Working Paper: CEPR ID: DP5314
Authors: Zhaohui Chen; William J. Wilhelm Jr.
Abstract: 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.
Keywords: Conflicts of interest; Financial analysts; Industrial organization; Investment banking; Securities regulation
JEL Codes: D82; G14; G24; L22
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| presence of sellside analysts (G24) | information content in financial market prices (G19) |
| competition among buyside fund managers (G23) | profitability of sellside information (G24) |
| subsidies necessity (H20) | maintenance of sellside research (G24) |
| sellside research (G24) | welfare (I38) |
| conflicts of interest (G34) | sellside research (G24) |
| information produced by analysts (G24) | real investment decisions (G31) |
| sellside research existence in equilibrium (D53) | information complementary to that produced by fund managers (G23) |