Insider Trading and Real Activities Manipulation through Overproduction

• In Event: Analytical models
  In Paper Session: Analytical Models

Abstract

Corporate insiders, particularly managers, have access to their firms' private information as well as control over their firms' operational decisions. In this paper, we consider a setting where managers manipulate the firms' real activities in anticipation of subsequent insider trading opportunities. We find these managers choose production quantities that are strictly higher than the quantities absent insider trading. The increased production outputs lead to lower firm profits but higher consumer surplus. When we allow the managers to trade not only in their own firms but also in their rival firms' stocks, we find that the competition among insiders in the financial market drives down the expected insider trading profits and their incentives to distort production decisions. That is, the competition in the financial market softens the competition in the product market, indicating an implicit substitutable relation between the competitions in these two markets.

Authors

• Hui Chen, University of Zurich

• Bjorn Jorgensen, London School of Economics