Research Handbooks in Law and Economics series
Edited by Claire A. Hill and Brett H. McDonnell
Chapter 22: Self-Dealing by Corporate Insiders: Legal Constraints and Loopholes
Vladimir Atanasov, Bernard Black, and Conrad S. Ciccotello Abstract: Insiders (managers and controlling shareholders) can extract (tunnel) wealth from firms using a variety of methods. This chapter examines the different ways in which US law limits, or fails to limit, three types of self-dealing transactions – cash flow tunneling, asset tunneling, and equity tunneling. We examine how US corporate, securities, bankruptcy, and tax law, accounting rules, and stock exchange rules impact each form of self-dealing, and identify weaknesses in these rules. We argue that a variety of complex asset and equity transactions, as well as equity-based executive compensation, can escape legal constraints. We propose changes in corporate, disclosure, and shareholder approval rules to address the principal gaps that emerge from our analysis. 1. INTRODUCTION1 Managers and controlling shareholders (insiders) can extract (tunnel) wealth from firms using a variety of self-dealing transactions. Self-dealing occurs across both developed2 and developing3 markets. It impacts the value of shares and the premiums paid for corporate control.4 This chapter studies how effectively US rules limit self dealing by insiders of public companies. We consider three broad types of self-dealing transactions: cash flow tunneling, in which insiders extract some of the firm’s current cash flows; asset tunneling, in which insiders buy (sell) assets from (to) the firm at below (above) market prices; and equity tunneling, in which insiders acquire equity at below market price, either from the firm through an equity issuance or from other shareholders, often in a freezeout. We also examine how a broad set...
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