This study explores the phenomena associated with conflicts of interest, particularly as they pertain to the brokerage and proprietary trading divisions of investment banks. This distinguishes it from past studies, which have researched conflicts of interest between underwriting and brokerage divisions. We examine whether or not an investment bank issues buy recommendations to the market and buys (sells) the same recommended stocks through its proprietary trading division before (after) recommendations, and if so, to what extent this goes on. We find that these conflicts of interest do exist and that these investment banks can profit from their recommendations in the short run.

This paper raises three issues related to the earnings management (EM) of banks across 48 countries. First, does earnings management of banks exist in all 48 countries? Second, what is the incentive of banks to manage earnings? Third, why does EM vary across countries? To answer these three questions, two thresholds (viz., a threshold of zero earnings and a threshold of zero earnings change) are employed. The answer to the first question above is that banks in more than two-thirds of the 48 countries sampled are found to have managed their earnings. With respect to the second question, prospect theory is used to provide an answer. The relationship between return and risk is positive for high earnings groups, but is negative for low earnings banks. Finally, as to the last question, stronger protection of investors and greater transparency in accounting disclosure can reduce banks’ incentives to manage earnings. Also, higher real GDP per capita decreases the degree of earnings management. It is seen that stronger enforcement of laws can counter intuitively result in stronger earnings management. However, this effect appears in low-income countries only, and not in high-income countries.