The Real Effect of The Initial Enforcement of Insider Trading Laws

Restricting insider trading enhances price informativeness by encouraging investors to acquire and trade on private information. Therefore, corporate investment should be more sensitive to stock prices and more efficient as stock prices provide more precise information to guide the investment decisions. Consistent with this hypothesis, we find that the investment-to-price sensitivity increases significantly after a country’s initial enforcement of insider trading laws. The increase is positively associated with the enhancement of price informativeness around the enforcement. Finally, accounting performance is improved after the enforcement and the improvement is in general positively associated with the increase in the investment-to-price sensitivity. We thank Utpal Bhattacharya, Yanmin Gao, Ole-Kristian Hope, Jun-Koo Kang, Michael Lemmon, Jiang Luo, Pierre Liang, Gordon Richardson, Lakshmanan Shivakumar, Avanidhar Subrahmanyam, Sheridan Titman, Nan Zhou, and participants of seminars held at the City University of Hong Kong, the Hong Kong Polytechnic University, the Hong Kong University of Science and Technology, and the University of Texas at Dallas for helpful comments and suggestions and Shujing Wang for excellent research assistance. All remaining errors are our own. * Corresponding author: K.C. John Wei, Department of Finance, Hong Kong University of Science and Technology, Clear Water Bay, Kowloon, Hong Kong. Tel: (852)-2358-7676; Fax: (852)-2358-1749. Email: [email protected]. The Real Effect of the Initial Enforcement of Insider Trading Laws Abstract Restricting insider trading enhances price informativeness by encouraging investors to acquire and trade on private information. Therefore, corporate investment should be more sensitive to stock prices and more efficient as stock prices provide more precise information to guide the investment decisions. Consistent with this hypothesis, we find that the investment-to-price sensitivity increases significantly after a country’s initial enforcement of insider trading laws. The increase is positively associated with the enhancement of price informativeness around the enforcement. Finally, accounting performance is improved after the enforcement and the improvement is in general positively associated with the increase in the investment-to-price sensitivity.