2024 Theses Doctoral

Does Insider Trading Enforcement Always Yield Positive Consequences for the Stock Market? Evidence from U.S. vs. Newman

Lee, Shin Woo

This paper examines the impact of reduced insider trading enforcement on the stock market using a unique and plausibly exogenous U.S. court ruling that undermines the SEC’s ability to prosecute insider trading defendants in court. Contrary to the conventional view, the study finds that the court ruling has positive effects on liquidity and stock price, consistent with the idea that stock prices become more informative when insider trading enforcement is reduced.

The effects are less positive for firms with high ex-ante stock price informativeness, as the benefits of reduced insider trading enforcement are smaller for these firms. However, liquidity deteriorates in pre-earnings announcement periods after the court ruling, as investors anticipate forthcoming information and delay their trades until the announcement, due to heightened risks associated with trading against those with private information.

In sum, this paper shows that the effect of reduced insider trading enforcement on liquidity and stock price could be positive overall. This study holds implications for the SEC, which aims to regulate insider trading for a fair market while also considering liquidity to maintain an efficient market.