大三第三學期zj金融市場與機構

1、Chapter 16What Should Be Done About Conflicts of Interest? A Central Issue in Business EthicsCopyright 2009 Pearson Prentice Hall. All rights reserved.16-2Chapter PreviewIn the last several years, the U.S. stock market has been jolted by many corporate scandals. One of the biggest auditors, Arthur A

2、ndersen, was indicted on obstruction charges. Criminal charges have been filed again J.P. Morgan, Merrill Lynch, and Goldman Sachs.Copyright 2009 Pearson Prentice Hall. All rights reserved.16-3Chapter PreviewSurrounding many of these cases is a central theme of conflicts of interest a situation wher

3、e multiple interest have to be served, often the investing public and corporate clients. In this chapter, we examine this problem more closely.Copyright 2009 Pearson Prentice Hall. All rights reserved.16-4Chapter PreviewWe examine recent equity market scandals and the consequences on the investing p

4、ublic. We pose a broad question: what can be done to resolve these problems? Topics include:What Are Conflicts of Interest and Why Are They Important?Ethics and Conflicts of InterestCan the Market Limit Exploitation of Conflicts of Interest?What has been done to Remedy Conflicts of Interest?A Framew

5、ork for Evaluating Policies to Remedy Conflicts of InterestCopyright 2009 Pearson Prentice Hall. All rights reserved.16-5What Are Conflicts of Interest and Why Are They Important?Financial intermediaries engage in a variety of activities to collect, produce, and distribute information. By providing

6、multiple services, they realize economies of scope.However, these services may be competing with one another, and this creates the potential for a conflict of interest.Copyright 2009 Pearson Prentice Hall. All rights reserved.16-6What Are Conflicts of Interest and Why Are They Important?The conflict

7、s of interest may arise as the concealment of information for the dissemination of misleading information.We care about these conflicts of interest because a reduction in the quality of information increases the presence of asymmetric information. The problems therein were just discussed in the prev

8、ious chapter.Copyright 2009 Pearson Prentice Hall. All rights reserved.16-7Ethics and Conflicts of InterestConflicts of interest generate incentives to provide false or misleading information. This behavior is considered unethical.One way to limit these conflicts is to make workers aware of the ethi

9、cs issues at stake, so that they are less likely to engage in unethical behavior.Copyright 2009 Pearson Prentice Hall. All rights reserved.16-8Types of Conflicts of InterestWe will discuss, in turn, four areas of financial service activities that harbor the greatest potential for generating conflict

10、s of interest. These are:Underwriting and research in investment bankingAuditing and consulting in accounting firmsCredit assessment and consulting in credit-rating agenciesUniversal bankingCopyright 2009 Pearson Prentice Hall. All rights reserved.16-9Underwriting and Research in Investment BankingS

11、ome investment banks both underwrite new securities sold the public, and provide research (buy/sell mendations) to the investing publicWhen revenues from underwriting exceed brokerage commissions, favorable research will attract more business, at the expense of unbiased mendations to the investing p

12、ublic.Copyright 2009 Pearson Prentice Hall. All rights reserved.16-10Underwriting and Research in Investment BankingIn initial public offerings of equity, underwriters direct the new shares as they wish, typically to their best clients or potential new clients.Since most IPOs are underpriced, many o

13、f these shares are immediately sold for a profit (called spinning). This immediate “profit” may appear as nothing more than payment for future business.Copyright 2009 Pearson Prentice Hall. All rights reserved.16-11Underwriting and Research in Investment BankingSeveral recent cases highlight the con

14、flicts that IPOs can create. Lets look at two of these: “The King, Queen, and Jack of the Internet” and “Frank Quattrone and Spinning”Copyright 2009 Pearson Prentice Hall. All rights reserved.16-12The King, Queen, and Jack of the InternetThe title refers to three influential technology analysts duri

15、ng the internet boom:Henry Blodgett (ML)Jack Grubman (SSB)Mary Meeker (MS)Conflicts of interest may have influenced mendations they made.Copyright 2009 Pearson Prentice Hall. All rights reserved.16-13The King, Queen, and Jack of the InternetHenry Blodgett (ML)Publically hyped internet stocks while d

16、erailing them privately. Changed mendations when ML didnt get underwriting business.Jack Grubman (SSB)Similar to Henry, mendations were strong, but private comments suggested otherwise.Copyright 2009 Pearson Prentice Hall. All rights reserved.16-14The King, Queen, and Jack of the InternetMary Meeker

