4 Concluding Remarks

This paper has conducted an exploratory study regarding how insider trad-ing regulation may affect product market competition, corporate financtrad-ing decisions, the structure of debt maturity, and small firms incentives to form a strategic alliance.

We considered imperfectly competitive firms that engage in either Cournot or Stackelberg competition with at least one firm faced with an uncertainty in the marginal cost of production. We showed that, as in Brander and Lewis (1986), debt may be used to commit to a high-output reaction function in the product market when insider trading is prohibited, which however may cause productive inefficiency in certain states of nature. When insider trading is allowed, an all-equity firm faced with unit cost uncertainty can naturally commit to a high-output reaction function in the product market without incurring the agency costs associated with the use of debt. Hence insider trading restrictions may lead to excessive use of debt by firms faced with cost uncertainty.

We also demonstrated the relationship between insider trading regulation and viability of competitive firms. We showed that allowing insider trading may resurrect some firms which, because of the huge agency costs associated with debt, can only use equity financing. Allowing insider trading implies a commitment value of equity financing, and hence may make a negative NPV project become one with positive NPV.

We also identified conditions under which allowing insider trading may facilitate the formation of strategic alliance. It has been shown that if forming the alliance creates a new profit component that is independent of the original firm profit, and if this profit component cannot be privately observed before stock trading, then allowing insider trading does encourage small firms to form a strategic alliance. When those conditions fail, allowing insider trading may discourage the formation of strategic alliance.

This research has exhibited several limitations. Among the limitations, we have disregarded the possibility of information acquisition by outside speculators, and hence our theory cannot distinguish inside speculators and outside speculators, nor can we capture the latter’s impact on informational efficiency, as was the focus of Fishman and Hagerty (1992) and Khanna, Slezak, and Bradley (1994). Our analysis cannot address issues concern-ing consumer welfare. Even with the simplifyconcern-ing assumption of quasi-linear preferences the welfare implications of our analysis remain ambiguous. These problems define the directions in which the current research can be further extended and improved upon.

References

1. Admati, A. and P. Pfleiderer, 1991, Sunshine trading and financial market equilibrium, Review of Financial Studies, 4, 443-482.

2. Admati, A. and P. Pfleiderer, 1988, A theory of intraday patterns:

volume and price variability, Review of Financial Studies, 1, 3-40.

3. Admati, A. and P. Pfleiderer, 2000, Forcing firms to talk: financial disclosure and externalities, Review of Financial Studies, 13, 479-520.

4. Admati, A., 1985, A noisy rational expectations equilibrium for multi-asset securities markets, Econometrica, 53, 629-657.

5. Allen, F., 1993, Stock markets and resources allocation, in C. May-ers and X. Vives, eds., Capital Markets and Financial Intermediation, Cambridge: Cambridge University Press.

6. Arrow, K., 1964, The role of securities in the optimal allocation of risk-bearing, Review of Economic Studies, 31, 91-96.

7. Arrow, K., 1970, Essays in the Theory of Risk Bearing, Amsterdam:

North-Holland.

8. Ausubel, L., 1990, Insider trading in a rational expectations economy, American Economic Review, 80, 1022-1041.

9. Back, K., 1992, Insider trading in continuous time, Review of Financial Studies, 5, 387-410.

10. Back, K., 1993, Asymmetric information and options, Review of Fi-nancial Studies, 6, 435-472.

11. Back, K. and H. Pedersen, 1998, Long-lived information and intraday patterns, Journal of Financial Markets, 1, 385-402.

12. Back, K., H. Cao and G. Willard, 2000, Imperfect competition among informed traders, Journal of Finance, 55, 2117-2155.

13. Back, K. and S. Baruch, 2002, Information in securities markets: Kyle meets Glosten and Milgrom, working paper, Washington University at St. Louis.

14. Bagnoli, M., and N. Khanna, 1992, Insider trading in financial signaling models, Journal of Finance, 47, 1905-1934.

15. Biais, B., and P. Hillion, 1994, Insider and liquidity trading in stock options markets, Review of Financial Studies, 7, 743-780.

16. Black, F., 1989, Noise, Journal of Finance, 43, 540-555.

17. Boot, A., and A. Thakor, 1997, Financial system architecture, Review of Financial Studies, 10, 693-733.

18. Bolton, P., and D. Scharfstein, 1990, A theory of predation based on agency problems in financial contracting, American Economic Review, 80, 93-106.

19. Bossaerts, P., 1993, Transaction prices when insiders trade portfolios, Finance, 14, 2, 43-60.

20. Brander, J., and T. Lewis, 1986, Oligopoly and financial structure: the limited liability effect, American Economic Review, 76, 956-970.

