Working Paper: CEPR ID: DP12914
Authors: Roman Inderst; Jun Honda
Abstract: We analyze fi rms' competition to steer an advisor's recommendations through potentially non-linear incentives. Even when firms are symmetric, so that the overall size of compensation would not distort advice when incentives were linear, advice is biased when firms are allowed to make compensation non-linear, which they optimally do. Policies that target an advisor's liability are largely ineffective, as firms react to such increased liability by making incentives even steeper, increasing bonus payments while reducing the linear (commission) part at the same time. This observation may justify policymakers' direct interference with firms' compensation practice, as frequently observed notably in consumer finance.
Keywords: Nonlinear incentives; Advisor bias; Financial regulation
JEL Codes: L51; M52
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| nonlinear compensation (J33) | biased advice (D91) |
| increasing nonlinear aspect of compensation (J33) | biased advice (D91) |
| bonuses linked to sales (M52) | distortion in advisor's recommendations (D80) |
| increasing advisor's liability (K13) | maintains bias in advice (D91) |
| nonlinear compensation (J33) | cascading effect of bias (D91) |