Regulating Commission-Based Financial Advice: Evidence from a Natural Experiment

Abstract

Controversies around commission-based financial advice led many policy makers worldwide
to introduce commission caps. Are these regulations effective in reducing prices of
financial products and stimulating investment? I examine these questions in the context
of mutual fund market by estimating the causal effects of regulating commissions for fund
distribution. I exploit the unique institutional setting in Israel and the 2013 policy change
when the government reduced commissions differently for different fund types. The reform
led to a major decline in fund expense ratios and a consequent increase in fund flows.
Funds with price-sensitive investors experienced a 35% larger inflows, in line with investor
response to price declines. Mutual fund families introduced new funds in asset categories
with reduced commissions. These results suggest that a reduction in distribution costs by a
regulator fosters price competition, leading to significant savings for investors, reallocation
of capital toward financial products and changes in market structure.

Keywords: Financial Advice, Financial Regulation, Mutual Funds

JEL Classification: G23, G24, G28, G53