Economics of Money, Banking, and Financial Markets, 11e (Mishkin)
Web Chapter 5: Conflicts of Interest in the Financial Industry
1) Conflicts of interest is a type of ________ problem that occurs when a person or institution
has multiple objectives that are in conflict with each other.
A) moral hazard
B) adverse selection
C) risk sharing
D) spinning
2) A type of ________ problem that occurs when a person or institution has multiple objectives
that conflict with each other is called ________.
A) moral hazard; conflicts of interest
B) adverse selection; conflicts of interest
C) moral hazard; spinning
D) adverse selection; spinning
3) When financial institutions are able to reduce the costs of information for each service they
offer by applying the same information source to each service, we say that the financial
institution is realizing
A) economies of scope.
B) economies of scale.
C) increasing returns.
D) diminishing marginal returns.
4) Which of the following is an example of a bank realizing economies of scope?
A) The bank develops a standard mortgage loan application to make the process of loaning out
mortgages easier.
B) The bank reduces costs of credit checking for the loan process by outsourcing the process to a
specialist.
C) By using the information collected from a corporation, the bank can decide how easy it would
be to sell bonds issued by the corporation to the public.
D) A bank in a rural area specializes in providing agricultural loans.
5) One problem with conflicts of interest is that they can reduce the ________ in financial
markets, thereby increasing ________.
A) quantity of information; financial institutions’ profits
B) quantity of information; asymmetric information
C) quality of information; asymmetric information
D) quality of information; financial institutions’ profits
6) Describe what is meant by economies of scope and explain how financial institutions’
realizing economies of scope has led to an increase in conflicts of interest.
1) Not surprisingly, when financial institutions have consolidated more services under one roof,
the amount of conflicts of interest has ________, which has led to ________ in unethical
behavior.
A) increased; an increase
B) increased; a decrease
C) decreased; an increase
D) decreased; a decrease
1) In investment banking, a conflict usually is present between the issuers of securities, who
________, and investors, who ________.
A) benefit from unbiased auditing; desire unbiased consulting
B) desire unbiased research; benefit from optimistic research
C) benefit from optimistic research; desire unbiased research
D) desire unbiased consulting; benefit from unbiased auditing
2) The incentive for analysts in investment banks to distort research increases when
A) revenues from brokerage commissions increase.
B) the potential revenues from underwriting greatly exceed brokerage commissions.
C) the potential brokerage commissions greatly exceed revenues from underwriting.
D) revenues from underwriting decrease.
3) When investment banks allocate shares of a popular but underpriced IPO to executives of
other firms in order to attract their business, it is called
A) spinning.
B) a bribe.
C) reputational activities.
D) a kickback.
4) The problem with spinning is that it may ________ the cost of capital to a firm and thus
________ the efficiency of the capital market.
A) increase; increase
B) increase; decrease
C) decrease; increase
D) decrease; decrease
5) Which of the following is not a conflict of interest in accounting firms?
A) The firm provides consulting as well as rating creditworthiness.
B) Auditors may be pressured to skew their opinions so the client will stay with the firm.
C) Auditors may be reluctant to criticize advice put into place by nonaudit personnel of the firm.
D) Auditors release an overly favorable audit in order to solicit business.
6) Advice on taxes, accounting or management information systems, and business strategies are
commonly referred to as ________ services.
A) accounting audit
B) management advisory
C) seller
D) managing underwriter
7) Conflicts of interest arising from management advisory services brought down ________ in
2002.
A) Enron
B) WorldComm
C) Arthur Andersen
D) Global Crossing
8) Conflicts of interest may arise within the credit rating agencies because
A) the investors pay the credit agencies for ratings.
B) the issuers of debt securities pay the credit agencies for ratings.
C) the credit rating agencies provide auditing services to issuers of debt securities.
D) the credit rating agencies are involved in offering credit counseling to investors.
9) When the Glass-Steagall Act was repealed in 1999, potential conflicts of interest arose with
A) the development of universal banking.
B) the introduction of more credit-rating agencies.
C) accounting firms developing more comprehensive services.
D) investment analysis in investment banking.
10) Explain the type of conflicts of interest that can arise from the development of universal
banking.
1) Evidence suggests that credit-rating agencies ________ exploited conflicts of interest because
________.
A) have not; it would cause their ratings to lose credibility and thus have a lower value in the
marketplace
B) have not; they would have an increase in profits in the long-run
C) have; it would cause their ratings to lose credibility and thus have a lower value in the
marketplace
D) have; they would have an increase in profits in the long-run
2) Evidence suggests that the market ________ take into account the credibility of analyst’s
recommendations of IPOs that were underwritten at the analyst’s investment bank because the
performance of these recommendations was about 50% ________ compared to recommendations
made by other analysts at different investment banks.
