Regulating Conflicts of Interest : The Effect of Sanctions and Enforcement

This paper studies how legal sanctions and enforcement affect brokers' conflicts of interest emanating from investment banking activities. We exploit the recent adoption of the Market Abuse Directive (MAD) across European countries and use the variation in legal sanctions and enforcement that exists in Europe to identify brokers' reaction. Overall, the enactment of MAD significantly reduced optimistic investment advice. This reduction is larger in countries equipped with more severe legal sanctions and in countries that strongly enforce the rules. Our analysis underscores the importance of legal sanctions and enforcement power to understand the real consequences of regulatory changes