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Optimal Contracting and Insider Trading Restrictions

Authors

  • PAUL E. FISCHER

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    • Faculty of Commerce and Business Administration, The University of British Columbia, Vancouver, B.C., Canada V6T 1Z2. The contents of this paper were drawn from my dissertation which was completed at the University of Rochester. I have benefited greatly from discussions with and advice from Robert King and Jerry Feltham. I am also indebted to Thomas Cooley, Jack Hughes, James Kahn, William Schwert, Raman Uppal, David Heike, participants at the UBCOW accounting conference, the University of Minnesota accounting workshop, the University of British Columbia finance workshop, an anonymous referee, and the editor for their comments. I am responsible for any remaining errors.

ABSTRACT

Restrictions on trading by insider agents are analyzed using an optimal contracting framework. Prohibition of insider trading is shown to be Pareto preferred if, and only if, a revelation or moral hazard problem exists. If prohibition of insider trading is valuable, then trade registration with a delay is shown to be as valuable as complete prohibition. Short selling restrictions, however, are generally of less value than complete prohibition. Finally, regulation of insider agent trading by governmental institutions and/or professional associations is discussed.

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