A) does; better
B) does; worse
C) does not; better
D) does not; worse
3) Reputational rents refer to
A) the profit earned by a firm when it captures economies of scope.
B) the costs associated with building credibility of a firm.
C) the profit earned solely based on the credibility of a firm.
D) the costs associated with the firm’s achievement of economies of scale.
4) Explain how the market can reduce the incentive for credit-rating firms to take advantage of
conflicts of interest.
1) Which of the following is not a part of the Sarbanes-Oxley Act of 2002?
A) the establishment of a Public Company Accounting Oversight Board (PCAOB) to supervise
accounting firms and thus insure that audits are independent and controlled for quality
B) increased penalties for white-collar crime and obstruction of official investigations
C) requires a CEO and CFO to certify that periodic financial statements and disclosure of the
firm are accurate
D) requires investment banks to make public their analysts’ recommendations
2) Which policy measure increased the SEC budget to supervise securities markets?
A) Sarbanes-Oxley Act of 2002
B) Global Legal Settlement of 2002
C) Gramm-Leach-Bliley Act of 1999
D) Riegle-Neal Act of 1994
3) Which policy measure makes it unlawful for a registered public accounting firm to provide
any nonaudit service to a client contemporaneously with an impermissible audit?
A) Sarbanes-Oxley Act of 2002
B) Global Legal Settlement of 2002
C) Gramm-Leach-Bliley Act of 1999
D) Riegle-Neal Act of 1994
4) Which policy measure increases the punishment for white-collar crime and obstruction of
official investigations?
A) Sarbanes-Oxley Act of 2002
B) Global Legal Settlement of 2002
C) Gramm-Leach-Bliley Act of 1999
D) Riegle-Neal Act of 1994
5) Which of the following is a part of the Global Legal Settlement of 2002?
A) The establishment of a Public Company Accounting Oversight Board (PCAOB) to supervise
accounting firms and thus insure that audits are independent and controlled for quality.
B) Increased penalties for white-collar crime and obstruction of official investigations.
C) Requires a CEO and CFO to certify that periodic financial statements and disclosure of the
firm are accurate.
D) Requires investment banks to make public their analysts’ recommendations.
6) Which policy measure requires investment banks to sever the links between research and
securities underwriting?
A) Sarbanes-Oxley Act of 2002
B) Global Legal Settlement of 2002
C) Gramm-Leach-Bliley Act of 1999
D) Riegle-Neal Act of 1994
7) Which policy measure bans spinning?
A) Sarbanes-Oxley Act of 2002
B) Global Legal Settlement of 2002
C) Gramm-Leach-Bliley Act of 1999
D) Riegle-Neal Act of 1994
8) Which policy measure requires investment banks to make public their analysts’
recommendations?
A) Sarbanes-Oxley Act of 2002
B) Global Legal Settlement of 2002
C) Gramm-Leach-Bliley Act of 1999
D) Riegle-Neal Act of 1994
9) The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 included which of
the following provisions to deal with conflicts of interest in the credit-rating Industry?
1. Created an Office of Credit Ratings at the SEC with its own staff and the authority to fine
credit-rating agencies and to deregister an agency if it produces bad ratings.
2. Forced credit-rating agencies to provide reports to the SEC when their employees go to work
for a company that has been rated by them in the last twelve months.
3. Prohibited compliance officers from being involved in producing or selling credit ratings.
4. Required the SEC to prevent issuers of asset-backed securities from choosing the credit-
rating agencies that will give them the highest rating and supported earlier initiatives by the SEC.
5. Authorized investors to bring lawsuits against credit-rating agencies for a reckless failure to
get the facts when providing a credit rating.
A) 1, 2, 3, and 4.
B) 2, 3, 4, and 5.
C) none.
D) 1, 2, 3, 4, and 5.
10) Which of the following policy measures forced credit-rating agencies to provide reports to
the SEC when their employees go to work for a company that has been rated by them in the last
twelve months?
A) the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010
B) Sarbanes-Oxley Act of 2002
C) Global Legal Settlement of 2002
D) Gramm-Leach-Bliley Act of 1999
E) Riegle-Neal Act of 1994
11) Which of the following policy measures created an Office of Credit Ratings at the SEC with
its own staff and the authority to fine credit-rating agencies and to deregister an agency if it
produces bad ratings?
A) the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010
B) Sarbanes-Oxley Act of 2002
C) Global Legal Settlement of 2002
D) Gramm-Leach-Bliley Act of 1999
E) Riegle-Neal Act of 1994
12) Which of the following policy measures prohibited compliance officers from being involved
in producing or selling credit ratings?
