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INSIDER DEALING AND THE STOCK MARKET
This is an issue which has been the subject of recent well-publicised scandals: it has disturbed ethicists even though the arguments against it have never been well-formulated and the statutory attempts to curb it are, by common agreement, not satisfactory. [30] Once again it can be illuminated by the Austrian theory of the market. It is not difficult to define. It is trading in shares in the stock market on the basis of information not available to others, outside shareholders, who have an interest in the firm: the information could be derived from employment in the firm whose stocks are being traded or from price-sensitive facts picked up from such personnel, in which case the guilty party would be a 'tippee'.
It is sometimes thought to be a 'victimless' crime in that there are no immediate people harmed, as in the case of a robbery, although it could plausibly be said that there are people disadvantaged by it. Some gain a lot, or reduce their losses, by buying or selling first. It is much more convincing to say that insider trading is unethical if it involves information which properly belongs to company owners and has not been revealed to them: timing is crucial here. And there is quite likely a breach of fiduciary duty if the information properly belongs to the owners. In some jurisdictions, insider dealing is not a crime but a civil offence only (New Zealand), in others it is crime only and in most it is both a criminal and civil offence. It is thought to involve the moral concepts of equality and fairness but the notions of utility and economic freedom are relevant too. It matters more in Anglo-American economies because in these most of the capital for investment is raised on the stock market. The most spectacular cases involve takeovers where the unauthorised release of information can cause a dramatic rise in the share price. And this has an adverse effect on the prospects of a bidder. In continental Europe, where most capital is raised through bank loans, it is less important. Germany had no law against insider dealing until it was compelled to adopt the European Directive in 1994. The arguments against insider trading derived from justice and equality are the least satisfactory. In current moral and political theory [31] justice has two meanings. It refers to the basic rules of a game, equal access to all potential participants and the outlawing of racial and sexual discrimination. This could be called equality of opportunity and certainly does not demand equality of knowledge. But justice is used in a much wider sense where it refers to equality of outcome and relies on the slogan a level 'playing field'. While all Anglo-American stock markets can easily meet the equality of opportunity criterion it is clear that the latter is not only conceptually incoherent it is impossible to implement. There will always be inequalities of information and asymmetric knowledge in the stock market. Some people will know, quite legitimately, more than others. Indeed, it is the job of analysts in a competitive market to ferret out information that is not formally revealed. But the really tough laws in some jurisdictions seem to be designed to produce equality of outcomes and not just equality of opportunity. If successful they would turn the stock market into a lottery rather than a venue for the exercise of genuine skill. The real debate should be about what is meant by equality of opportunity.At the other end of the ideological spectrum, is the case for unrestricted insider dealing and here some help is available from Austrian economics. This starts from the assumption that markets are never in equilibrium but are being pushed towards it by the innovative actions of entrepreneurs alert to the possibility of profit. The stock market can be analysed just like any normal product market. Information is a scarce good and those who possess it should be entitled to a return. Markets are never perfectly efficient. If insider dealing were permissible information would circulate rapidly, so reducing profit. Big profits occur precisely because it is forbidden.
But the question turns on what is legitimate ownership; who rightfully owns the information that is used in capital markets? Is it the owners, or the people who discover it while working for the firm? If all of our working activity is entrepreneurial (as Kirzner maintains) then why should we not say that knowledge, even when working for the firm, partly belongs to the employee? Indeed, when tough laws are imposed on stock markets, they are in effect reassigning property rights: they are decreeing that all knowledge belongs to the employer. In the famous Texas Gulf Sulphur case (1968) [32] a firm made a valuable mineral discovery in Canada and those responsible for it bought stock in advance of the public announcement and made money when the disclosure was made. They were unaware they had done anything wrong and, by the tenets of Austrian economics, they hadn't. But they were charged with a (civil) offence by an adventurous interpretation of the Securities and Exchange Act (1934) and had to surrender their profits. This was followed by statutes in the US which formalised insider dealing as both a civil and a criminal offence. An insider dealer had to be in a fiduciary relationship when he traded on undisclosed information and he must have profited from the deal. Some early cases were quite important in clarifying the issue and one or two were favourable to the accused. [33] Indeed, in one case it was said that there was no fiduciary duty to the market as a whole, a collectivist claim of the moralists. British law (the Criminal Justice act, 1993) is even tougher than the American, for the definition of an insider is not limited to those in a fiduciary relationship but he can be anybody who possesses price-sensitive information, however acquired, and uses it in deals. Most of the statutory law in Anglo-American economies is in contradistinction to Austrian economics because it offers serious impediments to the acquisition of knowledge. No analyst in Britain will now be seen talking to a company chairman, hitherto a regular part of his research, through fear of being adjudged an insider. Also, there is a real problem with the rule of law here for many transactors are uncertain about what is permissible or not. The laws do not have that predictability which is an essential feature of a genuinely liberal market economy. A solution to the problem might be to repeal all statutory law and leave the matter to contracts between agents. It is the case that the demand for restrictions on insider dealing came not from outside shareholders but from moralistic activists. A firm could announce in advance that it permitted insider dealing in certain circumstances and under specified the conditions. Or it could say that it did not. It could always be sued for breach of contract if it broke some of the conditions. It might have an interest in motivating employers by offering them the prospect of profits from their discoveries. Of course, that may not work and employees might spend all their time playing the market and, perhaps, circulating false information. But these sorts of problems are best settled by the market, not the state.TAKEOVERS
Takeovers are a very controversial feature of Anglo-American economies and most likely to arouse the ire of communitarian critics. [34] They disrupt established businesses, disappoint expectations, are offensive to national pride when foreigners grab valued assets and lead to an economy in which money-making through paper deals rather than genuine productivity is decisive. Most of these objections are emotional rather than rational, especially when they are linked to globalisation.
