Illegal insider trading profitability and the legal environment

Abstract

This study examines how provincial legal environments shape the profitability of illegal insider trading in China. Using 521 adjudicated insider-trading cases from 2006 to 2018, we hand-collect detailed information from court judgments and CSRC sanction documents to reconstruct holding-period returns and illicit gains. We combine these data with established provincial indices of legal development and firm-level measures of ex ante litigation risk to test whether legal risk is priced in illegal insider trades. We find that stronger provincial legal environments are associated with significantly higher per-trade profitability among illegal trades that insiders execute after accounting for enforcement risk. This pattern is consistent with a risk-compensation mechanism rather than a failure of enforcement, as stricter legal environments deter low-return trades and leave only trades with suff iciently high expected gains. Firm-level litigation exposure further strengthens this effect. The results remain robust to sample-selection corrections, alternative return measures and a range of heterogeneity tests. Overall, our findings show how institutional variation in enforcement shapes insider incentives and the risk–return trade- off of illegal trading.