A Critical View of Manne’s “Insider Trading and the Stock Market”

by Rafael Sosa Arvelo

for Professor Bascuñán Rodríguez
January 6, 2011

Henry Manne adopted the unpopular view of favoring insider trading in a time where significant
regulation against insider trading was being adopted in the United States. Manne’s arguments refrained
from considerations of fairness and instead approached the issue with what he likes to think of as a
more scientific position. Thus, we see Manne indulge in a technical analysis of insider trading from an
economic perspective, where his ultimate goal is to prove to the legal and investment community, that
insider trading restrictions are not economically prudent restrictions. He attempts to make the case for
insider trading as the most effective form of entrepreneurial compensation in publicly held companies. T

His position is supported by several assumptions that will be analyzed throughout this essay, such as
that bonuses are less effective than trading on insider information as a form of compensation, that
insiders have more of an incentive to create good news than bad news, and that investors are generally
in a better position when insiders trade before any news have been divulged – to name a few. To
Manne, eliminating the capacity to trade on inside information was so crucial, that he claimed it “may
be fundamental to the survival of our corporate system.” 1 His arguments supporting such claim mostly
lie in the position throughout his book that real “profit” in his sense of the word was only attained
through entrepreneurial activity and that entrepreneurial activity was fueled by economic incentives.
These economic incentives in turn were only truly attainable through allowing insider trading.

To further understand his position, we must place ourselves in the time when Manne argued this
position. His book was published in 1966, just a few years after the groundbreaking decision of In the
Matter of Cady Roberts. It was an era that was defining the legal framework behind the prohibition of
insider trading. At this point, the memory was still fresh when corporate executives could use inside
information freely and profit from it through many forms of information exchanges and directly
throughout the direct purchase of stock in their own companies. Up to the 1960’s, previous attempts to
circumvent the practice of insider trading where rudimentary and mostly ineffective. This was explained
by Manne, for example, with the analysis of the explicit rule against insider trading within the Securities

1
Manne, Henry G., Insider Trading and the Stock Market, New York: Free Press, 1966, 110.
Exchange Act of 1934 in its Section 16(b), where insiders were prohibited from realizing a short term
profit of less than six months in a transaction of their own corporation’s stock. 2

Nevertheless, as they say, in hindsight vision is 20/20. Our corporate system has survived and flourished
since the publishing of this book, despite the fact that insider trading remains illegal. Entrepreneurial
activity has also continued to thrive within small, medium, and large corporations. The 21 st century has
come to represent a period of increasing acceleration in innovation and entrepreneurial activity as
defined by Manne. However, it will be analyzed if Manne’s assertions are in fact viable to further
accelerating such movement. This paper will attempt to put to the test Manne’s arguments and
demonstrate whether in fact Manne’s position truly captures a more efficient and profitable reality for
entrepreneurs and investors in the event of permitting insider trading.

I. A brief history of insider trading prior to Manne and his criticisms

His book begins with the argument of moral acceptance of insider trading dating back to days earlier
than 1910. According to Manne, it was not an objectionable practice to trade on inside information by
any of its officers or personnel. The reason why this began to change was due to the nature of stock
ownership changes, as a large corporation began to evolve into an entity owned by a large number of
small investors which had little to no power over the decisions made by its corporate executives. These
executives, in turn had none of the original stakes in the corporation, for their stock ownerships in it
were also minimal. With this new reality, a concern for fair dealing between the corporate executive and
the small investor arose.

Herein lies the first divergence from traditional thinking where Manne argues against the legal tendency
to analyze the fairness of a relationship by limiting the analysis to a point of view of two individuals. He
suggests that this is the common form for lawyers to see problems. On the contrary, he provides the
alternative view of economists. Economists, he claims, evaluate fairness on a more general and scientific
analysis of resource allocation within groups of people. This approach, in Manne’s view, will yield a more
equitable solution to the insider trading dilemma.

