In February 1998, Newbridge Networks Corporation, a telecommunications equipment maker based in Kanata, Ontario, announced that its revenues and profits for the quarter ending on February 1, 1998, would be substantially below analysts’ estimates. Its share price immediately fell by 23% on the Toronto and New York stock exchanges.
The sale, in December 1997, of over $ 5 million of the company’s shares by an inside director of Newbridge was widely reported in the financial media during February 1998. Details of sales by other Newbridge insiders, including its CEO, during previous months were also reported. The implication of these media reports was that these persons had taken advantage of inside information about disappointing sales of a new product line.
a. Which source of market failure is implied by these media reports of insider trading?
b. What effects on investors, and on the liquidity of Newbridge shares, would media reports of such insider sales be expected to create?
c. Suppose that Newbridge’s management felt that its share price was undervalued by the market after the February earnings announcement. Describe some signals that management and directors could engage in to counter the public impression of lower-than- expected profitability.