Are corporate governance mechanisms effective in reducing insider trading profits?

Corporate insiders have the opportunity to profit from share trading because of their informational advantage over outsiders such as shareholders. These shareholders face agency costs when insiders' interests are not fully aligned with their own. In an imperfect world where no contract can fully eliminate the potential for managerial self-dealing, prospects for opportunistic behaviour increase with information asymmetry. Internal and external governance mechanisms have been used to reduce this information asymmetry through the monitoring of management's decisions and activities. We use a selection of these mechanisms to examine their effect on the profits from insider trading activity, employed here as a proxy for information asymmetry. In our sample, firms with disclosed trading policies were larger in size, had higher proportions of non-executive directors on boards and audit committees, had chairpersons who are not also CEOs and lower levels of director and block ownership. The results showed that the profits insiders earned were affected by whether a firm had a disclosed trading policy and also by the proportion of block ownership. These findings suggest that blockholders' monitoring of management's activities can be potentially more effective in limiting insider profits than self-monitoring through governance mechanisms.