Controlling Conflicts of Interest: What Can the Securities and Exchange Commission Learn from Movie Critics?

Abstract

Much attention is being focused on the conflicts of interest of many research analysts' who recommend stocks for investors. These research analysts work for financial institutions that also have investment banking departments. As a result, these analysts have faced great pressure to write positive research reports about companies with which their employers have current or prospective investment banking business. Unfortunately this pressure has resulted in analysts giving biased recommendations in favor of these companies, harming investors who relied on these recommendations.

In response to this bias, the Securities and Exchange Commission, other regulatory organizations, and the courts have recently imposed a number of rules and regulations on research analysts. These reforms are targeted at reducing and publicly disclosing analysts' conflict of interests. To test whether these reforms are likely to be successful in reducing analysts' bias, this Article empirically examines the behavior of another group of professionals - movie critics - who are in a situation with many parallels to research analysts. Many prominent movie critics now regularly review movies that are distributed by subsidiaries of the critics' parent companies.

Despite these parallels, this Article finds no systematic bias in these critics' movie reviews. This lack of bias can be attributed to significant differences between the organizational structure and financial incentives facing movie critics and those facing research analysts. Because many of the recent reforms targeted at research analysts will make their organizational structure and financial incentives more like those of movie critics, this Article provides empirical support for the conclusion that such reforms will reduce research analysts' bias. However, other of the reforms, such as those mandating public disclosure of the analysts' conflicts of interest, may be unnecessary or even harmful to investors.

Keywords: Securities Regulation, Conflicts of Interest

JEL Classification: K22