As an example, Manne brings to criticism the position expressed by Berle suggesting that Berle is
proposing that motivation from investors is purely based on trading profits and not on long term gains
or dividends. 3 Here we must stop to analyze this position by Manne. It appears that Manne is then

2
Id. 26
3
Id. 7
downplaying the legitimacy, or the need to protect the activity of investors motivated by trading profits.
Is a trader in a lesser position of protection than an investor seeking long term profit? Is the legitimacy
of investment dictated by the length of the investment? This is a recurring argument that we will see
throughout Manne’s position that is never attended by Manne. Rather, he chooses to discredit many of
the motivations of traders as non-worthy of the protection granted by insider trading prohibitions.
However, why is it not as legitimate to seek short term profits?

Manne did raise the argument brought by others that short term investors motivated by quick gains
bring liquidity into the market, but then he brought it faintly and suggested that such liquidity was
probably not significant. As with his criticism of others that don’t take a rigorous economic view of their
arguments, Manne fails to do a rigorous scientific study on the liquidity brought by short term traders
and the benefits they bring into the market. One only has to look into the present to understand how
misstated Manne’s assumption on the liquidity brought by traders was. The Internet bubble of the year
2000 was marked by an avalanche of individual traders, many of them buying and selling stock from
their houses. These speculators could make stocks rise several hundred percent in a day.

To this point of liquidity, Manne makes his second criticism to Berle, stating that, “it is possible that
insiders who are trading add more liquidity than they frighten away.” 4 Again, this “possibility” is only
suggested and not empirically supported. He only supports the argument that prior to insider trading
prohibitions, there was a vast majority of investors and that is evidence that insider trading doesn’t
scare away a significant amount of investors. 5 However, Manne fails to acknowledge the changing
dynamics of the publicly held corporations of the present time. As corporate executives have more
control over the corporation, own less of the corporation’s stock, and individual investors have less
control over the operations of the company, a new reality of fiduciary duty between the officers and the
investors must arise. Assuming that the general public would not evolve in their demands for more
security, as more control of the company sipped through their hands is hardly a sustainable argument.
An economic analysis of investment would suggest that liquidity in the stock market would have
declined, as a result of less investors in the market. To illustrate this further, if an investor has $1 million
investment in Company X and he can control the outcome of the company with an 80% certainty of
reaching his desired return on investment, then how would that same investor react to having a $1
million investment in Company Y, where he has nearly zero control over the outcome of his desired

4
Id. 8
5
Id. 7
return on investment? Certainly, the difference in control must be compensated by a different form of
security, a security of fair dealing by the corporate officers of Company Y, in order to make it attractive
for investor to buy into Company Y instead of Company X. As investors lose control, they must gain
security in order to attract investors and this in turn fuels the liquidity machine needed for truly
competitive markets as desired for the stock market.

Further criticism is brought to Professor William Cary, who was also the Securities and Exchange
Commission chairman from 1961 to 1965. 6 Manne oversimplifies Cary’s argument into a position of
moral judgment unfounded on the rigors of scientific analysis. He also criticizes the fact that there is no
explicit prohibition on trading inside information, and thus it does not constitute “securing additional
compensation” as Cary suggests. Manne equates moral standards of behavior for insider trading as
simplistic reasons not to be held to the high standards of economic analysis. Nevertheless, is a moral
issue not a variable within an economic analysis?

Perhaps in the times of Manne, the field of behavioral economics was only incipient. It is certainly
reasonable to incorporate morality into the considerations for economic projections. It is undisputed
that insider trading is frowned upon. It is never accounted for, nor does Manne try to factor such a
variable into his equation. As we have seen throughout stock market history, it is common knowledge
that investing in the stock market has beat investing in bonds across a large period of time. Why is that?
To bring in some perspective, let us consider this reality:

When the S&P Index rose from 130 in March 1981 to 1,527 in March 2000, the return on
investor capital, excluding dividends, was 13.8 percent per year. Earnings growth amounted to
6.2 percent annually, less than half of the return, with the remainder the result of a rise in the
price-earnings ratio from eight times to thirty-two times. That increase alone accounted for
1,100 points of the 1,400-point gain, or 7.6 percent per year. If one were to attribute even a 5
percent corporate cost of capital as a threshold for stock option grant- a return a company
might have earned merely by placing all of its assets in a bank certificate of deposit- corporate
management could claim responsibility for an extra 1.2 percent per year. 7

