Out-of-pocket vs. out-of-investment in financial advisory fees: Evidence from the lab

Abstract

• We are studying different payment methods for services with uncertain outcomes. • We identify a novel effect for payments that take place after the outcome. • This study has important implications for regulatory measures. • Indeed, the study emerged from an advisory project for regulators. The implications of the method of payment to financial advisors on the behavior of individuals are of interest to economists and regulators around the globe. This paper uses an experimental approach to compare two common alternative forms of payment. The first is “out-of-pocket” (an upfront payment from a checking account), and the second is “out-of-investment” (a deferred payment from an investment portfolio account). We document that for the same financial advice, the subjects in the first treatment were willing to pay on average 25 per cent less than the subjects in the second treatment – payment following an investment outcome knowledge, where the payment was framed in terms of gains. We introduce an additional out-of-pocket payment structure where the actual payment is deferred until after the subject discovers the outcome of the investment. Thus, the design can be broken down into two distinct possible effects, an out-of-pocket vs. out-of-investment framing effect and a pre-outcome vs. post-outcome timing effect. We find that the timing effect is the key element: across out-of-pocket payment structures, the subjects were willing to pay significantly less in the pre-outcome treatment than their counterparts were in the post-outcome treatment. Our results highlight the difference between post-service and pre-service payments in a broader context, and provide an explanation for why allowing late payment, after the service has been performed and its outcome revealed, may increase the ex-ante willingness to pay for the service.