The Effect of Advisors’ Incentives on Clients’ Investments

Financial advisors' compensation has a causal effect on client investment decisions, particularly when changes occur following the MiFID II reform in January 2018. The study found that clients whose advisors experienced incentive changes adjusted their portfolios more rapidly and substantially than those who did not, with adjustments occurring over approximately eighteen months. The effect is strongest when clients introduce new money into the relationship, where the elasticity between trailer fees and investments is estimated at 150% for new clients, compared to three times this effect for existing clients. Furthermore, trust in an advisor may amplify the effects of incentive misalignment; longer relationships or greater proximity between client and advisor correlate with larger outcomes, suggesting that trust can magnify investment distortions if incentives are misaligned. Financial knowledge appears to mitigate the negative effects of these conflicts, as clients with higher financial literacy experienced significantly smaller utility losses from distorted advice. Ultimately, the compensation reform reduced estimated welfare losses associated with conflicted advice by one-fifth to one-half.

The interaction between trust, knowledge, and incentive structure reveals a complex system of agency problems that extends beyond simple fiduciary duty. The finding that client portfolios adjust to advisor incentives, especially with new capital, suggests that agent misalignment is most potent during the initial structuring of wealth rather than ongoing maintenance, implying governance failures are acute at onboarding and contribution points. The observation that trust can amplify these distortions forces a critical re-evaluation of relationships: trust acts as an accelerant for agency risk if the underlying incentive structure remains flawed. This challenges the notion that long-term relationships inherently resolve conflicts; instead, the stability of the relationship may inadvertently grant the agent greater persuasive power over the principal's long-term objectives, provided incentives are skewed. Furthermore, financial literacy proves to be a critical moderator, suggesting that knowledge functions not just as an independent path to better decisions but also as a mechanism for better evaluation and mitigation of professional advice. The implication is that regulatory focus should shift from merely disclosing fees to designing compensation structures that actively promote client well-being, recognizing that the architecture of incentives fundamentally shapes realized outcomes regardless of advisory trust or baseline knowledge. What mechanisms exist beyond explicit disclosure to ensure structural alignment in all financial relationships? How can we design institutional safeguards that are robust enough to withstand the psychological weight of perceived trust during times of incentive disparity?