17、 (MS)Unlike Henry and Jack, Mary did have strong buy mendations, but didnt derail them privately. Indeed, she did have poor mendations for firms with poor prospects. She was never subject to criminal charges.Copyright 2009 Pearson Prentice Hall. All rights reserved.16-15Frank Quattrone and SpinningF

18、rank worked for Credit Suisse First Boston underwriting new internet stock issues.NASD filed a complaint in 1993 that he pressured analysts to provide favorable coverage.“Friends of Frank” account used for spinning was also alleged shares sold vary quickly for profit to “friends”.Copyright 2009 Pear

19、son Prentice Hall. All rights reserved.16-16Auditing and Consulting in Accounting FirmsTo return to our discussion of Types of Conflicts, we now look at the role of auditors in public firms. They provide an unbiased view of the financial reports to reduce asymmetric information between the firms man

20、agement and the investing public.By also providing management advisory services (such as systems support), the auditor has an incentive to fudge the audit if the fees from other services are substantial.Copyright 2009 Pearson Prentice Hall. All rights reserved.16-17Auditing and Consulting in Account

21、ing FirmsAuditors also have a conflict of interest since they are paid by the firm they audit. If the auditor gives an unfavorable audit report, the auditor may lose the auditing business as well.A well known case of the failure of auditors to provide unbiased reports was Arthur Andersens audit of E

22、nron.Copyright 2009 Pearson Prentice Hall. All rights reserved.16-18Credit Assessment and Consulting in Credit-Rating AgenciesBond investors rely on credit-rating agency assessment of firms debt (debt ratings).However, ratings are only provided when the firm pays the agency. Agencies, then, have an

23、incentive provide “better” ratings to attract business.Copyright 2009 Pearson Prentice Hall. All rights reserved.16-19Credit Assessment and Consulting in Credit-Rating AgenciesRating agencies have also started providing firms with other services, and have the same conflicts as auditors in this regar

24、d.Lets look at this further in our mini-case.Copyright 2009 Pearson Prentice Hall. All rights reserved.16-20Mini-case: Why get rated?In the 1970s, rating agencies earned revenue by providing information about securities (ratings). However, this changed to where the agencies now charge the issuer to

25、have its debt rated. Why the switch?Copyright 2009 Pearson Prentice Hall. All rights reserved.16-21Mini-case: Why get rated?“Free-riders” explains this. Few actually paid for the research. One would pay, and then make copies for everyone else. The agencies started losing revenue. Its unfortunate tha

26、t the solution (charging issuers) created a conflict. Was there a better solution?Copyright 2009 Pearson Prentice Hall. All rights reserved.16-22Universal BankingUniversal banking refers to institutions that provide some combination of commercial banking, investment banking, and insurance services.G

27、lass-Steagall prohibited this in the U.S. as of 1933. However, in 1999, Congress repealed this act, allowing for some form of universal banks in the U.S.Copyright 2009 Pearson Prentice Hall. All rights reserved.16-23Universal BankingIssuers that use the underwriting services of a bank will also bene

28、fit from sale of its products to the banks other (retail) customers. Customers should expect unbiased advice, but may not get it.Bank managers may push investing products of its affiliates, even if they arent in customers best interest.Copyright 2009 Pearson Prentice Hall. All rights reserved.16-24U

29、niversal BankingLenders with private (bad) information have an incentive to withhold the information during security issuances in order to get paid themselves, at the expenses of the investing public.Lenders may offer favorable terms to secure future underwriting business.Copyright 2009 Pearson Pren

30、tice Hall. All rights reserved.16-25Universal BankingBanks may use strong-arm tactics to sell its affiliate insurance products.Copyright 2009 Pearson Prentice Hall. All rights reserved.16-26Can the Market Limit Exploitationof Conflicts of Interest?Conflicts of interest are a problem when they lead t

31、o a decreased flow of reliable information (increased asymmetric information).However, even with potential conflicts, the incentives (financial gain) may not be present to actually act on them.Copyright 2009 Pearson Prentice Hall. All rights reserved.16-27When Are Conflicts of Interest a Serious Pro

32、blem?Empirical evidence suggests that rating agency debt ratings are unbiased, despite being paid by the firms.Underwriting and commercial banking also appeared to be free from exploitations. Many banks in then 1920s spun-off their investment banking activities to separate the functions.Copyright 20

33、09 Pearson Prentice Hall. All rights reserved.16-28When Are Conflicts of Interest a Serious Problem?Empirical evidence also suggests that the investing public “discounts” mendations made by the underwriters analysts.However, when temporary rewards to high (such as the late 1990s), “trusted” firms ma