6
Id. 12
7
Bogle, John (2005) The Battle for the Soul of Capitalism (Yale University Press), 17.
The increase in the Price over Earnings multiple is a vote of higher confidence in the stock market. Thus,
much of the wealth created through the stock market was really a higher contribution by investors,
rather than a net profit generation by publicly traded companies. It would be naïve to think that this
amount of confidence would be exhibited in a market where only a select few would be guaranteed to
repeat profits without any particular merits or fiduciary obligations to its investors. On the contrary, the
rise in PE ratios and the increase in liquidity in the stock market must have undoubtedly been in part a
result of the policies of transparency and investor warranties that have been incorporated into the
market. Moral considerations can be attributed to some of that assurance that an investor has when
investing in a publicly traded company.

II. SEC Rule 10b-5

At the moment of Manne’s publication, the last critical case resolved by the Supreme Court was the case
of Texas Gulf Sulfur Company. Prior to this case, another important case was In the Matter of Cady,
Roberts. This section will analyze Manne’s views in these events of his time and the arguments
presented to support his view of insider trading. It is worth noting that despite the evolution of
jurisprudence in this area, this section will be limited to the consideration of the cases resolved in the
time of publishing of Manne, in order to evaluate his position more clearly.

As is suggested by Manne, SEC rule 10b-5 was for its initial times, limited to actions for fraudulent or
deceptive behavior by stock brokers. 8 The first case to open the gate to insider trading occurred with
Speed v. Transamerica, but this was considered to be more of a special-facts rule. However, the amount
of insider trading cases based on rule 10b-5 increased significantly since then. 9

Rule 10b-5 reads as follows:

It shall be unlawful for any person, directly or indirectly, by the use of any means or
instrumentality of interstate commerce, or of the mails or of any facility of any national
securities exchange,

To employ any device, scheme, or artifice to defraud,

8
Id. 34. Manne.
9
Id. 36.
 To make any untrue statement of a material fact or to omit to state a material fact necessary in
order to make the statements made, in the light of the circumstances under which they were
made, not misleading, or

To engage in any act, practice, or course of business which operates or would operate as a fraud
or deceit upon any person, in connection with the purchase or sale of any security. 10

In Speed v. Transamerica, there was an issue with the disclosure of critical information to the minority
shareholder which caused the loss of a significant amount of profit. In this case, the majority stockholder
knew of a plan to generate a much higher profit by liquidating the company, and without sharing such
plan, offered to buy the shares of the minority stockholder. Once the minority shares had been
purchased, majority stockholder proceeded to execute his liquidation plan, reaping all of the profits for
himself.

Under rule 10b-5, the court held the majority stockholder liable. Nonetheless, the details of the case
were different to that of a stock exchange. In this case, there was a direct relationship and the purchase
had been to liquidate the entire company. 11 Then came In the Matter of Cady, Roberts & Co.

In the Matter of Cady, Roberts & Co. is about a dividend cut announcement that reaped profits for an
insider prior to its announcement. Gintel, a broker and partner of Cady, Roberts had been purchasing
shares of Curtis-Wright Corporation as a consequence of their business relationship and news of a new
engine. Due to the news, shares of the corporation were rising. Gintel used several discretionary
accounts to perform the purchases. A day before the dividend of the corporation was cut, Gintel began
to sell his shares. When he found out about the dividend cut, he efficiently sold his shares plus sold short
shares on the corporation. All of this was done prior to the general public being notified of the dividend
cut.

The SEC found this activity to be in violation of Rule 10b-5. The two arguments to support this decision
were that there existed a special relationship giving access and that there was an inherent unfairness in
taking advantage of such information prior to the dissemination of it. 12 The decision was the first

10
17 C.F.R. § 240.10b-5
11
Id. 36 Manne.
12
Id. 38.
concrete application of Rule 10b-5 on the issue of insider trading prohibition. The elements to apply it to
any situation of trading in an exchange with a publicly traded company were there.

