How to Restore Trust in Financial Markets?

Abstract

Without trust, financial markets cannot function efficiently. Trust and integrity depend to an important degree on the reputation of financial markets to generate reliable valuations of companies and business ventures. This perspective makes clear why the integrity of the gatekeepers of the public trust to vouch for accurate and reliable information about public companies is at the heart of the proper functioning of financial markets. And since the `garbage in, garbage out' principle also prevails in financial markets, public trust in the functioning of financial markets has declined as a result of major financial reporting scandals involving Enron, Tyco, WorldCom, Parmalat and others. Also, massive overvaluations of equity that occurred in the second half of the 1990s and in the early 2000s have been singled out as being caused by misinformation and manipulation of financial results (Jensen, 2002). More generally, when information about the operation of public companies is false, misleading or opaque, trust in financial markets is likely to be affected adversely. This gives financial market participants a stake in the disclosure of timely and meaningful information, including by assuring that the quality of financial reporting by public companies is as high as possible. And this in turn puts the spotlight on the role of the gatekeepers of the public trust, in particular accounting firms, banks, rating agencies, supervisors and regulators.