Do Commissions Cause Investment Adviser Misconduct?

Abstract

Sales commissions may present a conflict of interest that allows investment advisers to obtain rents from uninformed clients. Alternatively, commissions might be a contracting solution to motivate information provision. To analyze the relation between commissions and adviser misconduct, I exploit quasi-exogenous changes in individual investment advisers' compensation arrangements caused by mergers between large registered investment advisory firms. The opportunity to earn sales commissions increases the probability that an adviser engages in misconduct, but competition is an important mediator. In regions with greater competition, sales commissions decrease misconduct claims. Increased misconduct from commissions is concentrated among low-experience advisers and male advisers. Damages paid out in claims involving commission-motivated advisers are $25,013 (36%) greater than other claims. The experimental design rules out latent firm and market explanations. Overall, I find that the connection between conflicts of interest and information provision depends on the competitive environment.