Out-of-Pocket vs. Out-of-Investment in Financial Advisory Fees: Evidence from the Lab
61 Pages Posted: 30 Oct 2017 Last revised: 17 Sep 2019
Date Written: September 16, 2019
The implications of the method of payment to financial advisors on the behavior of individuals and their willingness to pay (WTP) are of interest to economists and regulators around the globe. This paper uses an experimental economics technique to compare two common alternative payment structures. The first payment structure is “out-of-pocket” (payment from a checking account) and the second is “out-of-investment” (payment from an investment portfolio account). We document that for the same financial advice, the subjects in the “out-of-pocket” treatment – an upfront payment – were willing to pay on average 25 percent less than the subjects in the “out-of-investment” treatment – a deferred payment following an investment realization, where the payment was framed in terms of gains. We introduce an additional “out-of-pocket” payment structure where payment is deferred until after the investment realization. Thus, the design can be decomposed into a possible “out-of-pocket” vs. “out-of-investment” framing effect and a pre-realization vs. post-realization 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-realization treatment than their counterparts were in the post-realization treatment. The “out-of-pocket” vs. “out-of-investment” framing effect was insignificant. These results hold after controlling for a vector of personal, demographic, and behavioral characteristics, as well as for performance on a math test. 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 that takes place after the outcome of the service has been revealed may increase the 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: Suggested Citation