But there are some genuine ethical problems, none of which is fatal to the capitalist system. And they are rarely picked up by the moralists. We noticed earlier when discussing Kirzner's ideas about discovery in the market that there might be a problem in determining who made the discovery and who is entitled therefore to the profit. There was a famous takeover in Britain in the 1980s which raised this issue. The drinks company, Distillers, was known to be badly managed; it wasted shareholders' money and was not innovative. It was a sitting target for a takeover. The first to attempt one was James Gulliver, of the Argyll Group. He did an immense amount of research, especially on the financing of the deal. It was expensive and had to be achieved by a share swap rather than a cash offer. However, Ernest Sanders of Guiness, who had been called in originally as a 'white knight' to ward off Gulliver, eventually took over in highly controversial circumstances. By what were thought to be dubious methods he managed to keep the price of Guiness stock high and to consummate his own share swap financing.
The abstract ethical question is, who was entitled to Distillers? Gulliver, who made the original discovery, or Saunders who 'grabbed' the company. Saunders, and others, were eventually convicted of criminal offences but the charges did not actually relate to the ethical issue discussed here. [35] It might be difficult to formulate into law a solution to the ethical problem but merely by alluding to it we are raising some doubts about Kirzner's theory of justice in discovery.
There are some other minor ethical problems that relate to takeovers. Is there not a temptation with 'buyouts' for managements to reduce the value of the shares so as to make their acquisition cheaper? Who is to blame when greenmail, the practice of a potential bidder, who builds up small stake in the company, being bought off at a price not available to other stockholders, occurs? Are 'golden parachutes', very favourable terms paid to the top employees of the captured company, always necessary or acceptable? But it is difficult to see why the market could not solve these issues. Do we need the whole panoply of ethics to adjudicate on what is a necessary feature of normal business?
CONCLUSION
Contemporary business ethics shows a lack of understanding of business and the motivation that drives it, self-interest. Least of all do the moralists grasp the point that the public good comes about not by deliberate intention but is an unplanned by-product of private desires. Austrian economists understood Adam Smith's point well and perfected our knowledge of the working of the market system - especially the role of the entrepreneur. It is surely the case that the stress on the social responsibility of business would hinder the entrepreneurial process.
Anglo-American capitalism is undoubtedly individualistic and provokes those critics of business who recommend a more communitarian approach. Yet methodologically, individualism has proved to be a potent explanation of human action, and ethically, it is plausible account of how rewards and punishments in business should be distributed. They should go to those responsible for actions. The Austrian economists did not write specifically about business ethics but an analysis of their economic and social philosophy is illustrative of the position outlined here.
The answer to the current 'crisis' in business ethics is not the propagation of supererogatory ethics, which if taken seriously would attenuate the efficiency properties of the market, but the reassertion of conventional ethics and uncontroversial law. They were first adumbrated by Hume and later spelt out more fully by Hayek. Important here is the fiduciary duty of managers to owners; it is in the interests of ordinary shareholders to resist rent-seeking by employees. This requires, of course, considerable shareholder activism, an activity indulged in more often by antic-capitalist pressure groups. They buy a few shares in the company and try to shift policy away from the maximisation of shareholder value towards what are basically political objectives. [36] Capitalism has to save itself.
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footnotes
[30] . See Norman Barry, Business Ethics, London, Macmillan, 1998, chapter 5.
[31] . Norman Barry, An Introduction to Modern Political Theory, 4th edition, London, Macmillan, 2000, pp. 173-8.
[32] . See Barry, Business Ethics, pp. 96-97.
[33] . Barry, Business Ethics, pp. 96-99.
[34] . See Barry, Business Ethics, Chapter 6.
[35] . Ibid pp. 139-41. Saunders and is associates were convicted under a particularly repressive British statute, which was later ruled in breach of the European Convention on Human Rights by the European Court of Human Rights.
Copyright:
Open Republic Institute Ltd.