Are corporate governance mechanisms effective in reducing insider trading profits?

Corporate insiders have the opportunity to profit from share trading becauseof their informational advantage over outsiders such as shareholders. Theseshareholders face agency costs when insiders’ interests are not fully alignedwith their own. In an imperfect world where no contract can fully eliminatethe potential for managerial self-dealing, prospects for opportunisticbehaviour increase with information asymmetry. Internal and externalgovernance mechanisms have been used to reduce this informationasymmetry through the monitoring of management’s decisions andactivities. We use a selection of these mechanisms to examine their effecton the profits from insider trading activity, employed here as a proxy forinformation asymmetry. In our sample, firms with disclosed trading policieswere larger in size, had higher proportions of non-executive directors onboards and audit committees, had chairpersons who are not also CEOs andlower levels of director and block ownership. The results showed that theprofits insiders earned were affected by whether a firm had a disclosedtrading policy and also by the proportion of block ownership. These findingssuggest that blockholders’ monitoring of management’s activities can bepotentially more effective in limiting insider profits than self-monitoringthrough governance mechanisms.