The Economics of Fiduciary Investment Advice

Authors: Benjamin Cummings and Michael Finke (September 2010)

Abstract: An inability to accurately detect quality prior to or even after purchase distinguishes professional advice from other consumer goods or services. A consumer that is unable to assess the difference between an advisor’s recommendation and the ideal recommendation is vulnerable to the self-serving behavior of the agent. Regulation that decreases the agency costs to consumers (or increases costs to planners not acting prudently) can increase consumer welfare. A client who trusts their advisor believes that the advisor is less likely to take advantage of the information asymmetry inherent in an expert-advice relationship. This trust also reduces client oversight and provides opportunities for advisors to make recommendations that maximize their own welfare within the boundaries of the regulatory rulebook. Applying a fiduciary standard to all financial professionals who provide personalized advice will eliminate many of these conflicts of loyalty between advisors and clients and will increase bonding costs to more closely align incentives.

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