Insider Trading from a Value Investing Perspective

I saw an article on (I think) CNBC the other day arguing that rules against insider trading are pointless because allowing insiders to trade would improve the efficiency of the market and allow a company’s true value to be known.

I might be reinventing the wheel here, but it occurred to me that this argument crumbles when you come at it from an ownership (value investing) point of view. It distorts the fundamental relationships involved. If you’re buying stock in a company, you’re buying ownership of that company. As the owner, you have certain rights and expectations. One is that the people who work in the company – that is, work for you – ought to be serving your best interests. Everyone from the CEO on down is a steward of your investment. Thing is, it’s hard to trust them with your investment: there’s the principal-agent problem. There isn’t any guarantee that their self-interest is aligned with yours.

Arguing for insider trading on the basis of market effeciency doesn’t make sense; all it does is exacerbate the principal-agent problem for owners. Corporate leaders serve the owners (shareholders), not the idea of “market efficiency.” Allowing them to act otherwise decouples their self-interest from the company’s, which is the last thing that owners working to better align executive/owner interests want or need. Owners of a privately-owned business would probably have a good laugh at the idea that employees should be able to profit at the owner’s expense if the business is failing (or, worse yet, if they are failing!), so why should a publicly-traded business be treated differently? This just seems like a knee-jerk reaction that “regulation bad, freedom good!”

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