The Effect of Advisors' Incentives on Clients' Investments

Abstract

We use granular data from an investment firm and a credible identification strategy to estimate the effect of financial advisors' incentives on client investments. Exploiting a natural experiment triggered by the 2018 implementation of Markets in Financial Instruments Directive II (MiFID II), we find that clients' investments respond strongly to changes in advisor incentives. Advisors react through multiple mechanisms: (i) inducing existing clients to bring in new money, (ii) channeling it to high-incentive funds, and (iii) attracting more new clients. We also find that the MiFID II reform generated more balanced incentives, which translated into higher portfolio efficiency through lower average fees and stronger portfolio diversification.