Insider trading as a tool for efficiency

The Life: Insider trading is usually view as providing investors with an unfair advantage. But could it actually be good for markets? One top finance professor believes it could.

Meziane Lasfer, a Cass Business School finance professor, is ranked among Europe's top 20 economic researchers. Jaime Puebla / The National

Insider trading, which is illegal but not criminal in the UAE, is usually viewed as providing an unfair advantage. But could it actually be good for markets? The Cass Business School finance professor Meziane Lasfer, who is ranked among Europe's top 20 economic researchers, believes it could.

What is insider trading?

In general, we mean that there are insiders, i.e., the managers and board members, who trade on inside information before the company announces [the] information, like, for example, a takeover, earnings or any price-sensitive information. [They] take advantage of their private information, and therefore that distorts the equilibrium in the market … But, in general, managers could trade well before the information for other reasons.

Such as?

They could assess that their company is mispriced … If I know that my company is undervalued, I could probably go and buy shares because I know that the market will revalue my company without announcing any news. It is just because my company is relatively stable, but in terms of its operating performance, the price of my company is going down, I feel that my company is undervalued, therefore I go and buy shares … There are other reasons that might push managers to trade, not related at all to any specific information that is going to be released.

So what is the benefit of making insider trading legal?

For the managers, they make money. For the market, there is also a big benefit in the sense that you are making the market more efficient - that you are disclosing the information before the actual disclosure of the information.

I don't see it. Can you explain how insider trading could make markets more efficient?

What drives stock markets? Demand is one [thing], but that demand is also driven by the information. If there is no information about a company, if the company doesn't release at all its information, if there are no annual accounts and the managers do not have confidence codes, etc., the stock price would be inefficient. You won't trust it because you don't know if the company is worth $100 billion, or whether this company is worth $1bn, or maybe it's worth just $100,000, so the information plays a significant role in the valuation of the company. And the more this information is hidden, the higher the likelihood that this company is going to be mispriced.

What do you think should happen?

We need to define a blackout period where they shouldn't trade, but that blackout period shouldn't be very long, maybe something like one month before the announcement of the information is fine, but you cannot just do it for six months or 10 months. Then the insiders obviously are not going to trade at all. You need to leave the insiders a window where they can trade for, ideally non-information reasons, because they should be good citizens, but even if they trade on the information, at least there is some benefit there - that they make the market a bit more efficient.

* Gillian Duncan