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Note: what is wrong with insider dealing

Published online by Cambridge University Press:  02 January 2018

David Campbell
David Campbell*
Affiliation:
Sheffield Hallam University
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Extract

In this journal Harry McVea recently has asked ‘What's Wrong with Insider Dealing?’ One imagines that many readers will have thought the question rather supererogatory, but Mr McVea more than adequately shows that just this question is very live in many of the leading works on the economics of stock markets. One is here dealing with seminal works such as those of Easterbrook, Fischel, Hirshleifer and Manne which are identified with the discipline of financial economics as such. Mr McVea, in my opinion rightly, concludes that insider dealing is wrong, but does so in a way that I think is wrong headed, particularly in the way that one fears his conclusion will be interpreted by most readers of this journal. Though there is much that is admirable in Mr McVea's paper, his conclusion is uncompelling, and is so for a reason with which I think it important to take issue.

Type
Research Article
Information
Legal Studies , Volume 16 , Issue 2 , July 1996 , pp. 185 - 199
Copyright
Copyright © Society of Legal Scholars 1996

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References

1. (1995) 15 Legal Studies 390 . Unattributed references in parentheses in the main text are references to this paper.

2. At their heart, these arguments raise the fundamental claim that private property in the means of production (and hence money) is necessary for rational price formation. M Weber Economy and Society (Berkeley (USA): University of California Press, 1978) pp 109–13.

3. To Mr McVea's thorough citation of most of the leading works in this literature, which it would be pointless of me to repeat, it is really necessary to add only F Black and M Scholes ‘The Pricing of Options and Corporate Liabilities’ (1973) 81 Journal of Political Economy 637 on the fundamental theorem of asset price.

4. This especially is so when Mr McVea concedes that, in effect, the necessary cost-benefit calculation has not been carried out with any precision for the rather compelling reason that it has not indeed been carried out with reference to any ‘loss or injury to an individual or specific group’ (p 413).

5. M Walzer Spheres of Justice (Oxford: Basil Blackwell, 1983) ch 4.

6. R Nozick Anarchy, State and Utopia (New York (USA): Basic Books, 1974) pp 155–60.

7. J Rawls A Theory of Justice (Cambridge (USA): Belknap Press, 1971) pp 83–90.

8. D Campbell ‘The Relational Constitution of the Discrete Contract’, in D Campbell and P Vincent-Jones (eds) Contract and Economic Organisation: Socio-legal Initiatives (Aldershot, Dartmouth Press, 1996) pp 60–1.

9. I have set out the relevant economics in their relationship to contract in D Campbell, ‘Introduction,’ in D Campbell and S Clay, Long-term Contracting: A Bibliography and Review of the Literature (Oxford, Centre for Socio-legal Studies, 1995) pp 3–38.

10. KJ Arrow ‘Pareto Optimality with Costly Transfers,’ in KJ Arrow, Collected Papers, vol 2 (Cambridge (USA): Belknap Press, 1983) p 290.

11. L Walras Elemenrs of Pure Economics (Philadelphia (USA) Orion Editions, 1983) lesson 12.

12. V Pareto Manual of Political Economy (New York (USA): Augustus M Kelley, 1971) ch 6, sec 33.

13. Kj Arrow and G Debreu General Competitive Equilibrium,’ in Arrow, Collected Papers, vol 2, op cit, pp –2.

14. RH Coase ‘The Nature of the Finn,’ in RH Coase The Firm, the Market and the Law (Chicago (USA): University of Chicago Press, 1988) pp 38–41 and RH Coase ‘The Problem of Social Cost,’ in Coase, The Firm, the Market and the Law, pp 114–9.

15. HA Simon Administrative Behviour (New York (USA): Free Press, 1976) p xxviii.

16. G Akerlof The Market for Lemons’ (1970) 84 Quarterly Journal of Economics 488 and MV Pauly ‘The Economics of Moral Hazard’ (1968) 58 American Economic Review 531.

