Centre for Economic Policy Research

Acknowledgements
The authors have benefited from the discussions, both formal and informal, 
during the ICMB/CEPR Conference in Geneva on 9 May 2003. They also wish to
thank participants in seminars at the Federal Reserve Bank of New York and
Columbia University’s Macro Lunch, for their helpful comments. The views 
presented in this report are entirely those of the authors and should not be taken
to represent those of their employers, past and present.

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Foreword
In the last few years, investors have witnessed a sharp fall-off in equity market
valuations, the dramatic failures of the Enron Corporation and its auditing firm,
Arthur Andersen, and serious manipulation and lack of transparency in the
accounts of several large companies. Understandably, they distrust the practices
by which firms provide information about companies and financial instruments
to market participants. Meanwhile, recent settlements between the State of New
York and a number of prominent investment banks have exhibited apparent con-
flicts of interest in financial services firms. The provision of reliable information
is necessary for financial markets to perform their essential function of chan-
nelling capital to the most productive investment opportunities. The effects of
such conflicts of interest, and possible policy responses to minimize them, are
worthy of serious analysis.
In this fifth publication in the series of Geneva Reports on the World Economy, a
distinguished team of authors, with extensive experience in capital markets and
economics, develops a framework with which to analyze these concerns.The eco-
nomic theory of information underlies this framework. Conflicts of interest are
most evident in firms that provide multiple financial services. The authors single
out several cases for closer inspection: conflicts of interest between underwriting
and research in investment banks, between auditing and consulting services in
accounting firms, between credit assessment and consulting in rating agencies
and, finally, between various lines of business in universal banks.
Policy options range from laisser-faire to full socialization of the provision of
information to market participants. The trick is to choose policies that do not per-
versely end up impairing financial markets by reducing the quality of the infor-
mation available. The authors' information-theory-based approach leads them to
recommend supplementing market discipline with a combination of mandatory
disclosure and supervisory oversight is the optimal.
This structured approach to analysing conflicts of interest should provide a
robust foundation for debates over policies to limit the potential damage caused
by conflicts of interest. ICMB and CEPR are delighted to offer a forum for the
authors to contribute their ideas on a topic so important for the healthy func-
tioning of the world's capital markets.
Richard Portes
Tommaso Padoa-Shioppa
CEPR
ICMB
September 2003
xvii

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