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Insider Trading in Financial Signaling Models

Authors

  • MARK BAGNOLI,

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    • Bagnoli is from the School of Business, Indiana University, and Khanna is from the School of Business, University of Michigan. We wish to thank Robert Battalio, Ted Bergstrom, Eli Berkovitch, David Brown, Mike Fishman, Craig Holden, Ronen Israel, Kose John, Bart Lipman, M. P. Narayanan, Steve Slezak, Anjan Thakor and the participants in the IU and the University of Michigan finance seminars for helpful comments. This paper has been substantially improved by the referees and the comments and suggestions of the editor, René Stulz. As always, we are responsible for any errors.

  • NAVEEN KHANNA

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    • Bagnoli is from the School of Business, Indiana University, and Khanna is from the School of Business, University of Michigan. We wish to thank Robert Battalio, Ted Bergstrom, Eli Berkovitch, David Brown, Mike Fishman, Craig Holden, Ronen Israel, Kose John, Bart Lipman, M. P. Narayanan, Steve Slezak, Anjan Thakor and the participants in the IU and the University of Michigan finance seminars for helpful comments. This paper has been substantially improved by the referees and the comments and suggestions of the editor, René Stulz. As always, we are responsible for any errors.


ABSTRACT

We study the impact of voluntary trade by the manager. We find that, in contrast to standard signaling models, an action is good news for some firms and bad news for others, depending on observable characteristics of the firm, its managers, and their compensation plans. Further, voluntary trade eliminates separating equilibria and thus the possibility of exactly inferring the manager's private information. This may cause the manager to take inefficient actions so as to earn trading profits. Such undesirable behavior can be more effectively constrained by compensation contracts based on phantom shares or nontradeable options instead of large stockholdings.

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