Brokers vs. Retail Investors: Conflicting Interests and Dominated Products

Mark  Egan

Article | Journal of Finance | Forthcoming

Brokers vs. Retail Investors: Conflicting Interests and Dominated Products

Abstract

I study how brokers distort household investment decisions. Using a novel convertible bond dataset, I find that consumers often purchase dominated bonds—cheap and expensive versions of otherwise identical bonds coexist in the market. The empirical evidence suggests that broker incentives are responsible for the inferior investments, as brokers earn a 1.12 percentage point higher fee relative to the notional invested for selling the dominated bond on average. I develop and estimate a broker intermediated search model that rationalizes this behavior and quantifies the distortions in these markets. In the model, consumer search is endogenously directed according to the incentives of brokers, and brokers price discriminate based on a consumer's level of sophistication. The model estimates indicate that costly search is a key friction in retail financial markets, but the effects of search costs are compounded when brokers are incentivized to direct the search of consumers towards high fee inferior products.

Keywords: Brokers; Fiduciary Standard; consumer finance; structured products; Household; Investment; Decisions; Motivation and Incentives; Conflict of Interests;

Format: Print

Citation:

Egan, Mark. "Brokers vs. Retail Investors: Conflicting Interests and Dominated Products." Journal of Finance (forthcoming).

Working Paper | HBS Working Paper Series | 2018

Arbitration with Uninformed Consumers

Mark Egan, Gregor Matvos and Amit Seru

We examine whether firms have an informational advantage in selecting arbitrators in consumer arbitration as well as the impact of the arbitrator selection process on outcomes. We collect data containing roughly 9,000 arbitration cases in securities arbitration. Securities disputes present a good laboratory: the selection mechanism is similar to other major arbitration forums; arbitration is mandatory for all disputes, eliminating selection concerns; and the parties choose arbitrators from a randomly generated list. We first document that some arbitrators are systematically industry friendly while others are consumer friendly. Firms appear to utilize this information in the arbitrator selection process. Despite a randomly generated list of potential arbitrators, industry friendly arbitrators are 40% more likely to be selected than their consumer friendly counterparts. Better informed firms and consumers choose more favorable arbitrators. We develop and calibrate a model of arbitrator selection in which, like the current process, both the informed firms and uninformed consumers have control over the selection process. Arbitrators compete against each other for the attention of claimants and respondents. The model allows us to interpret our empirical facts in equilibrium and to quantify the effects of changes to the current arbitrator selection process on consumer outcomes. Competition between arbitrators exacerbates the informational advantage of firms in equilibrium resulting in all arbitrators slanting towards being industry friendly. Evidence suggests that limiting the respondents' and claimants' inputs over the arbitrator selection process could significantly improve outcomes for consumers.

Keywords: Arbitration; Financial Advisers; Financial Advisors; Brokers; consumer finance; Financial Misconduct; Personal Finance; Conflict and Resolution; Information; Fairness;

Citation:

Egan, Mark, Gregor Matvos, and Amit Seru. "Arbitration with Uninformed Consumers." Harvard Business School Working Paper, No. 19-046, October 2018. (NBER Working Paper Series, No. 25150, October 2018.) View Details

Cite View Details SSRN Read Now

We examine gender differences in misconduct punishment in the financial advisory industry. We find evidence of a "gender punishment gap": following an incident of misconduct, female advisers are 20% more likely to lose their jobs and 30% less likely to find new jobs relative to male advisers. Females face harsher outcomes despite engaging in misconduct that is 20% less costly and having a substantially lower propensity towards repeat offenses. The gender punishment gap in hiring and firing dissipates at firms with a greater percentage of female managers at the firm or local branch level. The gender punishment gap is not driven by gender differences in occupation (type of job, firm, market, or financial products handled), productivity, misconduct, or recidivism. We extend our analysis to explore the differential treatment of ethnic minorities and find similar patterns of "in-group" tolerance. Our evidence is inconsistent with a simple Bayesian model and suggests instead that managers are more forgiving of missteps among members of their own gender/ethnic group.

Aware of the impact that modern society was having on the environment, Ashley Telkes had always tried to be cognizant of her own impact on the environment and to take reasonable steps to mitigate her own effects. Having already implemented a number of passive measures to minimize her “carbon footprint,” Telkes must now confront the bigger decision of whether or not to invest in solar panels to generate electricity for her home. Although pre-disposed to pursue environmentally friendly alternatives, the project entailed significant up-front expenses and Telkes could not afford to make a poor financial decision. Telkes must assess the financial merits of the project, as well as understand the regulatory and technological risks associated with going forward or choosing to delay.

Faculty & Research

Brokers vs. Retail Investors: Conflicting Interests and Dominated Products

Abstract

Citation:

About the Author

More from the Author