After In the Matter of Cady, Roberts & Co., the issue was heightened in the case of Texas Gulf Sulphur
Company. Texas Gulf was a company in the business of exploring and excavating sulphur. The company
had gone through a downturn because of a slowdown in demand for sulphur and the fact that they had
spent millions of dollars in unsuccessful attempts to find other deposits of sulphur. Other smaller
competitors were beating Texas Gulf at their game.

A new management came to Texas Gulf and more effective, as well as more diversified exploration
techniques were incorporated. As a result, in one of the explorations, a geologist successfully found an
enormous discovery of several metal deposits. The discovery would have significant effects in the value
of the company. In fact, throughout the period in question, the stock rose from a low of $17 to a high of
$71.

Control measures were taken to conceal the information. Texas Gulf geologist in charge, kept the
employees at the site of discovery without communicating capacity, and it is alleged that the geologist
then communicated the discovery with the chief executive officer of Texas Gulf. However, company
executives, employees, and even outside investors with some direct or indirect connection to the
company got word of the discovery and proceeded to purchase large number of shares and call options,
prior to any announcement. Furthermore, when Texas Gulf finally announced the discovery, they had
downplayed the announcement. The final full acknowledgement of the magnitude of the discovery was
announced much later.

As a result, the SEC brought suit against Texas Gulf and demanded the return of profits obtained from
the execution of insider trading by the employees and the persons external to the company who had
received access to the inside information and had acted on it. The court concluded that a company is
obligates to disclose their information and not trade on it prior to such disclosure.

There were several issues with the clarity and application of rule 10b-5 which raised concerns for
Manne. However, a recurring claim by Manne from the case facts was that it was necessary for Texas
Gulf to conceal the information in order for the company to secure more land rights, which would result
in more profits for the company and that it did not act in a deceptive way. By delaying the disclosure of
the information, Texas Gulf was in fact able to buy more land rights at a lower cost and increase its
ownership of metal deposits from within the area. While this is perfectly reasonable to accept, this
argument does not follow with the argument in favor of inside trading. Giving deference to a company’s
timing of information release is not dependent on allowing corporate executives to trade on inside
information.

III. Market Value and Marketing of Information

To understand Manne’s technical analysis, this section will briefly explain the way he sees a market for
information and the several forms of gaining value for such information. He begins by distinguishing
between forms of information. There is the information for which anyone can easily have access to, or
that there is no uncertainty in the veracity of the information. The second kind of information deals with
the uncertain. It is information that cannot be predicted, which alters the considerations of a particular
stock. This he calls second-category information. 13

In the first-category information he makes a comment that he will later bring again, pertaining to
“sophistication about conditions in an industry or a particular company.” 14 Although he makes clear that
sophistication is rare, but not insider information, he also tries to imply a similarity between the two
alluding as what could be interpreted as equally benevolent, yet inaccessible to most. Again, he fails to
acknowledge the variable of morality which clearly differentiates sophistication from insider trading. In
the latter, neither effort nor merit can be attributable to the behavior. Thus, the extraction of profit by
insiders cannot be equated to that of a person whose efforts in the cultivation of a specialty grants him
an advantage over average investors with the pretense that both of these advantages are shared by a
small and closely held group. The accountant who notices the change of accounting system from LIFO to
FIFO, from publicly disclosed information and trades accordingly to her belief of an appreciation of value
in the stock, from the knowledge she has obtained in her studies as an accountant is not the same as an
accountant inside the company who learns that the company she works for is nearly bankrupt and
trades on such non-public information.

On secondary-information, Manne explains that not all of it would constitute inside information. Two
elements would need to be present for it to be considered inside information: 1.) the information would
have to have a significant impact on the price of the stock, and 2.) the information should be exploitable
by and individual or individuals.

13
Id. 48
14
Id. 49
After the distinction of the types of information is made, Manne continues on to describe the forms that
the inside information can be converted into value for the individual holding the inside information. The
most obvious one would be selling the information directly for money. The second one is to act on the
information by purchasing stock. In this second form of gaining value for inside information, Manne
makes an absolute argument which must be carefully analyzed. “The insiders’ gain is not made at the
expense of anyone.” 15 The argument suffers from a case of myopia.

