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

Author

Listed:
  • Jun Honda

    (Economic Analysis Office, Japan Fair Trade Commission, Tokyo 100-8987, Japan)

  • Roman Inderst

    (Johann Wolfgang Goethe University, 60323 Frankfurt, Germany)

  • Marco Ottaviani

    (Bocconi University, IGIER, and BIDSA, 20136 Milano, Italy)

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.

Suggested Citation

  • Jun Honda & Roman Inderst & Marco Ottaviani, 2024. "When Liability Is Not Enough: Regulating Bonus Payments in Markets with Advice," Management Science, INFORMS, vol. 70(2), pages 1301-1314, February.
    • Handle: RePEc:inm:ormnsc:v:70:y:2024:i:2:p:1301-1314
    DOI: 10.1287/mnsc.2023.4750
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