When Liability Is Not Enough: Regulating Bonus Payments in Markets with Advice

Jun Honda (), Roman Inderst and Marco Ottaviani ()
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Jun Honda: Economic Analysis Office, Japan Fair Trade Commission, Tokyo 100-8987, Japan
Marco Ottaviani: Bocconi University, IGIER, and BIDSA, 20136 Milano, Italy

Management Science, 2024, vol. 70, issue 2, 1301-1314

Abstract: We introduce a model of advice in which firms steer advisors through nonlinear incentive schemes. In addition to developing an isomorphism to pricing with mixed bundling, we obtain three main insights. First, firms optimally use nonlinear bonuses to economize on the rent paid to advisors. Second, equilibrium bonus payments induce advisors to make biased recommendations that are artificially contingent on each other, resulting in an inefficient allocation. Third, if advisor liability is stepped up, firms respond by increasing the size of the bonus, leaving advisor bias unchanged. These results shed light on prevailing compensation practices for advisors and support direct regulatory interference.

Keywords: markets with advice; nonlinear incentives and bonus payments; biased recommendations; liability; regulation (search for similar items in EconPapers)
Date: 2024
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http://dx.doi.org/10.1287/mnsc.2023.4750 (application/pdf)

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Working Paper: When Liability is Not Enough: Regulating Bonus Payments in Markets With Advice (2022)
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Persistent link: https://EconPapers.repec.org/RePEc:inm:ormnsc:v:70:y:2024:i:2:p:1301-1314

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