How can the gain of an insider not be made at the expense of anyone? Is the insider purchasing the
shares from thin air? In Texas Gulf, it was shown that prior to the discovery of the metal deposits, the
stock had been in a decline. Now, following Manne’s same characteristics, we can do an economic
analysis to see if in fact, the insider’s gain was not made at the expense of anyone.

All variables constant, investor knows that Texas Gulf is worth $55 if a significant metal site is discovered
within a year. Investor buys that stock at $50. As Texas Gulf continues its explorations, spending millions
of dollars in them (as was in the real case), without finding anything, the stock continues to slide. By the
time insiders are aware of the new discovery, the stock value has gone down to $17. For all outside
investors, $17 represents the market value, based on all of the available information. As insiders begin
to buy, based on their privileged information, sellers must sell. Without sellers, there wouldn’t be any
sales, obviously.

Even though investor bought at $50, and the stock is now at $17, which is the fair value based on all
available information, investor hopes that regular market fluctuations can raise the price to $25 in order
to get some of his investment back. Investor places a sell order at $25, based on the fact that no
available information supports any valuation higher than that. As insiders flock to purchase more shares
on the news of the discovery, and other outsiders join in, the sell order for investor is triggered at $25.
Many other seller orders are precisely for very similar reasons. Insiders get the shares of investor at $25
and ride the shares all the way to $71. Investor, in turn, takes a loss of 50% of his investment, based on
his initial share cost of $50. Was insider’s gain not made at the expense of anyone?

IV. Effects of Insider Trading in the Market

Manne dedicates two chapters of his book in the description of what he believes are the market effects
of insider trading. He creates scenarios for conditions where no insider trading is allowed and scenarios
where insider trading is allowed. He then attempts to explain the economic effects it has on investors,
15
Id. 61
insiders and outsiders. It is interesting to note, however, that all of his illustrations are based on a piece
of positive information. None of the illustrations contemplate on the event of negative news being
disclosed.

In the introduction he mentions that there are practical limits to the full exploitation of inside
information. “If an individual wished to exploit the full value of a certain piece of information, it would
seem that he would have to purchase every share of the company’s stock.” 16 This statement is
inconsistent with another statement made by Manne in a later chapter evaluating adequate forms of
compensation for entrepreneurial activity. In the case for insider trading as a form of compensation,
Manne says, “insider trading meets all the conditions for appropriately compensating entrepreneurs.” 17
His preference over a bonus, appears to be in contradiction to the incapacity of an inventor to gain the
proper compensation for his idea, through the exploitation of the inside information.

In the same example he uses of a company X having shares worth $50 per share, and the idea being
worth an additional $5 per share, it can be illustrated how unreliable this method of compensation
would be. First, as was correctly explained by Manne, it would take ownership of all shares in order to
realize the full profit from the information contributed. This, for practical reasons, is far from possible.
Second, the road to $55 from $50 is highly erratic from company to company. There are dependent
variables that affect the amount of capital required to move a stock from $50 to $55, liquidity being a
major one. Yes, market capitalization is another of the variables, but a company worth $50 billion could
have a much lower liquidity than a hot company worth only $5 billion. In the latter, it could take much
more capital to get from $50 to $55 a share, than on the first one. Thus, there is no direct correlation
between the idea, the value generated, and the amount of compensation to the entrepreneur.

Another contradiction in his compensation proposal appears when he recognizes that the smaller the
effect of the inside information, the larger the risks from other uncertainties associated with stock
purchases. Thus, an insider might not have sufficient motivation to trade on a small piece of inside
information. By the definition of entrepreneur that Manne provides, many persons will have contributed
to the generation of “profit” through some sort of entrepreneurial activity performed. Yet, despite the
profit contributed, it is safe to assume that most contributions will likely be of minimal informational
value. The impact on the stock price might be no greater than the normal daily fluctuations of the price.
Again, this presents a problem for proper compensations of entrepreneurial activity.

