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Regulate for Transparency.

A competitive market structure does not always adequately reduce information asymmetries. The gathering of information is costly, and any individual economic agent will gather information only if the private benefit outweighs the cost. When the information collected becomes available to the market immediately, the free-rider problem may reach serious levels. Information has the attribute of a public good, which will be undersupplied in the absence of some public intervention. To some extent, mandatory information disclosure can alleviate information asymmetries and is a key element of regulation of the financial system.

When mandatory disclosure of information reveals whether a conflict of interest exists, the market is able to discipline the financial firm that fails to ameliorate conflicts of interest. In addition, if a financial institution is required to provide information about potential conflicts of interest, the user of the institution's information services may be able to judge how much weight to place on the information this institution supplies.

At the same time, mandatory disclosure could create problems if it reveals so much proprietary information that the financial institution is unable to profitably engage in the information production business. The result could then be less information production, rather than more. Also, mandatory disclosure may not work if financial firms can successfully avoid the regulation and continue to hide relevant information about potential conflicts of interest. The free-rider problem might likewise result in insufficient monitoring of conflicts of interest because the benefits of monitoring and constraining these conflicts accrue only partially to the monitors. Finally, complying with regulations requiring information disclosure may be costly for financial firms—possibly exceeding the costs due to conflicts of interest.

 
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