Research Handbooks in Corporate Law and Governance series
Edited by Stephen M. Bainbridge
Chapter 8: Decision theory and the case for an optional disclosure-based regime for regulating insider trading
This chapter is being drafted amid what the Wall Street Journal has dubbed “an unprecedented era of insider trading prosecutions.” In just over two years, the U.S. government has secured 56 guilty pleas or convictions out of 63 individuals charged with insider trading. Given the extensive enforcement resources currently allocated toward insider trading prosecutions, one might infer that stock trading on the basis of material, nonpublic information is an unmitigated “bad.” But that is most certainly not the case. As Stephen Bainbridge details in the Introduction to this Handbook, stock trading on the basis of material, nonpublic information may create social benefits as well as harms. Moreover, particular instances of insider trading will differ in terms of the amount of social harm or benefit they occasion: some instances will be, on net, harmful; others will create a net social benefit. Insider trading is, in short, a “mixed bag” type of economic activity. Regulating mixed bag behavior is a tricky business. Liability rules may err in two directions: they may condemn or discourage good instances of the behavior (i.e., produce “Type I errors”), or they may acquit or encourage bad instances (i.e., produce “Type II errors”). In either case, social welfare suffers.
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