Private Regulation of Insider Trading in The Shadow of Lax Public Enforcement (and a Strong Neighbor): Evidence from Canadian Firms

Abstract

Few studies have examined firms’ voluntary self-regulation of insider trading. In this article, we investigate the characteristics of Canadian firms that voluntarily adopt policies restricting trading by their insiders when they are already subject to insider trading laws. We hypothesize that certain firm-specific characteristics -- such as larger size, higher market-to-book ratio, greater firm-specific uncertainty, the presence of controlling shareholders, and cross-listing into the United States where insider trading laws are more vigorously enforced -- are positively related to a firm\u27s propensity to adopt an insider trading policy (ITP), because insider trading is likely to be more costly for firms with these characteristics. We test these hypotheses using data on Canadian firms included in the Toronto Stock Exchange/Standard and Poor’s (TSX/S&P) Index. Using an ordered probit analysis, we find that larger firms, firms that have more than one controlling shareholder, firms with greater firm-specific uncertainty, and firms that are cross-listed in the United States, where public enforcement of insider trading laws is more frequent and severe than in Canada, tend to have ITPs that are stricter than required by Canadian insider trading law (i.e., super-compliant ITPs). Our results suggest that firms do not randomly restrict insider trading, but rather do so predictably and with a predictable level of intensity. They thus challenge the claim that firms are merely window dressing by adopting ITPs. Our results also illustrate the strong extra-territorial effects of U.S. securities laws and enforcement on Canadian firms. In addition, they suggest that formal organizational rules may dominate private sanctions in this context, consistent with norms/trust theories of organizational rules rather than economic deterrence theories of such rules. On net, our empirical results support the case made by those who see insider trading as economically harmful to firms