Document Type

Article

Abstract

When insider trading prohibitions limit the ability of insiders (or of a corporation itself) to use material non-public information to trade a particular firm’s stock, there may be incentive to use the information to trade instead on the stock of that firm’s rivals, suppliers, customers, or the manufacturers of complementary products. We refer to this form of trading as trading in stock substitutes. Stock substitute trading by a firm is legal. In many circumstance, substitute trading by employees is also legal. Trading in stock substitutes may be quite profitable, and there is anecdotal evidence that employees often engage in such trading. Our analysis suggests that substitute trading is less socially desirable than traditional insider trading. We recommend a set of disclosure rules designed to clarify existing law and provide information on the extent of stock substitute trading. We also discuss possible changes in the law that might limit inefficient trading in stock substitutes.

Date of Authorship for this Version

4-2-2001

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