Why both insider trading and non-mandatory disclosures should be prohibited

This paper shows that insider trading reduces outside searchers' trading profits and thus their incentive to search for information. This reduces social welfare since allocation decisions are made with less information. Non-mandatory disclosures are also socially undesirable for identical reasons. Thus society would benefit if the rule to 'disclose or abstain' were altered to just 'abstain'. Also, since firms may not voluntarily restrict insider trading, government regulation is necessary. I investigate which economies are more likely to provide political impetus to regulate. Where public corporations are primarily owned and controlled by entrepreneurs or large undiversified stockholders, pressure to regulate (or enforce existing regulation) will be lower. However, insider trading is more likely to be effectively regulated where owners are largely diversified. Evidence is presented to show that the USA experienced just such a transformation in the 1960s and that this change accounts for stricter enforcement of insider trading regulations. This may explain both why regulation in the USA developed in the manner it did, and why certain countries like UK, Japan, Germany and France, etc. do not yet have restrictions on insider trading. © 1997 John Wiley & Sons, Ltd.