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Conflicts of Interest, Information Provision and Competition in Banking

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  • Patrick Bolton
  • Xavier Freixas
  • Joel Shapiro

Abstract

In some markets, such as the market for drugs or for financial services, sellers have better information than buyers regarding the matching between the buyer's needs and the good's actual characteristics. Depending on the market structure, this may lead to conflicts of interest and/or the underprovision of information by the seller. This paper studies this issue in the market for financial services. The analysis presents a new model of competition between banks, as banks' price competition influences the ensuing incentives for truthful information revelation. We compare two different firm structures, specialized banking, where financial institutions provide a unique financial product, and one-stop banking, where a financial institution is able to provide several financial products which are horizontally differentiated. We show first that, although conflicts of interest may prevent information disclosure under monopoly, competition forces full information provision for sufficiently high reputation costs. Second, in the presence of market power, one-stop banks will use information strategically to increase product differentiation and therefore will always provide reliable information and charge higher prices than specialized banks, thus providing a new justification for the creation of one-stop banks. Finally, we show that, if independent financial advisers are able to provide reliable information, this increases product differentiation and therefore market power, so that it is in the interest of financial intermediaries to promote external independent financial advice.

Suggested Citation

  • Patrick Bolton & Xavier Freixas & Joel Shapiro, 2004. "Conflicts of Interest, Information Provision and Competition in Banking," Working Papers 130, Barcelona Graduate School of Economics.
  • Handle: RePEc:bge:wpaper:130
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    References listed on IDEAS

    as
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    Cited by:

    1. Mehran, Hamid & Stulz, Rene M., 2007. "The economics of conflicts of interest in financial institutions," Journal of Financial Economics, Elsevier, vol. 85(2), pages 267-296, August.
    2. Simona Grassi & Ching-To Albert Ma, 2015. "Information Acquisition, Referral, and Organization," Boston University - Department of Economics - Working Papers Series wp2015-007, Boston University - Department of Economics.
    3. Levy, Gilat & Razin, Ronny, 2004. "On the limits of communication in multidimensional cheap talk," LSE Research Online Documents on Economics 545, London School of Economics and Political Science, LSE Library.
    4. Dimitris Georgarakos & Roman Inderst, 2011. "Financial Advice and Stock Market Participation," BCL working papers 51, Central Bank of Luxembourg.
    5. Inderst, Roman & Ottaviani, Marco, 2012. "How (not) to pay for advice: A framework for consumer financial protection," Journal of Financial Economics, Elsevier, vol. 105(2), pages 393-411.
    6. Gu, Yiquan & Wenzel, Tobias, 2012. "Strategic obfuscation and consumer protection policy in financial markets: Theory and experimental evidence," DICE Discussion Papers 76, University of Düsseldorf, Düsseldorf Institute for Competition Economics (DICE).
    7. David Bardey & Denis Gromb & David Martimort & Jérôme Pouyet, 2016. "Drugs, Showrooms and Financial Products: Competition and Regulation when Sellers Provide Expert Advice," PSE Working Papers halshs-01400841, HAL.
    8. Roman Inderst & Marco Ottaviani, 2009. "Misselling through Agents," American Economic Review, American Economic Association, vol. 99(3), pages 883-908, June.
    9. Michiel Bijlsma & Machiel van Dijk & Marc Pomp & Cora Zonderland, 2005. "Competition in markets for life insurance," CPB Document 96, CPB Netherlands Bureau for Economic Policy Analysis.
    10. Wang, Zigan & Zhu, Youwei, 2011. "A dynamic model of house price," MPRA Paper 34395, University Library of Munich, Germany, revised 29 Oct 2011.
    11. Inderst, Roman, 2010. "Misselling (financial) products: The limits for internal compliance," Economics Letters, Elsevier, vol. 106(1), pages 35-37, January.
    12. Jeremy Burke & Angela Hung & Jack Clift & Steven Garber & Joanne K. Yoong, 2015. "Impacts of Conflicts of Interest in the Financial Services Industry," Working Papers WR-1076, RAND Corporation.

    More about this item

    JEL classification:

    • G2 - Financial Economics - - Financial Institutions and Services
    • L1 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance

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