 Financial Analysts Journal article, "Insider Trading: Two Comments," wrote:

"...If one of the primary jobs of markets is price discovery -accurate price discovery- this exclusion [the exclusion of insiders] makes no sense. By eliminating insiders, we make markets less informed. Market prices no longer reflect the combined knowledge of all participants. We push prices in the direction that less well informed investors would take them. And we may increase volatility from uncertainty..."

Sep. 2007 - Jack L. Treynor, MBA 
Dean LeBaron, MBA  

CON (no)

James Surowiecki, Staff Writer for The New Yorker, in his Oct. 31, 2005 article "Capitol Gains," wrote:

"...Ultimately, insider trading is an inefficient way of achieving market efficiency, because insiders earn all their profits on the lag between when they start selling and when the market figures out what's going on. This gives them every reason to hoard information, with the result that stock prices are out of whack for longer than they otherwise would have been. Markets thrive on transparency, but insider trading thrives on opacity..."

Oct. 31, 2005 - James Surowiecki 

Joseph A. Grundfest, MSc, JD, W.A. Frank Professor of Law and Business at Stanford University and former Commissioner of the Securities and Exchange Commission, in a speech, "To Catch a Thief: Recent Developments in Insider Trading Law and Enforcement," on June 20, 1986 stated the following:

"...Information is property. The taking of property without consent is theft, and theft is both immoral and inefficient. Theft is inefficient because it erodes the incentive to create and invest, and subverts the important price signaling mechanisms of a free-market system..."

June 20, 1986 - Joseph A. Grundfest, MSc, JD, PhD 

Stephen Bainbridge, MS, PhD, William D. Warren Professor of Law at the University of California, Los Angeles (UCLA) School of Law, in his Sep. 24, 2004 Capitalism Magazine article, "Regulate Insider Trading," wrote:

"...[I]nsider trading affects stock market prices through what is known as 'derivatively informed trading.' First, those individuals possessing material nonpublic information begin trading. Their trading has only a small effect on price. Some uninformed traders become aware of the insider trading through leakage or tipping of information or through observation of insider trades. Other traders gain insight by following the price fluctuations of the securities. Finally, the market reacts to the insiders' trades and gradually moves toward the correct price. But while derivatively informed trading can affect price, it functions slowly and sporadically. Given the inefficiency of derivatively informed trading, the market efficiency justification for insider trading loses much of its force..."

Sep. 24, 2004 - Stephen M. Bainbridge, MS, JD 

Laura Nyantung Beny, PhD, JD, Assistant Professor of Law at the University of Michigan, in her Winter 2007 Journal of Corporation Law article, "Insider Trading Laws and Stock Markets Around the World: An Empirical Contribution to the Theoretical Law and Economics Debate," wrote:

"...[I]nsider trading undermines stock price accuracy because it discourages arbitrage [The simultaneous purchase and sale of an asset in order to profit from a difference in the price.] traders by increasing the risk of expropriation [The taking over of private property by the government.] and/or by stifling competition in the market for information, and/or it increases insiders' incentives to manipulate information disclosure.."

Winter 2007 - Laura Nyantung Beny, PhD, JD