The Industrial Organization of Financial Market Information Production

47 Pages Posted: 3 Jan 2006

See all articles by Zhaohui Chen

Zhaohui Chen

Independent

William J. Wilhelm

University of Virginia - McIntire School of Commerce

Date Written: October 2005

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: Financial analysts, industrial organization, investment banking, conflicts of interest, securities regulation

JEL Classification: D82, G14, G24, L22

Suggested Citation

Chen, Zhaohui and Wilhelm, William J., The Industrial Organization of Financial Market Information Production (October 2005). CEPR Discussion Paper No. 5314, Available at SSRN: https://ssrn.com/abstract=873498

William J. Wilhelm

University of Virginia - McIntire School of Commerce ( email )

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