21. Brown, D. and R. Jennings, 1989, On technical analysis, Review of Financial Studies, 2, 527-552.

22. Brown, D., and Z. M. Zhang, 1997, Market orders and market efficiency, Journal of Finance, 52, 277-308.

23. Brudney, V., 1979, Insiders, outsiders, and the information advantages under the federal securities laws, Harvard Law Review, 93, 322-376.

24. Bulow, J., J. Geanakoplos, and P. Klemperer, 1985, Multimarket oligopoly:

strategic substitutes and complements, Journal of Political Economy, 93, 488-511.

25. Carlton, D., and D. Fischel, 1983, The regulation of insider trading, Stanford Law Review, 35, 857-895.

26. Chakravarty, S., and C. Holden, 1995, An integrated model of market and limit orders, Journal of Financial Intermediation, 4, 213-241.

27. Chen, Chyi-Mei, and Chia-Hui Chen, 2004, Financial leverage, corpo-rate hedging and product market competition, working paper, National Taiwan University.

28. Chen, Chyi-Mei, and Chien-Shan Han, 2006, Product market compe-tition, insider trading regulation, and optimal managerial contracts, working paper, National Taiwan University.

29. Chiappori, P.-A., I. Macho, P. Rey, and B. Salani´e, 1994, Repeated moral hazard: the role of memory, commitment, and the access to credit markets, European Economic Review, 38, 1527-1553.

30. Debreu, G., 1959, Theory of Value: An Axiomatic Analysis Of Eco-nomic Equilibrium, New Haven: Yale University Press.

31. Dow, J., and G. Gorton, 1997, Stock market efficiency and economic efficiency: Is there a connection? Journal of Finance, 52, 1087-1129.

32. Duffie, D., and C. Huang, 1985, Implementing Arrow-Debreu equilibria by continuous trading of few long-lived securities, Econometrica, 53, 1337-1356.

33. Easley, D., and M. O’Hara, 1992, Time and the process of security price adjustment, Journal of Finance, 47, 577-606.

34. Easterbrook, F., 1981, Insider trading, secret agents, evidentiary privi-leges, and the production of information, Supreme Court Review, 309-365.

35. Easterbrook, F., 1985, Insider trading as an agency problem, in J.W.

Pratt and R. J. Zeckhauser, eds. Principals and Agents: The Structure of Business, Boston: Harvard Business School Press.

36. Faure-Grimaud, A., and D. Gromb, 1999, Trading, voice and exit Over the firm’s life cycle, working paper, MIT.

37. Fischer, P., 1992, Optimal contracting and insider trading restrictions, Journal of Finance, 47, 673-694.

38. Fishman, M., and K. Hagerty, 1992, Insider trading and the efficiency of stock prices, Rand Journal of Economics, 23, 106-122.

39. Fishman, M. and K. Hagerty, 1995, The mandatory disclosure of trades and market liquidity, Review of Financial Studies, 8, 637-676.

40. Froot, Kenneth A., David S. Scharfstein, and Jeremy C. Stein, 1993, Risk management: Coordinating corporate investment and financing policies, Journal of Finance 48, 1629-1658.

41. Fudenberg, D., and J. Tirole, 1986, A ‘signal-jamming’ theory of pre-dation, Rand Journal of Economics, 17, 366-376.

42. Fudenberg, D., and J. Tirole, 1991, Game Theory, Cambridge: MIT Press.

43. Glosten, L., and P. Milgrom, 1985, Bid, ask, and transaction prices in a specialist market with heterogeneously informed traders, Journal of Financial Economics, 14, 71-100.

44. Glosten, L., 1989, Insider trading, liquidity, and the role of the monop-olistic specialist, Journal of Business, 62, 211-235.

45. Gollier, C., 2001, The Economics of Risk and Time, Cambridge: MIT Press.

46. Greenwald, B., and J. Stein, 1991, Transactional risk, market crashes, and the role of circuit breakers, Journal of Business, 64, 443-462.

47. Grossman, S., and M. Miller, 1988, Liquidity and market structure, Journal of Finance, 43, 617-633.

48. Grundy, B. and M. McNichols, 1989, Trade and revelation of informa-tion through prices and direct disclosure, Review of Financial Studies, 2, 495-526.

49. Handa, P., and R. Schwartz, 1996, Limit order trading, Journal of Finance, 51, 1835-1861.

50. Harris, L., and J. Hasbrouck, 1996, Market versus limit orders: the SuperDOT evidence on order submission strategy, Journal of Financial and Quantitative Analysis, 31, 213-231.

