Economics 2.0: What the Best Minds in Economics Can Teach You About Business and Life by Norbert Häring

Author:Norbert Häring
Language: eng
Format: mobi
Publisher: St. Martin's Press
Published: 2008-12-23T00:00:00+00:00

The Dirt on Coming Clean

Ever since the scandals surrounding Enron, WorldCom and others, investors are alerted to potential conflicts of interest. Every analyst report today is accompanied by page-long disclaimers.

However, such warnings can do more harm than good. Three American economists and psychologists, Daylian Cain, George Loewenstein and Don Moore, showed test subjects a glass jar filled with coins from a distance, and asked them to estimate its value. The closer a subject came with his guess, the higher the reward would be. Each of them had an adviser assigned to them who was allowed to inspect the contents from close up. As the advisers’ reward would go up in proportion with the subjects’ estimate, they had a similar conflict of interest as stock analysts do at a bank: The bank will earn commissions from the stock purchases of its clients; so when an adviser discourages clients with bearish forecasts, he is doing his employer a disfavor, since positive outlooks will boost business. The researchers informed half of the clients about their advisers’ conflict of interest (in the advisors’ presence); the other half was not explicitly informed.

As could be expected, most advisers exaggerated the amount of money in the jar. But could the better-informed group of estimators defend their interests more effectively? They could not. Advisers with a known conflict of interest exaggerated the jar’s contents even more than their peers, on the premise that their clients would subtract something anyway. The estimators, on the other hand, who knew of their advisers’ conflict of interests, trusted them almost as much as those unaware. In the end, the informed group came out worse than the uninformed one. The advantage went to the advisers who, on top of everything, did not even need to have any feelings of guilt since their clients had been in the know.

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