Can a Bonus Overcome Moral Hazard? Experimental Evidence from Markets for Expert Services

By Vera Angelova and Tobias Regner

Expert financial advice can hurt clients if the interests of advisors and clients are not aligned. For instance, recent evidence from the US financial market shows that funds offering higher broker commissions attract more investments but, at the same time, higher broker commissions are related to lower investment performance.

In this project, BCCP Fellow Vera Angelova and Tobias Regner investigate which factors could improve advice quality. In a laboratory experiment, they study the interaction between an expert advisor and a client. The advisor recommends a product to the client. However, one product is more profitable for the client, while another one yields the highest commission to the advisor. The authors introduce competition among advisors, the possibility for them to build a reputation, and a channel through which clients can reciprocate if they receive truthful advice: a voluntary bonus paid after feedback about advice quality. The key innovation is to test whether the bonus can increase honesty, on its own and together with competition and reputation.

The highest rate of truthful advice results when advisors compete and can build reputations at the same time. The authors observe a similar effect when the bonus is combined with either competition or reputation. Thus, whenever it is impossible to implement competitive environments or reputation mechanisms in real life settings at the same time, a voluntary component can act as a substitute for either of them, increasing honesty. In a broader sense, the voluntary payment can be seen as any act that is costly to the client but would benefit the advisor, such as writing a review about the advisor online or telling family and friends.

The full paper “Can a bonus overcome moral hazard? Experimental evidence from markets for expert services” is published in the Journal of Economic Behavior and Organization, 154 (2018) 362–378.