ANN ARBOR—Countries with stricter insider trading laws and enforceable criminal sanctions are likely to have stock prices that better reflect a company’s performance, more stock owners, and more liquid stock markets, according to new research at the University of Michigan.

"My preliminary results suggest that there is a positive correlation between the level of a country’s stock market development and the stringency of its insider trading laws and enforcement," said Laura Beny, an assistant law professor in the U-M Law School. "The open question is whether these laws and their enforcement cause stock market development or instead whether countries with more developed stock markets tend to implement tougher laws for political or economic reasons."

"Nevertheless, my results are at least consistent with policy arguments that favor banning insider trading," Beny said. "They suggest that governments seeking to develop their stock markets and thereby to facilitate industrial investment might want to consider implementing tougher insider trading laws and enforcement. They also suggest why individual investors might worry about unregulated insider trading: it can reduce market transparency and liquidity, making it difficult for investors to interpret changes in stock prices and to allocate their savings efficiently."

The investing public has become increasingly concerned about corporate malfeasance. Beny explored the relationship between insider trading laws and financial structure and performance in 33 countries. The research appears in the spring 2005 issue of American Law and Economics Review.

In countries whose insider trading laws contain stronger penalties for trading violations, large public corporations have more widespread ownership, she said, meaning there are more individuals holding that company’s stock.

Stronger insider trading laws also coincide with more informative stock prices. The informativeness of a stock’s price is a measure of how much information is gleaned about the company from its stock price. If the price is not informative, it indicates little about the company’s health. If it is informative, it tells more about the company’s health.  

Beny’s preliminary findings also suggest that some combination of fines and jail time (or other criminal sanctions) might be desirable for countries that wish to deter insider trading. While the United States has the most vigorous insider trading enforcement regime, more countries, including those with emerging stock markets, have or are adopting insider trading laws and are increasingly enforcing such laws, Beny said.

"There is definitely a global trend toward more unfavorable legal and ethical attitudes toward insider trading," Beny added.

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Beny

American Law and Economics Review