16
Id. 78
17
Id. 138
The basic premise presented by Manne on the behavior of a share price under free trading rules and no-
insider-trading rule can be summarized in the following. Free trading rules will allow for the share price
to rise gradually as insiders begin purchasing shares. Then, outsiders, seeing something is going on, will
join and accelerate the curve to the point of surpassing the actual value of the information. Then, the
share price will ripple a bit until stabilizing. Thus, Manne points out that under free trading rules,
investors realize a gain in value faster than if there had to be a wait on the information being disclosed.

On the event of a no-insider trading rule, the effect would be to have a steeper curve with the same
result, but in a more condensed amount of time. Manne makes an interest argument here that also
needs consideration. He claims that, “if the insider is allowed to buy at $50 ½ after disclosure, we have
really accomplished very little over a rule allowing him to purchase at $50 before disclosure.” 18 This
statement clearly fails to understand the value proposition behind the insider trading prohibition. It is
indisputable that one of the pillars of insider trading prohibition is to create more inviting market
conditions for all sorts of investors to participate in the stock market. More participants, means more
activity and more liquidity. There is no place in this argument by Manne to support that allowing an
insider to trade on readily available public information is contrary to any protection afforded to
investors. On the contrary, there is more liquidity brought into the market when insiders participate on
the buying and selling activity after disclosure of information. The suggestion of requiring insiders to
abstain from trading for a longer period of time than regular investors adds nothing to the problem
attended by insider trading prohibition.

Another fundamental premise to which Manne holds on to for his assumptions is the fact that long
term, stocks tend to go up. 19 This assumption follows with the argument that, “if we limit our concern
to the long-term investor, rather than the short-swing share trader, there is little likelihood for injury
from insider trading.” This argument implicitly accommodates the preference of protection into the
long-term investor only. Basically, this same argument can be used to justify an infinity of activities
throughout the long term. For one, we could say that government corruption is fine, because in the long
term the government officials deliver some benefits to its citizens.

Manne offers no explicit explanation as to why he would rely on assumptions that don’t consider the
well-being of short-term investors. It appears as though it is a lack of legitimate recognition from these
groups of investors. However, it goes further. Long-term investors would also be dragged into this group

18
Id. 87
19
Id. 102.
when invisible forces are affecting the course of a stock. If a long-term investor is holding on to a stock
that has steadily risen to what the investor believes to be unsustainable levels based on available
information, it would be highly probable for the investor to want to realize her gain. Yet, this gain is in
result a loss in additional profit, because information was concealed from her. Thus, what purpose does
it serve to limit an analysis of the harm caused by insider trading to a singular and ideal group?

Manne goes on to affirm that, “the intelligent long-term investor, as we have seen, has substantially no
interest in preventing his company’s executives from trading in the company’s shares.” 20 There are no
considerations to support this assumption in absolute terms. Personal motivations by corporate
executives have no proven correlation with their interest for the corporation’s well-being. One only has
to look at the scandals at Enron, Worldcom, AIG, and Bear Stearns to get a glimpse of the loyalties of
many individuals. To believe that, facilitating the accumulation of wealth through means that have no
correlation to merit for company executives, is in the interest of the long-term investor is unfounded
and there exist no empirical evidence to support this.

V. Entrepreneurship, Compensations and Corporation Competitiveness

In the closing of his empirical analysis of why insider trading should be allowed, Manne shifts to another
topic which has been discussed several times in this paper – entrepreneurial compensation. Manne
distinguishes “profit” from capital gains. Profit, is an increase in value from the traditional management
practices. Thus, a manager, or an officer perform management operations and these generate capital
gains. Profit, arises from performing an entrepreneurial function. An entrepreneurial function in turn,
signifies a form of innovation which changes the way value is generated.

Interesting points are brought on the necessity to increase and promote entrepreneurial activity within
the corporations. A particularly important quote included by Manne, from Schumpeter states:

In capitalist reality as distinguished from its textbook picture, it is not that kind of competition
which counts but the competition from the new commodity, the new technology, the new
source of supply, the new type of organization (the largest-scale unit of control for instance)–
competition which commands a decisive cost or quality advantage and which strikes not at the
margins of the profits and the outputs of the existing firms but at their foundations and their
very lives. 21

20
Id. 107.
21
Id. 125
The acknowledgment of the need for entrepreneurial activity is a reality that has continued to proper
throughout the decades. However, in Manne’s arguments, it is suggested that only through insider
trading, can this form of compensation be effectively realized.

