Centre for Economic Policy Research

1.6
A framework for evaluating policies to remedy conflicts 
of interest
The information view of conflicts of interest we have proposed here also provides
a framework for evaluating whether they require public policy actions to 
eliminate or reduce them. Some combinations of financial service activities may
result in incentives for agents to conceal information, but they may also result in
synergies that make it easier to produce information. Thus, preventing the 
combination of activities to eliminate the conflicts of interest may actually make
financial markets less efficient. This reasoning suggests that there are two 
propositions that are critical for evaluating what should be done about conflicts
of interest:
1. The fact that a conflict of interest exists does not mean that the conflict will 
have serious adverse consequences. Even though a conflict of interest exists, 
the incentives to exploit the conflict of interest may not be very high. 
Exploitation of a conflict of interest which is visible to the market will 
typically result in a decrease in the reputation of the financial firm where it
takes place. Given the importance of maintaining and enhancing 
reputation, exploiting the conflict of interest would then decrease the future
profitability of the firm because it will have greater difficulty selling its 
services in the future, thus creating incentives for the firm to prevent 
exploitation of the conflict of interest. Hence, the market-place may be able
to control conflicts of interest because there is a high value to financial 
firms’ reputations. When evaluating the need for remedies, this proposition
raises the issue whether the market has the information and incentives to 
control conflicts of interest.
2. Even if incentives to exploit conflicts of interest remain strong, eliminating 
the conflict of interest may be harmful, if doing so destroys economies of 
scope, thereby reducing information flows. Thus in evaluating possible 
remedies, we also need to examine the issue of whether imposing the 
remedy will do more harm than good by reducing the flow of information
in financial markets. 
Specific remedies for conflicts of interest can be grouped into five generic
approaches:
1. Market discipline.
2. Mandatory disclosure of increased transparency.
3. Supervisory oversight.
4. Separation of functions.
5. Socialization of information production.