Abstract
The current paper produces the very first experiment on the relationship between insider trading and earnings management in an unregulated scenario, where the decision of misreporting only depends on ethical considerations. Using a price formation model based upon the excess of supply/demand, but also on the difference between the reported and real earnings of the firm, our results indicate that (1) insiders systematically misreport earnings, (2) earnings management is perceived as a self-dealing strategy, (3) insiders time opportunistically their transactions, thus, achieving higher returns than outsiders, and (4) insider information is not properly conveyed in prices, what erodes market efficiency. Therefore, earnings management and insider trading induce inefficiencies on stock prices and affect the reliability and confidence on financial markets. We thus advocate for the enforcement of financial market regulation since the ethical reasoning of investors is not enough to prevent opportunistic practices.
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