Misconduct and Market Implications of Honest Advisors’ Decisions

Abstract

Previous literature has studied the factors that influence investment advisor misconduct. However, most advisors have not engaged in misconduct. We establish that advisors with clean records are likely to leave firms that exhibit increased misconduct to firms with fewer occurrences. This decision of honest advisors has important market implications, affecting the flow of AUM and the matching between firms and advisors in relation to misconduct. We demonstrate that in an industry where reputation and trust are central, being affiliated with a firm that experiences misconduct elevates reputational concerns and threatens future cash flows. Changes in local economic conditions, the firms' responses, changes in enforcement, or competing firms reaching out to the advisors do not drive honest advisors' decisions to leave. Further, we perform instrumental variable and diff-in-diff analyses to estimate a firm's misconduct occurrences.

Keywords: Financial Misconduct, Investment advisor, Separations, Reputation

JEL Classification: D14, D18, G20, G24, G38, J44, K42, L22, M53