Out-of-Pocket vs. Out-of-Investment in Financial Advisory Fees: Evidence from the Lab

29 Pages Posted: 30 Oct 2017 Last revised: 4 Sep 2020

See all articles by Yevgeny Mugerman

Yevgeny Mugerman

Bar Ilan University

Orly Sade

Hebrew University of Jerusalem - Department of Finance

Eyal Winter

Hebrew University of Jerusalem - Department of Economics

Date Written: September 3, 2020

Abstract

The implications of the method of payment to financial advisors on the behavior of individuals are of interest to economists and regulators around the globe. This paper uses an experimental approach to compare two common alternative forms of payment. The first is “out-of-pocket” (an upfront payment from a checking account), and the second is “out-of-investment” (a deferred payment from an investment portfolio account). We document that for the same financial advice, the subjects in the first treatment were willing to pay on average 25 per cent less than the subjects in the second treatment – payment following an investment outcome knowledge, where the payment was framed in terms of gains. We introduce an additional out-of-pocket payment structure where the actual payment is deferred until after the subject discovers the outcome of the investment. Thus, the design can be broken down into two distinct possible effects, an out-of-pocket vs. out-of-investment framing effect and a pre-outcome vs. post-outcome timing effect. We find that the timing effect is the key element: across out-of-pocket payment structures, the subjects were willing to pay significantly less in the pre-outcome treatment than their counterparts were in the post-outcome treatment. Our results highlight the difference between post-service and pre-service payments in a broader context, and provide an explanation for why allowing late payment, after the service has been performed and its outcome revealed, may increase the ex-ante willingness to pay for the service.

Keywords: lab experiment; payment structure; advisor remuneration; willingness to pay; post-service and pre-service payments

JEL Classification: G40; G28

Suggested Citation

Mugerman, Yevgeny and Sade, Orly and Winter, Eyal, Out-of-Pocket vs. Out-of-Investment in Financial Advisory Fees: Evidence from the Lab (September 3, 2020). Journal of Economic Psychology, Forthcoming, Available at SSRN: https://ssrn.com/abstract=3061020 or http://dx.doi.org/10.2139/ssrn.3061020

Yevgeny Mugerman (Contact Author)

Bar Ilan University ( email )

Ramat Gan
5290002
Israel

Orly Sade

Hebrew University of Jerusalem - Department of Finance ( email )

Mount Scopus
Jerusalem, 91905
Israel
972 2 588 3227 (Phone)

Eyal Winter

Hebrew University of Jerusalem - Department of Economics ( email )

Mount Scopus
Jerusalem, 91905
Israel

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