Conflicts of Interest

            The one thing that has remained unchanged over the entire history of mankind is man’s tendency to work for self-interest. Self-interest in different and far from the common notion of selfishness we used so commonly to describe others (but most of the time not ourselves). According to Brue (2008), self-interest is found when an individual or an organization works for the benefit and well-being of one’s own self and is commonly found in almost every individual. A working man trying to get a promotion to earn more money to raise the standard of living of his family is working for his self-interest and not because he is being selfish.

            However in a society or community with many individuals, self-interest normally leads to conflicts of interest as many individuals with different goals and objectives are forced to work together in the same place and at the same time. A classic example by Hendrik Van Loon (a famous historian) is during the middle ages whereby the Pope in Rome, Head of the Catholic Church would often disagree with the management of the people by their respective monarchs. Monarchs like the notorious King Henry VIII was forced in the end to establish his own church (obviously with the Mr Henry as the head of the church) in order to legalize his own divorce and marry another woman.

            The list of conflicts of interest in human history goes on and on. John Ray narrates how the world was plunged into chaos as World War II in 1939-1945 because of ideological and economic reasons. On the side of the Allies, we have the United Kingdom under Winston Churchill that fought for their independence and the control of British colonies and world trade routes. The United States on the other hand fought to make sure that by the end of the war, they would emerge as the strongest industrialized nation in the world (this means dismantling a huge portion of the United Kingdom’s colonies after the war). Last but not least, the Soviet Union under Stalin who fought not only to defend their independence but also to spread communism and wrestle a better economic position from the capitalist Allies.

            Seldom is a coalition fighting solely for common goals. Peter Rose (2008) shows us how managers are likely to exhibit the expense preference behavior whereby they are in favor of obtaining external benefits like a luxurious company car, a generous travel budget, and so on and so forth. The ‘moral hazard problem’ as stated by Frederic Mishkin (2007) also shows us how shareholders and managers may sometimes face conflicts of interest like those seen in Enron, Tyco, and WorldCom. People are normally inclined to work for their own benefit. Managers are obviously people. Therefore managers are normally more motivated to work for their own benefit instead of working for the benefit of the shareholders. It is in many ways inevitable for managers to do so.

            In 2001, rogue trader Nick Lesson made headlines as he virtually wiped out most of the reserves of Barrings Bank single handedly through trading way above his authorized limit. Like always, the world experience profound awe and shock as Leeson was sent to prison in Singapore. Similarly in 2008, Jerome Kerviel, a young (rogue) trader from French bank Societe Generale also became famous the same way Leeson did by eating up € 4-.—of the bank’s reserves sparking dangerous speculation on the bank’s financial health. Both Leeson and Kerviel had incentives to act against the will of the bank’s shareholders. Should they have succeeded in garnering profits for banks, they would be hailed as heroes instead of being jailed for their crime. Furthermore, it is the bank’s depositors that would be facing the losses should their plan fail. The incentive drastically outweighs the penalty for their crime.

            Steven Levitt (2005) also pointed another common conflict of interest that most people will face, namely in the real estate market. Selling a real estate property like a house would for most people (me included) be the largest transaction in their life. In order to secure a good deal for their property, ‘professional’ real estate agents are hired to handle these deals. But do real estate agents do manage to sell your property for its highest price? Data comparison by Mr Levitt shows us an interesting finding that property owned by real estate agents themselves are selling consistently higher on average compared to the property of their customers. Further studies shows that real estate agents would try and sell off their customer’s property as soon as possible instead of waiting for the best offer to come along because the difference in commission is too little to be an incentive for waiting.

            The list of conflicts of interest would be a never ending story. The recent subprime crisis mortgage crisis also stand testament to this with rating agencies and investment banks giving artificially high ratings on derivative like financial instruments like CDOs and CLOs that virtually became worthless when the housing market turned south. As the financial sectors are deregulating, the frequency of conflicts of interest is likely to increase. Nevertheless, financial regulators should reduce the incentives of the emergence of rogue traders and fraudsters as much as they can. Because human beings naturally work for their own self-interest, increasing the penalty or reducing the incentive of unwanted behavior is imperative and crucial to the prevention of more ‘Leesons’ and ‘Kerviels’. So the next time a real estate agent promises to ‘help’ you, be skeptical about it. Most of the time, they are helping themselves.

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