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Conflicts of interest, information provision and competition in banking

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 rices 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.

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Paper provided by Department of Economics and Business, Universitat Pompeu Fabra in its series Economics Working Papers with number 760.

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Date of creation: Jun 2004
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Handle: RePEc:upf:upfgen:760
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  1. Okuno-Fujiwara, Masahiro & Postlewaite, Andrew & Suzumura, Kotaro, 1990. "Strategic Information Revelation," Review of Economic Studies, Wiley Blackwell, vol. 57(1), pages 25-47, January.
  2. Milgrom, Paul & Roberts, John, 1982. "Limit Pricing and Entry under Incomplete Information: An Equilibrium Analysis," Econometrica, Econometric Society, vol. 50(2), pages 443-59, March.
  3. John G. Riley, 2001. "Silver Signals: Twenty-Five Years of Screening and Signaling," Journal of Economic Literature, American Economic Association, vol. 39(2), pages 432-478, June.
  4. Shaked, Avner & Sutton, John, 1983. "Natural Oligopolies," Econometrica, Econometric Society, vol. 51(5), pages 1469-83, September.
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  6. Paul R. Milgrom & John Roberts, 1985. "Relying on the Information of Interested Parties," Cowles Foundation Discussion Papers 749, Cowles Foundation for Research in Economics, Yale University.
  7. Benabou, R. & Laroque, G., 1989. "Using Privileged Information To Manipulate Markets: Insiders, Gurus, And Credibility," Working papers 513, Massachusetts Institute of Technology (MIT), Department of Economics.
  8. Pitchik, Carolyn & Schotter, Andrew, 1987. "Honesty in a Model of Strategic Information Transmission," American Economic Review, American Economic Association, vol. 77(5), pages 1032-36, December.
  9. Morgan, J. & Stocken, P., 1998. "An Analysis of Stock Recommendations," Papers 204, Princeton, Woodrow Wilson School - Public and International Affairs.
  10. Asher Wolinsky, 1991. "Competition in a Market for Informed Experts' Services," Discussion Papers 959, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
  11. Wolfgang Pesendorfer & Asher Wolinsky, 2003. "Second Opinions and Price Competition: Inefficiency in the Market for Expert Advice," Review of Economic Studies, Wiley Blackwell, vol. 70(2), pages 417-437, 04.
  12. Darby, Michael R & Karni, Edi, 1973. "Free Competition and the Optimal Amount of Fraud," Journal of Law and Economics, University of Chicago Press, vol. 16(1), pages 67-88, April.
  13. Emons, Winand, 2001. "Credence goods monopolists," International Journal of Industrial Organization, Elsevier, vol. 19(3-4), pages 375-389, March.
  14. Winand Emons, 1994. "Credence Goods and Fraudulent Experts," Diskussionsschriften dp9402, Universitaet Bern, Departement Volkswirtschaft.
  15. Meurer, Michael & Stahl, Dale II, 1994. "Informative advertising and product match," International Journal of Industrial Organization, Elsevier, vol. 12(1), pages 1-19, March.
  16. Helmut Bester, 1998. "Quality Uncertainty Mitigates Product Differentiation," RAND Journal of Economics, The RAND Corporation, vol. 29(4), pages 828-844, Winter.
  17. Steven Shavell, 1994. "Acquisition and Disclosure of Information Prior to Sale," RAND Journal of Economics, The RAND Corporation, vol. 25(1), pages 20-36, Spring.
  18. Mailath, George J, 1989. "Simultaneous Signaling in an Oligopoly Model," The Quarterly Journal of Economics, MIT Press, vol. 104(2), pages 417-27, May.
  19. Wolfgang Pesendorfer & Asher Wolinsky, 2003. "Second Opinions and Price Competition: Inefficiency in the Market for Expert Advice," Review of Economic Studies, Oxford University Press, vol. 70(2), pages 417-437.
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