51. Hart, O., 1995, Firms, Contracts, and Financial Structure, New York:

Oxford University Press.

52. Hart, O., and B. Holmstr¨om, 1987, The theory of contracts, in Ad-vances in Economic Theory—Fifth World Congress, edited by T. Bew-ley, Cambridge University Press.

53. Holmstr¨om, B., 1979, Moral hazard and observability, Bell Journal of Economics, 10, 74-91.

54. Holmstr¨om, B., and P. Milgrom, 1987, Aggregation and linearity in the provision of intertemporal incentives, Econometrica, 55, 303-328.

55. Holmstr¨om, B., and J. Tirole, 1993, Market liquidity and performance monitoring, Journal of Political Economy, 101, 678-709.

56. Huang, C., and R. Litzenberger, 1988, Foundations for Financial Eco-nomics, New York: North-Holland.

57. Jensen, M., and W. Meckling, 1976, Theory of the firm: Managerial behavior, agency cost and ownership structure, Journal of Financial Economics, 3, 305-360.

58. Jensen, M., 1986, Agency costs of free cash flow, corporate finance, and takeovers, American Economic Review, 76, 323-329.

59. Khanna, N., S. Slezak, and M. Bradley, 1994, Insider trading, outside search, and resource allocation: why firms and society may disagree on insider trading restrictions, Review of Financial Studies, 7, 575-608.

60. Kyle, A., 1985, Continuous auctions and insider trading, Econometrica 53, 1315-1336.

61. Kyle, A., 1989, Informed speculation with imperfect competition, Re-view of Economic Studies, 56, 317-355.

62. Laffont, J.-J., and E. Maskin, 1990, The efficient market hypothesis and insider trading on the stock market, Journal of Political Economy, 98, 1, 70-93.

63. Laffont, J.-J., and J. Tirole, 1993, A Theory of Incentives in Procure-ment and Regulation, Cambridge: MIT Press.

64. Leland, H., 1992, Insider trading: should it be prohibited?, Journal of Political Economy, 100, 4, 859-887.

65. Lin, Yi-Hsuan, 2007, Security design and corporate governance when financial markets are incomplete, Unpublished master thesis, Graduate Institute of Finance, National Taiwan University.

66. Madhavan, A., 1995, Consolidation, fragmentation, and the disclosure of trading information, Review of Financial Studies, 8, 579-603.

67. Manove, M., 1989, The harm from insider trading and informed spec-ulation, Quarterly Journal of Economics, 823-845.

68. Meulbroek, L., 1992, An empirical analysis of illegal insider trading, Journal of Finance, 47, 1661-1699.

69. Newbery, D., 1984, Pareto inferior trade, Review of Economic Studies, 51, 1-12.

70. Parlour, C., 1998, Price dynamics in limit order markets, Review of Financial Studies, 11, 789-816.

71. Pratt, J., 1964, Risk aversion in the small and in the large, Economet-rica, 32, 122-136.

72. Radner, R., 1972, Existence of equilibrium of plans, prices and price expectations in a sequence of markets, Econometrica, 40, 289-303.

73. Rapoport, A., and A. M. Chammah, Prisoner’s Dilemma, Ann Arbor:

University of Michigan Press, 1965.

74. Rochet, J., and J. Vila, 1994, Insider trading with normality, Review of Economic Studies, 61, 131-152.

75. Rock, K., 1987, The role of the specialist’s order book: a possible ex-planation for certain price anomalies, mimeo, Harvard Business School.

76. Rogerson,W., 1985, Repeated moral hazard, Econometrica, 53, 69-76.

77. Scharfstein, D., 1988, The disciplinary role of takeovers, Review of Economic Studies, 185-199.

78. Seppi, D., 1997, Liquidity provision with limit orders and a strategic specialist, Review of Financial Studies, 10, 103-150.

79. Seyhun, H., 1986, Insiders’ profits, costs of trading, and market effi-ciency, Journal of Financial Economics, 16, 189-212.

80. Spiegel, M. and A. Subrahmanyam, 1992, Informed Speculation and Hedging in a Noncompetitive Securities Market, Review of Financial Studies, 5, 307-330.

81. Stein, J., 1987, Informational externalities and welfare-reducing spec-ulation, Journal of Political Economy, 95, 1123-1145.

