Financial Advisor Compensation Structure and Client Equity Allocations

Abstract

Investment advice is a difficult-to-value service and aligning incentives between financial advisors and investors is imperative. A compensation structure that pays advisors primarily through up-front commissions creates a potential short-term relationship, while a trailing commission arrangement better aligns with an intertemporal relationship. This paper explores this effect using a dataset of approximately 120,000 variable annuities from a single insurance company sold from January 1999 to December 2020. We find that clients of financial advisors who are paid higher up-front commissions have greater recent return bias compared to clients of advisors who receive higher trailing commissions. These findings indicate that a nuanced approach to compensation may be needed to balance investor protection with the proper incentives for financial advisors to provide unbiased and high-quality advice.