NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

The Effects of Insider Trading on Insiders' Choice Among Risky Investment Projects

Lucian Arye Bebchuk, Chaim Fershtman

NBER Technical Working Paper No. 96
Issued in February 1991
NBER Program(s):   ME

This paper studies certain effects of insider trading on the principal-agent problem in corporations. Specifically, we focus on insiders' choice among investment projects. Other things equal, insider trading leads insiders to choose riskier investment projects, because increased volatility of results enables insiders to make greater trading profits if they learn these results in advance of the market. This effect might or might not be beneficial, however, because insiders' risk-aversion pulls them toward a conservative investment policy. We identify and compare insiders' choices of projects with insider trading and those without such trading. We also study the optimal contract design with insider trading and without such trading, thus identifying the effects that allowing such trading has on other elements of insiders' compensation. Using these results, we identify the conditions under which insider trading increases or decreases corporate value by affecting the choice of projects with uncertain returns .

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Document Object Identifier (DOI): 10.3386/t0096

Published: Journal of Financial and Quantitative Analysis, vol. 29, no. 1, pp. 1-4 (1994)

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