DP5314 The Industrial Organization of Financial Market Information Production

Author(s): Zhaohui Chen, William J Wilhelm Jr
Publication Date: October 2005
Keyword(s): conflicts of interest, financial analysts, industrial organization, investment banking, securities regulation
JEL(s): D82, G14, G24, L22
Programme Areas: Financial Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=5314

In our model, information-producing agents can opt to produce from the sell-side, in which case they can only sell their information to other market participants, or produce from the buy-side, in which case they agent can trade in the financial market. If sell-side information substitutes for that produced on the buy-side, some form of subsidy is necessary to sustain sell-side production in equilibrium because sell-side agents cannot commit to narrow dissemination of their information among buy-side agents. Competition among buy-side agents leaves buy-side (private) information as the primary source of trading profits. Subsidizing sell-side research promotes welfare because such information enters financial market prices and thereby improves real investment decisions. But subsidies compromise welfare through conflicts of interest facing the sell-side analyst. We derive conditions under which the net welfare effect is positive and shed light on means of managing the tradeoff.