Corporate Governance

Stimulus Money Might Stimulate Insider Trading

A new study reveals that politically connected shareholders cashed in with suspiciously well-timed trades during the 2008 federal bailout.

July 15, 2020

| by Seb Murray


Man in a bowler hat with his face obscured by a one hundred dollar bill. Credit: Cory Hall

The study underscores a potential shortcoming of federal bailout programs — that shareholders take advantage of insider knowledge. | Illustration by Cory Hall

Many executives may have exploited their inside knowledge of government intervention during the financial crisis of 2008 to extract millions of dollars in stock-trading profits through suspect transactions, a new study shows.

A new paper, coauthored by Stanford Graduate School of Business professor David F. Larcker and published in the April 2020 issue of Journal of Finance, examined trades made by officers and directors of nearly 500 financial institutions between 2005 and 2011.

To shed light on the link between political connections and insider trades, the researchers looked into the work history of board members for financial institutions receiving funding through the Troubled Asset Relief Program. Executives at firms with at least one board member who’d worked at the Federal Reserve, Treasury, Congress, or as a bank regulator, were deemed to have political connections — a channel for information transfer.

The study found that the advantage was greatest among those with recent and direct connections to political institutions, and it benefited other board members in their firms as well.

A Warning to Policymakers

“It’s truly disturbing that people might have abused their position of trust and responsibility to benefit their own pocketbooks, at a time when millions of Americans were suffering the loss of jobs, savings, and investment,” says Larcker. He finds it “shocking” that bankers, blamed for their starring role in the 2008 crisis, would use advance knowledge of a taxpayer bailout for personal gain.

Larcker is the James Irvin Miller Professor of Accounting, Emeritus, and director of the Corporate Governance Research Initiative at Stanford GSB and also senior faculty of the Arthur and Toni Rembe Rock Center for Corporate Governance. The paper was coauthored by Alan D. Jagolinzer of Cambridge Judge Business School, Gaizka Ormazabal of IESE Business School, and Daniel J. Taylor from the Wharton School.

The study’s conclusions are a warning to policymakers currently doling out unprecedented monetary and fiscal stimulus in an attempt to keep the U.S. economy afloat during the coronavirus pandemic — opening the door for other forms of abuse through political connections and questionable trading behavior.

During the 2008 crisis, many banks were bailed out through the Troubled Asset Relief Program, through which the U.S. Treasury invested in bank stocks to shore up their capital. TARP was created through private meetings between government officials and bank bosses, but key details of the program were never publicly disclosed.

Ramping Up Trades

This gave corporate insiders advance knowledge of the likely scope of government intervention and its impact on their institution. Larcker’s study finds evidence that many seemed to trade on the basis of this private information to earn higher returns than public shareholders.


It’s truly disturbing that people might have abused their position of trust and responsibility to benefit their own pocketbooks, at a time when millions of Americans were suffering the loss of jobs, savings, and investment.
David F. Larcker

Prior to massive government stimulus, political connections had far less influence on trading decisions, the study shows. But in the nine months after TARP’s inception, transactions by politically connected insiders were correctly predicting future stock performance.

Federal law requires executives to disclosure equity stakes in their own firm through regulatory filings that investors pore over for clues about potential share price swings. The researchers’ analysis shows that trades were ramped up 30 days prior to TARP announcements. During allocation of government funds, insiders made 3,058 trades averaging $105,987 and yielding $22,251 in average market-adjusted profits ($68 million overall), significantly outperforming their unconnected counterparts. “Most of the profitable trades were purchases,” says Larcker. “They were buying more shares when it looked like their TARP infusion would pop their stock.”

A Call for Transparency

The fact that executives without political connections did not make similar market moves suggests that informed leaders acted on private information, Larcker says.

Larcker stressed that the researchers did not seek to establish the legality of individual trades but instead analyzed aggregate data. Still, he says, the study underscores the potential shortcomings of bailout programs that use government funding to prop up the financial system.

Transparency will be key to curbing insider trading that might result from the stimulus money currently being poured into the economy during the COVID-19 pandemic, Larcker says. Last year, the House of Representatives passed a bipartisan bill that would make such insider trading a federal crime. If the bill makes it through the Senate, Larcker says, it would codify the crime, promote transparency, and reduce the likelihood of questionable trading by informed persons.

While notoriously tough, investigation and litigation are important to discourage others from leveraging insider information of regulatory programs for personal gain, he says. “If someone gets caught, the whole network gets exposed.”

Larcker also advocates for a longer cooling-off period between a job in government and an executive appointment in the private sector, or vice versa. “Over time, the value of their contacts will fade.”

Without greater control, clarity, transparency, and scrutiny regarding insider trades, he concludes, executives risk shaking confidence in public markets and sowing distrust in the financial and government systems that support the economy.

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