Out-of-Pocket vs. Out-of-Investment in Financial Advisory Fees: Evidence from the Lab
63 Pages Posted: 30 Oct 2017 Last revised: 27 Mar 2019
Date Written: March 21, 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 “out-of-pocket” payment structure (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 per cent less than the subjects in the “out-of-investment” treatment – a payment following the realization framed in terms of gains. We employ an additional “out-of-pocket” deferred payment structure and decompose this effect to pocket vs. account component and actual payment after the advice realization component. We find that the “realization” component appears as the key element – across “out-of-pocket” payment structures, the subjects were willing to pay significantly less in the payment upfront treatment than their counterparts were in payment following the realization treatment. The pocket vs. account frame has insignificant effect. These results hold after controlling for a vector of personal, demographic, and behavioral characteristics, as well as for performance on a math test.
Keywords: experimental public choice; payment structure; advisor remuneration; willingness to pay; prospect theory; realization effect
JEL Classification: G40, G28
Suggested Citation: Suggested Citation