Most academic studies have shown that corporate insiders are able to generate above market returns through their purchases and sales of their company’s stock. James Surowiecki in the New Yorker notes that U.S. Senators seem to have a similiar ability.
Last year, Alan Ziobrowski, a professor at Georgia State, headed the first-ever systematic study of politicians as investors. Ziobrowski and his colleagues looked at six thousand stock transactions made by senators between 1993 and 1998. Over that time, senators beat the market, on average, by twelve per cent annually. Since a mutual-fund manager who beats the market by two or three per cent a year is considered a genius, the politicians’ ability to foresee the future seems practically divine.
Surowiecki notes that there has been much debate over the efficiency of insider trading laws. Some researchers believe that markets would be more efficient if insiders were given free rein to trade their own stock. However skepticism seems to be in order:
Ultimately, insider trading is an inefficient way of achieving market efficiency, because insiders earn all their profits on the lag between when they start selling and when the market figures out what’s going on. This gives them every reason to hoard information, with the result that stock prices are out of whack for longer than they otherwise would have been. Markets thrive on transparency, but insider trading thrives on opacity.
The Frist case is a rarity, in that the vast majority of insider trades never are investigated, let alone prosecuted. A Senate seat seems all the more attractive given its proximity to power and the potential for profit.
Below is the abstract from the cited article, which can be found in the Journal of Financial and Quantitative Analysis (December 2004):
Abnormal Returns from the Common Stock Investments of the U.S. Senate
Alan J. Ziobrowski, Ping Cheng, James W. Boyd, and Brigitte J. Ziobrowski
The actions of the federal government can have a profound impact on financial markets. As prominent participants in the government decision making process, U.S. Senators are likely to have knowledge of forthcoming government actions before the information becomes public. This could provide them with an informational advantage over other investors. We test for abnormal returns from the common stock investments of members of the U.S. Senate during the period 1993–1998. We document that a portfolio that mimics the purchases of U.S. Senators beats the market by 85 basis points per month, while a portfolio that mimics the sales of Senators lags the market by 12 basis points per month. The large difference in the returns of stocks bought and sold (nearly one percentage point per month) is economically large and reliably positive.