Journal Article

Investment banks, scope, and unavoidable conflicts of interest

Abstract: In recent years investment banks have drawn particular criticism for the lack of objectivity and independence in their research reports and analyst recommendations. This article argues that this conflict of interest is but one of many potential conflicts that arise as banks take advantage of the scope economies inherent in providing the customary business lines of investment banking under one roof. ; The author considers academic evidence on investment bank analysts? jobs, which entail both an acknowledged sales function and an unacknowledged information brokerage function. In these two roles, analysts are often serving two or more parties whose interests are not aligned. Though some research shows that analyst buy-sell recommendations are biased, the market appears to understand and correct for this bias, the author finds. Evidence on research quality also indicates that analysts at large banks make less biased and more precise earnings forecasts than do analysts at independent research firms. ; The author also examines conflicts of interest between banks? research and corporate finance functions and between internal proprietary trading and the customer-driven sales-and-trading function. These conflicts center around how and when research and proprietary trading information are disseminated to investors. Even more subtle conflicts may arise between investment banks and their customers when either party tries to further its own ends at the expense of a third party. ; Ultimately, the author believes there is little evidence that the mandated regulatory changes that physically and economically separate banking from research or that require banks to make independent research available to retail clients will improve investor welfare.

Keywords: Investment banking;

Bibliographic Information

Provider: Federal Reserve Bank of Atlanta

Part of Series: Economic Review

Publication Date: 2004

Volume: 89

Issue: Q 4

Pages: 23-35