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Updated 3:00 PM May 2, 2005
 

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  Research
Insider trading laws matter to stock market development

Countries with stricter insider trading laws and enforceable criminal sanctions are likely to have stock prices that better reflect a company's performance, according to new research at U-M.

The finding also shows these countries are likely to have more stockowners and more liquid stock markets.

"My preliminary results suggest that there is a positive correlation between the level of a country's stock market development and the stringency of its insider trading laws and enforcement," says Laura Beny, an assistant professor in the Law School. "The open question is whether these laws and their enforcement cause stock market development, or instead whether countries with more developed stock markets tend to implement tougher laws for political or economic reasons."

The investing public has become increasingly concerned about corporate malfeasance. Beny explored the relationship between insider trading laws and financial structure and performance in 33 countries. The research appears in the spring 2005 issue of American Law and Economics Review.

"My results are at least consistent with policy arguments that favor banning insider trading," Beny says. "They suggest that governments seeking to develop their stock markets and thereby to facilitate industrial investment might want to consider implementing tougher insider trading laws and enforcement. They also suggest why individual investors might worry about unregulated insider trading: it can reduce market transparency and liquidity, making it difficult for investors to interpret changes in stock prices and to allocate their savings efficiently."

In countries whose insider trading laws contain stronger penalties for violations, large public corporations have more widespread ownership, she says, meaning there are more individuals holding that company's stock.

Stronger insider trading laws also coincide with more informative stock prices. The informativeness of a stock's price is a measure of how much information is gleaned about the company from its stock price. If it is informative, it tells more about the company's health.

Beny's findings also suggest that some combination of fines and jail time or other criminal sanctions might be desirable for countries that wish to deter insider trading. While the United States has the most vigorous insider trading enforcement regime, more countries, including those with emerging stock markets, have or are adopting insider-trading laws and are increasingly enforcing such laws, Beny says.

"There is definitely a global trend toward more unfavorable legal and ethical attitudes toward insider trading," she adds.

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