Investors Are Trying to Learn Things About Companies
This post originally appeared in Money Stuff.
"Insider trading is not about fairness," I often say; "it's about theft." It's not a crime to know things that other people do not know, and to trade on your knowledge. In fact it is good. In fact it is the point of securities markets, or a point of them anyway: Society wants capital to flow to good projects and not to bad ones, and so we encourage people to work hard to get information about which projects are good and which are bad, and to buy the good ones and sell the bad ones.
On the other hand, we don't want people in positions of trust at companies to just steal from the shareholders. If you are the chief executive officer of a company and you know it will have bad earnings, you could dump all your stock, but that seems like a breach of your duties to your shareholders. When outsiders try to get good information about companies they make markets more efficient and socially useful; when insiders use their positions to enrich themselves and their friends, there are some downsides.
Here is Stuart Kirk of Deutsche Bank worrying about a dystopia in which specialized professionals use advanced technology to make capital-allocation decisions that are almost as sophisticated as the decisions Amazon.com Inc. makes in deciding how to price soap:
The latest trend, however, is the pursuit of observational truths. A satellite supported with clever software can potentially see what high street shops people are going into. Are they leaving with one bag or three? How many cars is that locomotive pulling to the port in Karratha, Western Australia? What blend of iron ore does its colour indicate?
Soon it is likely that investors will know more about the fortunes of a business than a line manager relying on weekly or monthly reports. This changes everything. For a start, the definition of insiders and outsiders becomes redundant. So, therefore, does the regulation.
People find this worrying! I don't, and don't even really understand why people find it worrying. "How should regulators respond to a world where some investors listening to a quarterly earnings call already know the exact number of trucks that left the company’s warehouse over the summer" asks Kirk, "with shadow length indicating how weighed down they were?" Why should they have to respond? Why is learning about the world bad? Why is it a matter for regulation? It is not generally in other fields: If a television studio observes what people like and then tries to make shows that fit their tastes, no regulator steps in to punish them, or to demand that they share their research with everyone.
"The nuclear option would be for regulators to make a clear distinction between data and analysis, then insisting that every scrap of information about a company is published as soon as it comes in — from insiders and outsiders alike," says Kirk. But why "every scrap of information about a company"? Why not every scrap of information about everything? Why is the understanding of capital markets a uniquely public good where everyone needs equal access, while the understanding of every other aspect of the world is a matter left to individual effort and insight and technology?
The endgame here is that sophisticated professionals will seek out investing edge using data and computing power that is not available to "the average mum and pop investor," which will drive those ordinary investors away from trying to beat the market on their own. If they want decent performance, they will be forced to choose between passive indexing or hiring those sophisticated professionals to manage their money. People, again, find this worrying, and again I do not. (Again I think it is obviously an improvement!) We do not generally expect the average amateur to outperform the most sophisticated professionals in dentistry or brain surgery or plumbing or basketball or any other sphere of human activity in which there are amateurs and professionals. But for some reason that expectation is built into many people's thinking about stock markets, with constant bizarre results.
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