The Cyclicality of Investment Advisor Misconduct

49 Pages Posted: 5 May 2022 Last revised: 22 Dec 2022

See all articles by Michael Gelman

Michael Gelman

Alfred Lerner College of Business and Economics, The University of Delaware

Zaheer Khan

University of Aberdeen

Amir Shoham

Temple University - Department of Finance

Date Written: April 28, 2022

Abstract

Stock market cycles affect an investment advisor's income, as a significant portion of their compensation is fees from AUM. However, the effect of the market-induced variation in income on the advisor's propensity to commit misconduct is unclear. Given no change in expected lifetime income, it is not apparent that temporary deviations in income would affect advisors. Assuming the effect holds, the benefits from misconduct during a market bust are expected to be higher than in boom times as avoiding loss generates higher utility than income gains. Yet, the potentially higher absolute value that can be gained from misconduct due to weaker due diligence may lead to further misconduct in a booming market. To resolve this tension, we empirically show that misconduct occurrences increase with declines in the stock market and validate the results across various endogeneity tests. Disentangling the influencing factors on the advisor's decision to commit misconduct, we show that the change in income is the main driver for the counter-cyclical effect of the stock market on advisor misconduct.

Keywords: Stock Market Cycle, Financial Misconduct, Investment advisor, Income

JEL Classification: D14, D18, G20, G24, G38, J44, K42, L22, M53

Suggested Citation

Gelman, Michael and Khan, Zaheer and Shoham, Amir, The Cyclicality of Investment Advisor Misconduct (April 28, 2022). Available at SSRN: https://ssrn.com/abstract=4096324 or http://dx.doi.org/10.2139/ssrn.4096324

Michael Gelman (Contact Author)

Alfred Lerner College of Business and Economics, The University of Delaware ( email )

20 Orchard Rd
United States

Zaheer Khan

University of Aberdeen ( email )

Dunbar Street
Aberdeen, Scotland AB24 3QY
United Kingdom

Amir Shoham

Temple University - Department of Finance ( email )

Fox School of Business and Management
Philadelphia, PA 19122
United States

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