Outsider Trading as an Incentive Device
- Author(s): Larry Ribstein, Bruce Kobayashi
- Date Posted: 2006
- Law & Economics #: 06-16
- Availability: Full text (most recent) on SSRN
Outsiders often have and seek to trade on material nonpublic information about firms. For example, lawyers have traded on advance information about the filing of a lawsuit, a social activist has announced a plan to trade on advance information of a boycott, and a hedge fund operator has engaged in a controversial trading maneuver in a control contest. Trading on nonpublic information is generally permitted if the information was not misappropriated or accompanied by fraud or manipulation or other misconduct. However, recent public focus on the above transactions signals possible regulation in some specific outsider trading situations. More generally, Ayres and Choi propose giving firms broad rights to decide whether outsider trading in their stocks will be regulated. We argue against broad regulation on the basis that outsider trading can provide incentives for socially beneficial conduct. In particular, outsider trading provides an important way to capitalize on investments in intellectual property that are not otherwise protected by the intellectual property laws. Understanding of these benefits is crucial in determining the appropriate limits of regulation.