34、y extract reputational rents from the investing public by seeking short-term gains at the expense of their future reputation.Copyright 2009 Pearson Prentice Hall. All rights reserved.16-29The BankstersWhen the market fell in 1929, investors asked why they had been encourage to buy securities. The Se

35、nate held hearings to investigate this, and several cases of conflicts arose. As a result, Congress passed Glass-Steagall to separate banking and securities. However, this was repealed in 1999 just in time for another collapse.Copyright 2009 Pearson Prentice Hall. All rights reserved.16-30What Has B

36、een Done to Remedy Conflicts of Interest?Two major policies were implemented following the scandals of the late 1990s and early 2000s. These are:Sarbanes-Oxley Act of 2002Global Legal Settlement of 2002Copyright 2009 Pearson Prentice Hall. All rights reserved.16-31Sarbanes-Oxley Act of 2002Passed fo

37、llowing the public outcry over corporate scandals. The act, in summary, has the following six major components:Established the Public Company Accounting Oversight Board to supervise accounting firms.Prohibited public accounting firms from engaging in nonaudit services to a client it is also auditing

38、.Members of the boards audit committee must be independent.Copyright 2009 Pearson Prentice Hall. All rights reserved.16-32Sarbanes-Oxley Act of 2002Passed following the public outcry over corporate scandals. The act, in summary, has the following six major components:Required the reporting of off-ba

39、lance sheet activities.Appropriated additional funding for the SEC.Increased the charges for white-collar crimes and obstruction.Copyright 2009 Pearson Prentice Hall. All rights reserved.16-33Global Legal Settlement of 2002This was a settlement reached between the New York Attorney General and sever

40、al of the largest U.S. investment banks. The key terms of the agreement included:Firms must severe the link between underwriting and research activities.Spinning is banned.Firms must make public analyst mendations and target prices.Copyright 2009 Pearson Prentice Hall. All rights reserved.16-34Globa

41、l Legal Settlement of 2002This was a settlement reached between the New York Attorney General and several of the largest U.S. investment banks. The key terms of the agreement included:Brokerage firms required to obtain third-party, independent research for their clients.$1.4 billion in fines.Copyrig

42、ht 2009 Pearson Prentice Hall. All rights reserved.16-35A Framework for Evaluating Policies to Remedy Conflicts of InterestA trade-off between potential conflicts of interest and economies of scale exists. Simply eliminating any potential conflict may not be the best solution:The existence of a conf

43、lict of interest does not mean that the conflict will have severe consequences.Even if incentives to exploit conflicts are high, eliminating the conflict may be worse if it reduces the flow of reliable information.Copyright 2009 Pearson Prentice Hall. All rights reserved.16-36Approaches to Remedying

44、 Conflicts of InterestLeave It to the Market: an appealing approach that relies on market forces, but has the problem that the market has a “short” memory for past problems.Regulate for Transparency: regulate mandatory disclosure, even if it is more costly than the information provided.Copyright 200

45、9 Pearson Prentice Hall. All rights reserved.16-37Approaches to Remedying Conflicts of InterestSupervisory Oversight: force firms to provide private information to a supervisor, who can act on it as deemed necessary.Separation of Functions: separate those functions that create conflicts, either with

46、in firms or (in extreme cases) by not allowing those functions within the same firm.Copyright 2009 Pearson Prentice Hall. All rights reserved.16-38Approaches to Remedying Conflicts of InterestSocialization of Information Production: look to public funding for information providers, such as credit ag

47、encies.Copyright 2009 Pearson Prentice Hall. All rights reserved.16-39Case: Evaluating SOX and GLSSOX has done some good, but it is costly. It is estimated that a firm with revenue less than $100 million will spend about $800,000 (1.5% of sales) to comply. Ouch!However, recent data suggests that the

48、se costs are coming down. But thats no surprise the setup costs arent being incurred.Copyright 2009 Pearson Prentice Hall. All rights reserved.16-40Case: Evaluating SOX and GLSThe Global Legal Settlement called for public disclosure of mendations. However, analysts still have two clients money manag

49、ers and small investors. Who do you think gets the information first?Other practices (like spinning) have been banned. And separation of functions is required in reduce conflicts.Copyright 2009 Pearson Prentice Hall. All rights reserved.16-41Case: Evaluating SOX and GLSBut conflicts are still present. And there are unintended es such as fewer analysts and lower research budgets. Solutions are never clear when trying to reduce conflicts of interest!Copyright 2009 Pearson Prentice Ha