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AbstractRecent academic work and policy analysis give insight into the governance problems exposed by the financial crisis and suggest possible solutions. We begin this paper by explaining why governance of banks differs from governance of nonfinancial firms. We then look at four areas of governance: executive compensation, boards, risk management, and market discipline. We discuss promising solutions and areas where further research is needed.
The collapse of AAA-rated structured finance products in 2007 to 2008 has brought renewed attention to conflicts of interest in credit rating agencies (CRAs). We model competition among CRAs with three sources of conflicts: (1) CRAs conflict of understating risk to attract business, (2) issuers' ability to purchase only the most favorable ratings, and (3) the trusting nature of some investor clienteles. These conflicts create two distortions. First, competition can reduce efficiency, as it facilitates ratings shopping. Second, ratings are more likely to be inflated during booms and when investors are more trusting. We also discuss efficiency-enhancing regulatory interventions.
In some markets sellers have better information than buyers over which products best serve a buyer's needs. Depending on the market structure, this may lead to con ‡icts of interest in the provision of information by sellers. This paper studies this issue in the market for …nancial services. The analysis presents a new model of competition between banks, where price competition in ‡uences the ensuing incentives for truthful information revelation. We also compare con ‡icts of interest in two di¤erent …rm structures, specialized banking and one-stop banking.
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