Across the globe, many view insider trading as a threat to stock market integrity and efficiency. This is evidenced by the fact that, as of 2000, eighty-seven countries had enacted insider trading legislation and thirty-eight had prosecuted insider trading at least once. However, these laws vary in stringency and many of them were enacted only recently. Enforcement intensity also varies across countries, with some countries regularly enforcing insider trading laws and others allowing insiders to trade with impunity notwithstanding the laws on the books. The aim of this study, The Political Economy of Insider Trading Law and Enforcement: Law vs. Politics? International Evidence, is to provide a greater understanding of the political and economic determinants of the differential timing of insider trading legislation and enforcement across countries.
Those who oppose insider trading regulation often rely on the private interest theory of regulation to explain how these laws, despite their presumed inefficiency, are enacted to satisfy influential private interests. In contrast, those who support insider trading restrictions rely on the public interest theory of regulation to explain how insider trading regulation is enacted to address market failures. The two theories are rarely merged into a single framework. However, because insider trading and its regulation concern the distribution of property rights to use private corporate information, the issue has both private (distributional) and public (efficiency) dimensions. I take both dimensions into account in this study.
The article’s main (and intriguing) empirical finding, based on data from a cross section of countries between 1980 and 1999, is that a country’s political system—not its legal or financial system—best explains its proclivity to regulate insider trading. Specifically, more democratic nations enacted and enforced insider trading laws earlier than less democratic nations, controlling for wealth, financial development, legal origin, and other factors. Furthermore, controlling for the same factors, left-leaning governments were latecomers to insider trading legislation and enforcement relative to right-leaning and centrist governments.
These findings are generally consistent with the political theory of capital market development and inconsistent with the legal origins theory of capital market development. They also challenge theoretical claims that insider trading restrictions are market-inhibiting because the kinds of governments that appear more inclined to regulate insider trading are precisely the governments that are generally thought to pursue market-promoting policies. That is, the results suggest that market-oriented democracies are more likely to overcome entrenched insider opposition to capital market development than authoritarian states.
The full text of the article is available here.