17. OE Williamson ‘Transaction Cost Economics: The Governance of Contractual Relations,’ in OE Williamson, Economic Organisation (Sussex: Harvester Wheatsheaf) 1986) p 124.

18. Coase ‘The Problem of Social Cost,’ op cit, p 114.

19. OE Williamson, The Economic Institutions of Capitalism (New York (USA): Free Press, 1985) p 41.

20. Cj Goetz and Re Scott The Mitigation Principle’ (1983) 96 Virginia Law Review 968 n 5.

21. L Hurwicz The Design of Mechanisms for Resource Allocation’ (1973) 63 American Economic Review 1.

22. Coase ‘The Nature of the Firm,’ op cit, p 38.

23. The distinction I am drawing between ‘information costs’ and ‘communication costs’ is taken from KJ Arrow ‘The Organisation of Economic Activity: Issues Pertinent to the Choice of Market Versus Non-market Allocation,’ in Arrow, Collected Papers, vol 2, op cit, p 149. This distinction is similar to that drawn between ‘discovering’ and ‘negotiating’ in Coase, ‘The Nature of the Finn,’ op cit, p 38. To lawyers coming fresh to the literature, however, perhaps the point is made most clear by the distinction drawn in CJ Dahlman ‘The Problem of Externality’ (1979) 22 Journal of Law and Economics 148 between ‘search and information costs,’‘bargaining and decision costs’ and ‘policing and enforcement costs.’ The latter two would constitute ‘communication’ costs in the terms used here.

24. I leave aside the sociologically highly significant point about the background existence of the physical and social structures which allow interaction at all and the economic and political structures which allow regular exchange. IR Macneil The New Social Contract (New Haven (USA): Yale University Press, 1980) ch 1.

25. Campbell ‘The Relational Constitution of the Discrete Contract’.

26. HH Gossen The Law of Human Nature (Cambridge (USA): MIT Press, 1983) ch 3 and WS Jevons The Theory of Political Economy (Harmondsworth: Penguin, 1970) ch 3.

27. D Campbell ‘The Relational Constitution of Contract and the Limits of ‘Economics:’ Kenneth Arrow on the Social Background of Markets’ in S Deakin and J Michie (eds) Contracts, Cooperation and Competition, forthcoming. The rest of this paragraph is based on a section of this chapter.

28. Arrow ‘The Organisation of Economic Activity: Issues Pertinent to the Choice of Market Versus Non-market Allocation,’ op cit, p 151.

29. Arrow ‘the Organisation of Economic Activity: Issues Pertinent to the Choice of Market Versus Non-market Allocation,’ op cit, pp 15 1–2.

30. KJ Arrow ‘Information and Economic Behaviour,’ in KJ Arrow, Collected Papers, vol 4 (Cambridge (USA): Belknap Press, 1984) p 150.

31. Kj Arrow The Economics of Moral Hazard: Further Comment,’ in Arrow, Collected Papers, vol 4. op cit, pp 104–5.

32. RH Coase ‘The Firm, the Market and the Law,’ in Coase The Firm, the Market and the Law, op cit, p 3.

33. Coase ‘The Firm, the Market and the Law,’ op cit, p 5.

34. Coase ‘The Firm, the Market and the Law,’ op cit, pp 7–8.

35. Probably the most important way in which the point can be taken up is in discussion of the specification of a commodity which is central to the very formulation of general equilibrium theory. However, this approach is not really helpful to those who are not concerned with the general theory.

36. Coase ‘The Firm, the Market and the Law,’ op cit, pp 9–10. Cf RH Coase ‘The Institutional Structure of Production,’ in RH Coase Essays on Economics and Economists (Chicago (USA): University of Chicago Press, 1994) p 12.

37. Walras, Incidentally, made no mistake here, for though he chose the stock market as an empirical illustration of the workings of an assumed perfect market, he did so in order to select ‘The markets which are best organised from a competitive standpoint.’ Walras, Elements of Political Economy, op cit, pp 83–4 (my emphasis).

