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Regulation of ''Guru'' Analysts' Conflicts of Interest

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  • Biard, Antoine
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    Abstract

    Conflicts of interest are the inherent price to pay to benefit from information synergies offered by multiple financial service providers. We focus on conflicts faced by a investment bank's "guru" sell-side analyst, which is torn between the pro-investor research department favoring fair valuation, and the "pro-corporate firms" underwriting department favoring overvaluation. Thanks to a delegated common agency game under moral hazard, we endogenize the influence of environment variables on conflicts outcome as regards market valuation. We demonstrate first that the risk of overvaluation depends crucially on the extent of the relative pricing preferences of opposite financial interests at stake. Thus, the more the potential profit from underwriting activities exceeds potential brokerage commissions, the more the bank favors issuers over investors, and the more likely market overvaluation is. Consequently, to protect naive uninformed investors, we introduce in a second time a regulator in the framework of a simultaneous intrinsic relationship, which su¤ers from overvaluation on the one hand, and is allowed to take costly judicial proceedings to penalize banks on the other hand. We then show that coercive regulation greatly mitigates damaging conflicts outcomes, even if it induces free-riding behaviors among fair-valuation partisans.

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    File URL: http://basepub.dauphine.fr/xmlui/bitstream/123456789/3370/2/biard.pdf
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    Bibliographic Info

    Paper provided by Université Paris-Dauphine in its series Open Access publications from Université Paris-Dauphine with number urn:hdl:123456789/3370.

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    Length: 31
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    Handle: RePEc:ner:dauphi:urn:hdl:123456789/3370

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    Related research

    Keywords: Overvaluation; Analyst; Moral Hazard; Common Agency;

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    1. Ottaviani, Marco & Sorensen, Peter Norman, 2006. "The strategy of professional forecasting," Journal of Financial Economics, Elsevier, vol. 81(2), pages 441-466, August.
    2. Morgan, John & Stocken, Phillip C, 2003. " An Analysis of Stock Recommendations," RAND Journal of Economics, The RAND Corporation, vol. 34(1), pages 183-203, Spring.
    3. Gilat Levy, 2000. "Strategic Consultation in the Presence of Career Concerns," STICERD - Theoretical Economics Paper Series 404, Suntory and Toyota International Centres for Economics and Related Disciplines, LSE.
    4. Harrison Hong & Jeffrey D. Kubik, 2003. "Analyzing the Analysts: Career Concerns and Biased Earnings Forecasts," Journal of Finance, American Finance Association, vol. 58(1), pages 313-351, 02.
    5. Marco Ottaviani & Peter Sorensen, 1999. "Professional Advice," Game Theory and Information 9906003, EconWPA.
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