Should Indirect Brokerage Fees Be Capped? Lessons from Mutual Fund Marketing and Distribution Expenses

Theory predicts that capping brokers’ compensation exacerbates the exploitation of retail investors. We show that regulated caps on mutual fund 12b-1 fees, effectively sales commissions, are associated with negative equity fund performance, but only after a structural shift toward maximum permitted levels of the fees around 2000. Past this break point, flow–performance sensitivity shifts from the middle- to the highest-performing funds, suggesting that the fee cap increases performance-chasing behavior by constraining brokers’ incentives to learn about lower-ranked funds. The policy implication is that regulators must reevaluate the efficacy of caps on brokerage fees.

Keywords: Mutual Funds, Brokerage Fees, Incentives, Performance, Money Flows

JEL Classification: G23, G24, G28

Suggested Citation: Suggested Citation

Oh, Natalie and Parwada, Jerry T. and Tan, Eric K. M., Should Indirect Brokerage Fees Be Capped? Lessons from Mutual Fund Marketing and Distribution Expenses (July 20, 2015). Journal of Financial and Quantitative Analysis, Volume 52, Issue 2April 2017 , pp. 781-809, FIRN Research Paper No. 2633816, Available at SSRN: https://ssrn.com/abstract=2633816 or http://dx.doi.org/10.2139/ssrn.2633816