Conflicts of Interests in the Financial Analysis Industry: Why Did Europeans Get MAD?

In an attempt to mitigate the conflicts of interest stemming from the interdependence of equity research and investment banking departments of brokerage houses, the European Commission has enacted the Market Abuse Directive (MAD) in 2003. We document that this reform was by and large inadequate and may have triggered counterproductive consequences. In particular, we first demonstrate that conflicts of interest were of minor importance in Europe. Also, we show that the scope of MAD appears narrow and leaves some potential conflicts largely unaddressed. More importantly, we find that investors were not materially affected by conflicted equity research. Indeed, they are sophisticated enough to see through biased research and internalize conflicted advises. Finally, we uncover that the passage of MAD reduced significantly the coverage that European firms receive. This loss of attention may lead to a damaging increase of their cost of capital.