38. Y Ben-Porath The F Connection’ (1980) 6 Population and Development Review 6.

39. This is a very under-researched issue. With D Boden and S Picciotto, 1 am hoping to begin the most detailed examination of the actual market processes by which futures exchanges do their business of which I am aware. Such very preliminary interviews as have so far been conducted lead one to believe that the integrity of an exchange is at least as important as its liquidity to those considering whether to deal on it.

40. LG Telser and HN Higinbotham ‘Organised Futures Markets: Costs and Benefits’ (1977) 85 Journal of Political Economy 969. The point has most forcefully been made in the sociological literature. J McCahery and S Picciotto ‘Creative Lawyering and the Dynamics of Business Regulation,’ in Y Dezalay and D Sugarman (eds) Lawyers, Accountants and the Social Construction of Markets (London: Routledge, 1995) pp 260–6.

41. OE Williamson ‘Franchise Bidding for Natural Monopolies’ in Williamson Economic Organisation, op cit, p 259.

42. The modern source of the argument against lying is, of course, I Kant Lectures on Ethics (Indianapolis (USA): Hackett Publishing Company, 1983) pp 224–35. This argument was set out in a commercial context of obvious application to dealing on the exchange. I Kant ‘Grounding for a Metaphysic of Morals,’ in I Kant Ethical Philosophy (Indianapolis (USA): Hackett Publishing, 1983) p 31. I do not mean to, as it were, win the point by weight of citation, but surely that an argument of this provenance is airily dismissed in financial economics is not evidence against the argument but against the economics.

43. I hope it is clear that I am passing no comment on the adequacy of the present form of regulation of insider dealing (nor am 1 wedded to its being regulated). I am merely arguing against the blanket rejection of such regulation on the basis of arguments ignorant of communications costs.

44. Coase ‘The Lighthouse in Economics,’ in Coase The Firm, the Marker and Law, op cit, p 213.

45. Coase ‘The Problem of Social Cost,’ op cit, p 154.

46. Coase ‘The Firm, the Market and the Law,’ op cit, p 30.

47. AC Pigou The Economics of Welfare (4th edn, London: Macmillan, 1932) pt 2.

48. Rg Lipsey and Kj Lancaster The General Theory of Second Best’ (1956) 24 Review of Economic Studies 11.

49. Wj Baumol and Df Bradford Optimal Departures from Marginal Cost Pricing’ (1970) 60 American Economic Review 280.

50. E Streissler and W Neudeck ‘Are there Precursors to the Idea of Second Best Optimisation?’, in D Bös and C Siedl (eds) Welfare Economics of the Second Best (Wien (Germany) Springer-Verlag, 1986) p 239.

51. Arrow ‘The Organisation of Economic Activity: Issues Pertinent to the Choice of Market Versus Non-market Allocation,’ p 149.

52. Mr McVea is, in fairness, quite prepared to countenance a ‘messy’ answer so long as it is the right one (p 413).

53. Coase's Own principal examples of what he calls ‘blackboard economics’ are unwarranted claims that certain goods are public goods. Coase ‘The Firm, the Market and the Law,’ op cit, pp 19–20, 28–9.

54. Coase ‘The Firm, the Market and the Law,’ op cit, p 28.

55. RH Coase ‘Notes on the Problem of Social Cost,’ in Coase The Firm, the Market and the Law, op cit, p 185.

56. G Soros The Alchemy of Finance (rev edn, New York: John Wiley, 1994) p 318.

57. For the latest major example of outright scandal which has breen brought to light, see D Greising and L Morse Brokers, Bagmen and Moles (New York (USA): John Wiley, 1991).

58. C Bruck, The Predators' Ball (rev edn, New York (USA): Penguin Books. 1989) pp 14–5.

59. Securities Review Committee (Chair I Hay Davidson), The Operation and Regulation of the Hong Kong Securities Industry (Hong Kong: Hong Kong Government Printer, 1988) appendix I, para 23.

60. L Course Ronald Li Acquitted after Reversing His Guilty Plea’ (25 June 1992) South China Morning Post 1.