Manne analyzes different forms of compensation to reach his conclusions. First he looks at salary and
bonus compensation. He rejects salary, because of obvious reasons that entrepreneurial activity is not a
fixed activity, yielding equal results. Then he goes on to reject bonuses. His main arguments against
bonuses is the fact that entrepreneurs would tend to value their contributions more than what their
companies would, that bonuses could represent legal issues, and that bonuses in excess of a certain
amount of money would require there be disclosures on payments made. Finally, he claims those on
years where the company actually incurred in losses that it would be particularly tough to compensate.
Stock options are also rejected as an effective method. Manne argues that they are “inefficient devices
for exploiting information” due to their usual lack of transferability and illiquidity.

This brings us back to insider trading as the form for effective entrepreneurial compensation, according
to Manne. The reason for this, he argues, is that it allows the entrepreneur to market his innovations in
the form of the sale of the information. These are the forms talked about earlier, such as trading the
information, buying stock prior to the release of information, etc. There is a major fault with this
assumption. And that is that it requires much specific qualifications in order for it to serve as adequate
compensation. First, as we saw earlier, even Manne recognizes that there can only be full realization of
the value contributed if all stocks of the company are owned by the person holding the information,
prior to the information being released. Second, the information must have significant value to
compensate for the noise from other uncertainties and fluctuations surrounding the stock exchange. We
have seen earlier, and Manne had also commented that many times, the value of the information won’t
surpass this threshold. Third, entrepreneurs would be in unequal positions to monetize the information,
should requirements 1 and 2 be satisfied. This is simply because some people have more access to
capital than others – economic capital and social capital. A poor scientist who has made a significant
discovery might only have his boss to tell and his family. With no access to capital, it is more likely that
his boss will reap the profits from the inside information and not the scientist. Thus, in many
circumstances, the compensation of a valuable piece of information, relying on insider trading as the
form of compensation, will result in a compensation proportional to the current wealth of the persons
with access to the information.
In conclusion, we can observe that Manne although brave to fight against the popular current of his
times, failed to deliver a truly convincing argument in favor of insider trading. His economic approach to
law is worthy of admiration and it is a field that needs many more contributors, but for the present
topic, insufficient considerations were empirically evaluated. The fundamental criticism of his peers on
the basis of moral arguments needed to be incorporated into the economic analysis presented.
Furthermore, Manne makes many assumptions that are not logically sound.

For example, Manne asserts that, “entrepreneurs will be attracted to those positions offering the
greatest opportunity for them to make large, indefinite gains. These may result from good news or bad,
intentionally or unintentionally created.” 22 Advocating for indefinite gains to potential entrepreneurs,
from good or bad news does not follow to sound business judgment. How can one justify indefinite
gains without a reciprocal and proportional contribution from the entrepreneur? How can one assure
that the contributing entrepreneur is the one benefiting from the inside information, and not the
privileged insiders managing the operation? Is an entrepreneur only properly compensated with the
ability to monetize inside information?

The answer across time clearly shows that insider information is not necessary for corporations to
attract entrepreneurial activity. Compensation in other forms, such as bonuses and stock options has
been effective in pushing forward advancements and innovations across all industries. Executive
compensation has steadily increased, making the proposition of working for a large company
economically very attractive. A simple look at executive compensation in the United States in
comparison to other nations shows how indefinite compensation can be derived through other means.
23

For the following above mentioned analysis, it is the position of this paper to reject the argument of
insider trading being beneficial to the market until further empirical studies suggest the contrary. Such
studies must be able to capture the economic effect that would inevitably arise from allowing an
immoral practice to be permitted freely, in detriment of others, in the stock exchange.

22
Id. 155
23
Eric Wahlgren. Spreading the Yankee Way of Pay. Business Week at
http://www.businessweek.com/careers/content/apr2001/ca20010419_812.htm#table