A) the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010
B) Sarbanes-Oxley Act of 2002
C) Global Legal Settlement of 2002
D) Gramm-Leach-Bliley Act of 1999
E) Riegle-Neal Act of 1994
13) Which of the following policy measures required the SEC to prevent issuers of asset-backed
securities from choosing the credit-rating agencies that will give them the highest rating and
supported earlier initiatives by the SEC?
A) the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010
B) Sarbanes-Oxley Act of 2002
C) Global Legal Settlement of 2002
D) Gramm-Leach-Bliley Act of 1999
E) Riegle-Neal Act of 1994
14) Which of the following policy measures authorized investors to bring lawsuits against credit-
rating agencies for a reckless failure to get the facts when providing a credit rating?
A) the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010
B) Sarbanes-Oxley Act of 2002
C) Global Legal Settlement of 2002
D) Gramm-Leach-Bliley Act of 1999
E) Riegle-Neal Act of 1994
1) If a conflict of interest exists
A) it will always have serious adverse consequences.
B) it may not have a serious adverse consequences if the incentive to take advantage of the
conflict is low.
C) the government needs to step in to pass legislation to remove the conflict.
D) there will not be serious adverse consequences, even if the incentive to take advantage of the
conflict is low.
2) If the incentive to take advantage of a conflict of interest is high
A) removing the economies of scope that created the conflict may induce higher costs because of
the decrease in the flow of reliable information.
B) then the government must step in to remove the conflict.
C) the costs of non-action in removing the conflict will always be higher than the cost of
removing the conflict.
D) firms will always step in and work to remove the conflict.
3) If there isn’t sufficient information available, then which of the following approaches to
reduce conflicts of interest will have the lowest probability of working?
A) leave it to the market
B) supervisory oversight
C) separation of functions
D) socialization of information production
4) When the SEC requires companies to publicly release financial statements, which of the
following remedies of conflicts of interest does this fall under?
A) leave it to the market
B) regulate for transparency
C) supervisory oversight
D) separation of functions
5) If firms have an incentive to hide information from mandatory disclosure because the
information is proprietary, then which of the following remedies is the least intrusive way to
overcome this incentive?
A) leave it to the market
B) separation of functions
C) supervisory oversight
D) socialization of information production
6) Under the Sarbanes-Oxley Act of 2002, the clause that makes it unlawful for a registered
public accounting firm to provide any nonaudit service to a client contemporaneously with an
impermissible audit is an example of which remedy of conflicts of interest?
A) regulate for transparency
B) supervisory oversight
C) separation of functions
D) socialization of information production
7) Of the remedies for conflicts of interest, which one is the most intrusive?
A) regulate for transparency
B) separation of functions
C) supervisory oversight
D) socialization of information production
8) Under the Global Legal Settlement of 2002, the provision that requires, for a period of five
years, brokerage firms to contract with independent research firms to provide information to their
customers is an example of
A) regulate for transparency.
B) supervisory oversight.
C) separation of functions.
D) socialization of information production.
9) Under the Global Legal Settlement of 2002, the provision that requires investment banking
firms to make their analysts’ recommendations public is an example of
A) regulate for transparency.
B) supervisory oversight.
C) separation of functions.
D) socialization of information production.
10) Under the Sarbanes-Oxley Act of 2002, the provision that established the PCAOB to
supervise accounting firms is an example of
A) regulate for transparency.
B) supervisory oversight.
C) separation of functions.
D) socialization of information production.
11) Under the Sarbanes-Oxley Act of 2002, the provision that gives more funding to the SEC is
an example of
A) regulate for transparency.
B) supervisory oversight.
C) separation of functions.
D) socialization of information production.
12) Under the Global Legal Settlement of 2002, the provision that requires investment banking
firms to sever the link between underwriting and research is an example of
A) regulate for transparency.
B) supervisory oversight.
C) separation of functions.
D) socialization of information production.
13) The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 did not prohibit
companies issuing securities from paying the credit-rating agencies to rate them. This is an
example of which remedy of conflicts of interest?
A) regulate for transparency
B) supervisory oversight
C) leave it to the market
D) socialization of information production
14) The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 authorized
investors to bring lawsuits against credit-rating agencies for a reckless failure to get the facts
when providing a credit rating. This is an example of which remedy of conflicts of interest?
A) regulate for transparency
B) supervisory oversight
C) leave it to the market
D) socialization of information production
15) The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 created an Office
of Credit Ratings at the SEC with its own staff and the authority to fine credit-rating agencies
and to deregister an agency if it produces bad ratings. This is an example of which remedy of
conflicts of interest?
A) regulate for transparency
B) supervisory oversight
C) leave it to the market
D) socialization of information production