Legal Risk and Insider Trading |
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| Authors: | MARCIN KACPERCZYK EMILIANO S. PAGNOTTA |
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| Affiliation: | 1. Marcin Kacperczyk is at Imperial College London and CEPR. Emiliano S. Pagnotta is at Singapore Management University. Previous versions of this article were circulated and presented under the titles “Becker Meets Kyle: Legal Risk and Insider Trading,” “Becker Meets Kyle: Inside Insider Trading,” and “Inside Insider Trading.” Kacperczyk acknowledges research support from European Research Council Consolidator Grant 682156. Pagnotta acknowledges research support from the Lee Kong Chian Fellowship Grant. We are indebted to Editor Wei Xiong, the Associate Editor, and two anonymous referees for insightful and helpful comments. For comments and helpful conversations, we thank Uptal Bhattacharya;2. Lauren Cohen;3. Fany Declerk;4. Itamar Drechsler;5. Vyacheslav Fos;6. Ruslan Goyenko;7. Chris Hansman;8. Wei Jiang;9. Peter Koudijs;10. Pete Kyle;11. Pascal Maenhout;12. Lasse Pedersen;13. Ioanid Rosu;14. Natasha Sarin;15. Michela Verardo;16. Xavier Vives;17. Luigi Zingales;18. and seminar participants at Arizona State University, IESE Business School, Imperial College London, The Wharton School of the University of Pennsylvania, the University of Technology Sydney, the City University of Hong Kong, the University of Bonn, the Asia-Pacific Microstructure Exchange Seminar, the 2018 Buyside Conference (London), the 2018 Dolomiti Winter Finance Conference, the 2018 World Finance Conference (Dubai), the 2018 European Financial Association Conference (Warsaw), the 2018 National Bureau of Economic Research Summer Institute on Crime, the 2019 SFS Cavalcade (Pittsburgh), the 2019 Paris Dauphine Microstructure Workshop, the 2019 Capri Economics Conference, the 2019 CFM-Imperial Workshop on Market Microstructure, the 2020 American Financial Association Meetings (San Diego), the 2021 FIRS Meetings, and the 2021 Western Finance Association Meetings. We have read The Journal of Finance disclosure policy and have no conflicts of interest to disclose. |
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| Abstract: | Do illegal insiders internalize legal risk? We address this question with hand-collected data from 530 SEC (the U.S. Securities and Exchange Commission) investigations. Using two plausibly exogenous shocks to expected penalties, we show that insiders trade less aggressively and earlier and concentrate on tips of greater value when facing a higher risk. The results match the predictions of a model where an insider internalizes the impact of trades on prices and the likelihood of prosecution and anticipates penalties in proportion to trade profits. Our findings lend support to the effectiveness of U.S. regulations' deterrence and the long-standing hypothesis that insider trading enforcement can hamper price informativeness. |
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