Insider Trading in Financial Signaling Models

Mark Bagnoli and Naveen Khanna

Journal of Finance, 1992, vol. 47, issue 5, 1905-34

Abstract: The authors study the impact of voluntary trade by the manager. They find that, in contrast to standard signaling models, an action is good news for some firms and bad news for others, depending on observable characteristics of the firm, its managers, and their compensation plans. Further, voluntary trade eliminates separating equilibria and, thus, the possibility of exactly inferring the manager's private information. This may cause the manager to take inefficient actions so as to earn trading profits. Such undesirable behavior can be more effectively constrained by compensation contracts based on phantom shares or nontradeable options instead of large stockholdings. Copyright 1992 by American Finance Association.

Date: 1992
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