The effect of advisors’ incentives on clients’ investments

We use granular information from a Spanish investment firm to estimate the causal effect of financial advisors’ compensation contracts on their clients’ investments. Our identification exploits: (a) the fact that, for historical reasons, compensation contracts at our firm differed across mutual funds for the same advisor and across advisors for the same fund, and (b) the overhaul to the firm’s compensation policy triggered by MiFIDII, which resulted in within-advisor-fund plausibly exogenous variation in incentives. We find that clients’ investments react markedly and swiftly to changes in their advisors’ incentives. The effect is larger for new clients, for clients who trust their advisors more, and for clients with lower financial knowledge. We identify a dual mechanism underlying this effect: clients whose advisors experience a change in incentives bring more money into the fund portfolio and then direct this money into their advisors’ preferred funds. We introduce our reduced-form estimates into a portfolio-choice model to quantify investors’ utility loss due to the distortion in advice. We estimate losses ranging between 6% and 9%. The change in compensation policy triggered by MiFIDII reduced these losses significantly.