Truly Bad Economics
Do they do it for the money?
Utpal Bhattacharya & Cassandra Marshall. Journal of Corporate Finance, forthcoming
Abstract: Using a sample of all top management who were indicted for illegal insider
trading in the United States for trades during the period 1989–2002, we explore the economic rationality of this white-collar crime. If this crime is an economically rational activity in the sense of Becker (1968), where a crime is committed if its expected benefits exceed its expected costs, “poorer” top management should be doing the most illegal insider trading. This is because the “poor” have less to lose (present value of foregone future compensation if caught is lower for them.) We find in the data, however, that indictments are concentrated in the “richer” strata after we control for firm size, industry, firm growth opportunities, executive age, the opportunity to commit illegal insider trading, and the possibility that regulators target the “richer” strata. We thus rule out the economic motive for this white-collar crime, and leave open the possibility of other
Wow. I wouldn't accept this as a paper from a sophomore undergrad. The authors assume that everyone has IDENTICAL preferences toward income/leisure trade-off, and identical preferences on risk.
Let me propose an alternative. White collar workers in these firms are heterogeneous. They have differing risk preferences, and differing valuations of leisure. Therefore, the people in the "richer" strata will be those who value money most. Further, since we only observe those who are EMPLOYED, we are selecting on those who took the very highest risks throughout their career, as a matter of preference, not of strategy. (So, if 100 people took big risks, and five won, those five are likely to constitute the "richest" strata. The other 95 are unemployed, but we don't see them).
Is it a surprise, really, that the people who value money most and who are the biggest risk-takers would be the ones who dabble in insider trading schemes? Or is it a surprise that the people who are satisfied with their income and avoid risk do NOT engage in these schemes?
This paper would make sense only if all preferences are identical and if assignment to wealth strata were random. Since assignment to wealth strata is endogenous, and correlated sharply with the characteristics that make insider trading likely, I say: "back to school!"
(Nod to Kevin Lewis, who never really leaves school)