Do They Do It for the Money?

In our paper, “Do They Do It for the Money?” forthcoming in the Journal of Corporate Finance, we explore the motives for committing white collar crimes such as insider trading. The idea for the paper germinated when speaking with a prosecutor in the celebrated Enron case several years ago. He remarked that “they do it because they think they can get away with it.” We were skeptical. Being financial economists, our prior was that the strongest motivation for individuals to commit insider trading was for monetary gain.

In terms of anecdotes, the prosecutor seemed to be right. In 2001, Martha Stewart was charged in a civil case for insider trading. She avoided losses of $45,673, which was a paltry 1.7% of her $2,704,403 in legal compensation from (MSO) in 2001, and a miniscule .007% of her $650 million net worth at the time. Mark Cuban had a net worth of $1.3 billion when he was first charged with insider trading for avoiding losses of $750,000 in 2004. Don Tyson was one of the “Forbes Top 1,000 Richest” back in 1992 when he was convicted for making illegal trading profits of only $46,125.

To determine whether we or the prosecutor was correct, we collected data on a sample of all top executives who were indicted for illegal insider trading in the United States for trades during the period 1989‐2002. Gary Becker, an American economist and Nobel Laureate, proposed in his 1968 article ‘Crime and Punishment’ that the act of committing a crime is a rational economic decision. This implies that a crime is committed if its expected benefits exceed its expected costs. If this is true, “poorer” top management should be doing the most illegal insider trading. This is because the “poor” have less to lose, as the present value of foregone future compensation if caught is lower for them. Also, if one assumes risk aversion, the poor have more to gain – an extra dollar means more to them than it does to the rich.

We find that indictments are actually concentrated in the “richer” strata when controlling for firm size, industry, firm growth opportunities, and executive age. We also control for the opportunity to commit illegal insider trading by looking at top executives who traded on information about a future merger or acquisition. In these cases we can measure the potential benefit of the insider trading as the 30 day return prior to the announcement of the merger. Even after controlling for the potential profit or the “temptation”, we find that it is still the “richer” executives who commit illegal insider trading. Finally, in considering the possibility that regulators target the “richer” strata for a demonstration effect, we use an instrumental variable to rule out this potential reverse causality. Our results do not change.

To conclude, our paper finds that the economic motive for this white‐collar crime, if it exists, is weak. What other motives might exist? While our data set does not allow us to examine other motives, probable alternatives could be psychological theories like “hubris” and sociological theories such as “company culture.” We leave the rigorous examination of these alternative motives open to future research.

The full paper is available for download here.