82. Stein, J., 1988, Takeover threats and managerial myopic, Journal of Political Economy, 96, 61-80.

83. Subrahmanyam, A., 1991, A theory of trading in stock index futures, Review of Financial Studies, 4, 17-52.

84. Subrahmanyam, A., 1991a, Risk aversion, market liquidity, and price efficiency, Review of Financial Studies, 4, 417-442.

85. Sun, T.-S., 1992, Real and nominal interest rates: a discrete-time model and its continuous-time limit, Review of Financial Studies, 5, 581-611.

86. Tirole, J., 1988, The Theory of Industrial Organization, Cambridge:

MIT Press.

87. Vives, X., 1995, Short-term investment and the informational efficiency of the market, Review of Financial Studies, 8, 125-160.

88. Wang, J., 1993, A model of intertemporal asset prices under asymmet-ric information, Revies of Economic Studies, 60, 249-282.

89. Wang, J., 1994, A model of competitive stock trading volume, Journal of Political Economy, 102, 127-168.

NSC 95-2416-H-002-038-

95 8 1 ! 96 7 31 lmO PnStackelbergko p mO Pa q r s O P[ ;tu% v ! w x y z [ ;{ Slezak, & Bradley 1994; Boot & Thakor 1997; Dow & Gorton 1997)ö ÷ ø Q R ù ª ú Û h (Scharfstein 1988; Stein 1988; Holmström & Tirole 1993)û ü ýþ 2 ^ t ± C ì Í

Òt¡ ¢ ï ð + ^ Q R ù ª , ¹ 7(Rogerson 1985; Chiappori, et al.

1994)d Ì tß á M N 3á 8 9 ù : ; ^ - E< = ß á

þ # ¾PB q > (Manove 1989; Laffont & Maskin 1990; Leland 1992; Fischer 1992; Fishman & Hagerty 1992; Khanna, Slezak, & Bradley 1994)t uJ ? q ß á ^ @ I A B S ó

< = C ³ ¥ D E (Admati & Pfleiderer 2000, 1991, Fishman & Hagerty 1995)dç F S G ´ µ t # ¾H x I J ï ð Ì ^ K L a M N O 4 (Seyhun 1986; Meulbroek 1992)t` ° t& P F Q

R × (Securities and Exchange Commission, SEC)i1934 S T Â U a H I d V h H I (Carlton & Fischel 1983)tu¡ ¢

5 F Q M N a S ó lmO PnStackelbergko p mO Pa q r s O P[ ;tu% v ! w x y z [ ;{

; Jensen^< Meckling (1976)^=>?A@

@ U V a th 9 { ¹

" 2 lX & ' 0 m ; X & ' 0 m ; X & ' 0 m ; X & ' 0 m ; n o p q r sn o p q r sn o p q r sn o p q r s H & ' ; t u . v ; t w x y f z {

â ã Ü o ¶ æ à Û Ü a ç~ , Z Sunshine trading and financial market equilibrium, Review of Financial Studies, 4, 443-482.

2. Admati, A. and P. Pfleiderer, 1988, A theory of intraday patterns: volume and price variability, Review of Financial Studies, 1, 3-40.

3. Admati, A. and P. Pfleiderer, 2000, Forcing firms to talk: Financial

disclosure and externalities, Review of Financial Studies, 13, 479-520.

4. Admati, A., 1985, A noisy rational expectations equilibrium for multiasset

securities markets, Econometrica, 53, 629-657.

5. Allen, F., 1993, Stock markets and resources allocation, in C. Mayers and X. Vives, eds., Capital Markets and Financial Intermediation, Cambridge:

Cambridge University Press.

6. Arrow, K., 1964, The role of securities in the optimal allocation of risk-bearing, Review of Economic Studies, 31,

91-96.

7. Arrow, K., 1970, Essays in the Theory of Risk Bearing, Amsterdam:

North-Holland.

8. Ausubel, L., 1990, Insider trading in a rational expectations economy, American Economic Review, 80, 1022-1041.

9. Back, K., 1992, Insider trading in continuous time, Review of Financial Studies, 5, 387-410.

10. Back, K., 1993, Asymmetric

information and options, Review of Financial Studies, 6, 435-472.

11. Back, K. and H. Pedersen, 1998, Long-lived information and intraday patterns, Journal of Financial Markets, 1, 385-402.

12. Back, K., H. Cao and G. Willard, 2000, Imperfect competition among informed traders, Journal of Finance, 55,

2117-2155.

13. Back, K. and S. Baruch, 2002,

Information in securities markets: Kyle meets Glosten and Milgrom, working paper, Washington University at St.

Louis. The regulation of insider trading,

Stanford Law Review, 35, 857-895.