More on The Case for Insider Trading: Legalize It!
Suppose, for example, that shares of Acme Inc. are now selling for $50 per. Suppose also that an insider knows that Acme’s CEO and CFO have been cooking Acme’s books to make Acme appear to the public to be more profitable than it really is. If that insider can trade on that non-public information — obviously, by shorting Acme stock — the price of Acme stock will start to fall immediately upon the commencement of such insider trading.
Any trader who buys Acme stock after this insider trading commences gets a ‘fairer’ price — a more truthful price — than that trader would have gotten if Acme’s shares were still trading at $50 due to the fact that information about Acme’s true financial state remained private and unincorporated into Acme’s share price.
To the extent that insider trading causes prices to reflect asset values more quickly and more accurately, general investors should be more confident in asset markets and, hence, more likely to invest their earnings in such markets.
From Don Boudreaux at Cafe Hayek, following up on his WSJ article "Learning to Love Insider Trading."