A FRAMEWORK FOR EVALUATING POLICIES TO REMEDY CONFLICTS OF INTEREST
The information view of conflicts of interest developed in this chapter provides a framework for evaluating whether conflicts of interest require public policy actions to eliminate or reduce them. Some combination 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 two propositions are critical to evaluating what should be done about conflicts of interest:
1. The existence of a conflict of interest does not mean that it 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. An exploitation of a conflict of interest that is visible to the market will typically tarnish the reputation of the financial firm where it takes place. Given the importance of maintaining and enhancing its reputation, exploiting the conflict of interest would decrease the firm's future profitability because the firm would have greater difficulty selling its services. As a consequence, firms try to structure their salary and reward systems so as to include incentives to avoid the exploitation of the conflict of interest. Hence, the marketplace may be able to control conflicts of interest because a high value is placed on financial firms' reputations. When evaluating the need for remedies, this proposition raises the issue of whether the market has adequate information and incentives to control conflicts of interest.
2. Even if incentives to exploit conflicts of interest remain strong, eliminating the economies of scope that create the conflicts of interest may he harmful because it will reduce the flow of reliable information. Thus, in evaluating possible remedies, we need to examine whether imposing the remedy will do more harm than good by curtailing the flow of reliable information in financial markets.