Insider Trading Restrictions and Insiders’ Supply of Information: Evidence from Reporting Quality

Abstract

We exploit the natural experiment of first-time enforcement of insider trading laws to investigate the relationship between insider trading opportunities and insiders’ supply of information. We propose that insider trading opportunities curtail the informational efficiency of financial markets by motivating insiders to reduce financial reporting quality for the purpose of increasing their informational advantage over outsiders and extracting trading profits. Using data from 39 countries over the 1988-2004 period, we find that the quality of financial reporting increases significantly after the initial enforcement of insider trading laws in countries with a strong legal infrastructure. Further analyses show that the increase is concentrated in firms that are not closely held. In addition to uncovering a channel through which insider trading restrictions affect the information environment, our evidence also highlights the importance of country- and firm-level governance structures in determining the consequences of insider trading restrictions.