Impacts of Conflicts of Interest in the Financial Services Industry

66 Pages Posted: 12 Jun 2016

See all articles by Jeremy Burke

Jeremy Burke

Center for Economic and Social Research (CESR)

Angela Hung

RAND Corporation - Labor and Population

Jack Clift

RAND Corporation

Steven Garber

RAND Corporation

Joanne Yoong

RAND Corporation

Date Written: February 4, 2015

Abstract

Americans are increasingly being asked to take responsibility for their own retirement security. However, many people are ill-equipped to make financial decisions and have turned to professional financial advisors for help. While financial advisors often provide valuable services, it can be difficult for individual investors to evaluate the advice they receive and to identify when it has been influenced by a conflict of interest. In this literature review, we examine if and how financial advisors are influenced by their compensation schemes and how this influence impacts retail investors’ financial well-being. We find empirical evidence suggesting that financial advisors act opportunistically to the detriment of their clients. However, the current body of literature generally cannot account for selection issues and the intangible benefits financial advisors provide.

In our broader review of conflicts of interest in the financial services industry, we find considerable evidence that investment analysts were excessively optimistic prior to regulation seeking to mitigate bias. There is mixed evidence on how this excessive optimism impacted investors, though the literature generally concludes that retail investors were more acutely impacted, as compared to institutional investors. We also find evidence that conflicts of interest extend to mutual fund management, with actively managed funds imposing sizeable trading costs and brokerage commissions which are not easily observed by retail investors.

Regulation and disclosure are often suggested methods for reducing bias. We find evidence that regulation designed to mitigate conflicts of interest can help reduce the prevalence of biased advice, but regulation that penalizes bad advice may be less effective because bias may be unconscious. Disclosure is unlikely to be an effective strategy if employed in isolation, but may be an important part of a comprehensive mitigation strategy.

Suggested Citation

Burke, Jeremy and Hung, Angela and Clift, Jack and Garber, Steven and Yoong, Joanne, Impacts of Conflicts of Interest in the Financial Services Industry (February 4, 2015). RAND Working Paper Series WR- 1076. Available at SSRN: https://ssrn.com/abstract=2794246 or http://dx.doi.org/10.2139/ssrn.2794246

Jeremy Burke (Contact Author)

Center for Economic and Social Research (CESR) ( email )

635 Downey Way
Los Angeles, CA 90089-3332
United States

Angela Hung

RAND Corporation - Labor and Population ( email )

United States

Jack Clift

RAND Corporation ( email )

1200 S. Hayes St, w7304
Arlington, VA 22202
United States

Steven Garber

RAND Corporation ( email )

1776 Main Street
P.O. Box 2138
Santa Monica, CA 90407-2138
United States

Joanne Yoong

RAND Corporation ( email )

1200 South Hayes St
Arlington, VA 22202
United States

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