Professional Documents
Culture Documents
of External Funds
7-1
7-2
7-3
Transaction
Costs
! InSluence
on
Financial
Structure
a. Too
high
for
small-time
investors:
Stocks:
Brokerage
Commission
-
large
%
of
Purchase
Price
Bonds:
smallest
denomination
-
$10,000
b.
Restricted
number
of
investments
Inability
to
Diversify
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ConSlicts
of
Interest
- a type of moral hazard problem that arise when a
person or institution has multiple services.
- potentially competing objectives (interests) of those
services may lead an individual or firm to conceal
information or disseminate misleading information.
ConSlicts
of
Interest
- a concern because substantial reduction in the quality
of info in financial markets increases asymmetric info
- prevents financial markets from channeling funds to
most
productive
investment
opportunities.
Consequently, the financial markets & the economy
become less efficient
3
Types
of
nancial
service
activities:
1. Underwriting
&
Research
in
investment
banks
2.
Auditing
and
Consulting
in
Accounting
Firms
3.
Credit
Assessment
&
Consulting
in
Credit
Rating
Agencies
Financial Markets and Institutions
7 - 24
ConSlicts
of
Interest
3
Types
of
nancial
service
activities
1. Underwriting
&
Research
in
investment
banks
- Conict
between
2
client
groups
w/
diering
potential
revenues
a. security-issuing
rms
b. security-buying
investors
- Spinning:
when
an
investment
bank
allocates
hot,
but
underpriced,
initial
public
oerings
(IPOs)
to
executives
of
other
companies
in
return
for
their
companies
future
business
with
the
investment
banks
Financial Markets and Institutions
7 - 25
ConSlicts
of
Interest
3
Types
of
nancial
service
activities
2. Auditing
and
Consulting
in
Accounting
Firms
- Auditors
may
be
willing
to
skew
their
judgments
&
opinions
to
win
consulting
business
from
same
clients
- Auditors
may
be
auditing
info
systems
or
tax
&
nancial
plans
put
in
place
by
their
non-audit
counterparts
within
the
rm,
and
therefore
may
be
reluctant
to
criticize
the
systems
or
advice.
- Auditor
provides
overly
favorable
audit
to
solicit
or
retain
audit
business.
Case:
Collapse
of
Arthur
Andersen
1
of
the
5
largest
accounting
rms
in
the
US
Financial Markets and Institutions
7 - 26
ConSlicts
of
Interest
3
Types
of
nancial
service
activities
3. Credit
Assessment
&
Consulting
in
Credit
Rating
Agencies
- Probability
of
default
to
determine
the
creditworthiness
of
particular
debt
securities
- In
the
credit
rating
industry,
the
issuers
of
securities
pay
a
rating
rm
such
as
Standard
and
Poors
or
Moodys
to
have
their
securities
rated
- When
credit
rating
agencies
also
provide
ancillary
consulting
services:
Debt
issuers
often
ask
rating
agencies
to
advise
them
on
how
to
structure
their
debt
issues.
Financial Markets and Institutions
7 - 27
ConSlicts
of
Interest
What
has
been
done
to
Remedy
Conicts
of
Interest
1. Sarbanes-Oxley
Act
of
2002
- Public
Accounting
Return
and
Investor
Protection
Act
- Increased
supervisory
oversight:
! Established
a
Public
Company
Accounting
Oversight
Board
(PCAOB),
overseen
by
the
SEC,
to
supervise
accounting
rms
&
ensure
that
audits
are
independent
&
controlled
for
quality
! It
increased
the
SECs
budget
to
supervise
securities
markets
Financial Markets and Institutions
7 - 28
ConSlicts
of
Interest
What
has
been
done
to
Remedy
Conicts
of
Interest
1. Sarbanes-Oxley
Act
of
2002
- Directly
reduced
conicts
of
interest
! Illegal
for
a
registered
public
accounting
rm
to
provide
any
nonaudit
service
to
a
client
contemporaneously
with
an
impermissible
audit
(as
determined
by
PCAOB)
! It
beefed
up
criminal
charges
for
white-collar
crime
and
obstruction
of
ocial
investigations.
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ConSlicts
of
Interest
What
has
been
done
to
Remedy
Conicts
of
Interest
1. Sarbanes-Oxley
Act
of
2002
- Improve
the
quality
of
information
in
the
nancial
markets
! required
a
CEO
&
CFO,
as
well
as
its
auditors,
to
certify
that
periodic
nancial
statements
&
disclosures
of
the
rm
(esp.
o-balance-sheet
transactions)
are
accurate
! required
members
of
the
audit
committee
to
be
independent;
that
is,
they
cannot
be
managers
in
the
company
or
receive
any
consulting
or
advisory
fee
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ConSlicts
of
Interest
What
has
been
done
to
Remedy
Conicts
of
Interest
2. Global
Legal
Settlement
of
2002
- December
20,
2002,
with
10
largest
investment
banks
by
the
SEC,
the
New
York
Attorney
General,
NASD,
NASAA,
NYSE,
and
state
regulators.
- Directly
reduced
conicts
of
interest
! required
investment
banks
to
sever
the
links
between
Research
&
Securities
Underwriting.
! Banned
spinning
Financial Markets and Institutions
7 - 31
ConSlicts
of
Interest
What
has
been
done
to
Remedy
Conicts
of
Interest
2. Global
Legal
Settlement
of
2002
- Incentives
for
investment
banks
not
to
exploit
conicts
of
interest:
Imposed
$1.4
billion
of
nes
- Measures
to
improve
quality
of
info
in
nancial
markets
! Required
investment
banks
to
make
their
Analysts
Recommendations
public
! Over
5-yr
period:
Required
to
contract
with
at
least
3
independent
research
rms
that
would
provide
research
to
their
brokerage
customers.
Financial Markets and Institutions
7 - 32