Financial advice could play an essential role in well-functioning markets for retail financial products, given that many consumers find it difficult to evaluate the complex products on offer. However, conflicts of interest, which are pervasive in some parts of the industry, can turn advice into a curse rather than a blessing for consumers, especially when consumers are not sufficiently wary. Through a simple model of financial advice, we overview the pros and cons of various policy interventions, such as imposing mandatory disclosure, banning commissions, and regulating contract cancellation terms. (JEL D14, D18, G21, G28)

ABSTRACT We examine the role of security design when lenders make inefficient accept or reject decisions after screening projects. Lenders may be either “too conservative,” in which case they reject positive‐NPV projects, or “too aggressive,” in which case they accept negative‐NPV projects. In the first case, the uniquely optimal security is debt. In the second case, it is levered equity. In equilibrium, profitable projects that are relatively likely to break even are financed with debt, while less profitable projects are financed with equity. Highly profitable projects are financed by uninformed arm's‐length lenders.

We study optimal financial contracting for centralized and decentralized firms. Under centralized contracting, headquarters raises funds on behalf of multiple projects. Under decentralized contracting, each project raises funds separately on the external capital market. The benefit of centralization is that headquarters can use excess liquidity from high cash‐flow projects to buy continuation rights for low cash‐flow projects. The cost is that headquarters may pool cash flows from several projects and self‐finance follow‐up investments without having to return to the capital market. Absent any capital market discipline, it is more difficult to force headquarters to make repayments, which tightens financing constraints ex ante. Cross‐sectionally, our model implies that conglomerates should have a lower average productivity than stand‐alone firms.

This article shows that investors financing a portfolio of projects may use the depth of their financial pockets to overcome entrepreneurial incentive problems. Competition for scarce informed capital at the refinancing stage strengthens investors' bargaining positions. And yet, entrepreneurs' incentives may be improved, because projects funded by investors with “shallow pockets” must have not only a positive net present value at the refinancing stage, but one that is higher than that of competing portfolio projects. Our article may help understand provisions used in venture capital finance that limit a fund'sinitial capital and make it difficult to add more capital once the initial venture capital fund is raised.

This paper investigates the determinants of the compensation structure for brokers who advise customers regarding the suitability of financial products. Our model explains why brokers are commonly compensated indirectly through contingent commissions paid by product providers, even though this compensation structure could lead to biased advice. When customers are wary of the adviser's incentives, contingent commissions can be an effective incentive tool to induce the adviser to learn which specialized product is most suitable for the specific needs of customers. If, instead, customers naively believe they receive unbiased advice, high product prices and correspondingly high commissions become a tool of exploitation. Policy intervention that mandates disclosure of commissions can protect naive consumers and increase welfare. However, prohibiting or capping commissions could have the unintended consequence of stifling the adviser's incentive to acquire information. More vigorous competition benefits consumers and reduces exploitation, but firms have limited incentives to educate naive customers.

Our paper analyzes whether a planner should design a taxonomy for sustainable investment products when conventional tools for environmental regulation can also be used to address externalities arising from firm production. We first show that the private market provision of ESG funds marketed to retail investors involves greenwashing , so that a mandatory taxonomy is necessary to generate real effects of sustainable finance . However, the introduction of such a taxonomy can only improve welfare, on top of optimally chosen environmental regulation, if financial frictions constrain socially valuable economic activity. Otherwise, environmental policy alone is sufficient to optimally address externalities.

In markets for retail financial products and health services, consumers often rely on the advice of intermediaries to decide which specialized offering best fits their needs. Product providers, in turn, compete to influence the intermediaries' advice through hidden kickbacks or disclosed commissions. Motivated by the controversial role of these widespread practices, we formulate a model to analyze competition through commissions from a positive and normative standpoint. The model highlights the role of commissions in making the advisor responsive to supply-side incentives. We characterize situations when commonly adopted policies such as mandatory disclosure and caps on commissions have unintended welfare consequences. (JEL D21, D82, D83, G21, L15, L25)

This paper analyzes the implications of the inherent conflict between two tasks performed by direct marketing agents: prospecting for customers and advising on the product's “suitability” for the specific needs of customers. When structuring salesforce compensation, firms trade off the expected losses from “misselling” unsuitable products with the agency costs of providing marketing incentives. We characterize how the equilibrium amount of misselling (and thus the scope of policy intervention) depends on features of the agency problem including: the internal organization of a firm's sales process, the transparency of its commission structure, and the steepness of its agents' sales incentives. (JEL M31, M37, M52)

This article characterizes optimal compensation contracts in principal-agent settings in which the consequences of the agent’s action are only observed over time. The optimal timing of pay trades off the costs of deferred compensation arising from the agent’s relative impatience and potential consumption smoothing needs against the benefit of exploiting additional informative signals. By capturing this information benefit of deferral in terms of the likelihood ratio dynamics, our characterization covers general signal processes in a unified setting. With bilateral risk neutrality and agent limited liability, optimal contracts are high-powered and stipulate at most two payout dates. If the agent is additionally risk-averse, payouts are contingent on performance exceeding a hurdle that is increasing over time. We obtain clear-cut predictions on how the duration of optimal compensation depends on the nature of information arrival as well as agent characteristics and derive implications for the maturity structure of securities in financial contracting settings.

ABSTRACT We analyze the effects of regulatory interference in compensation contracts, focusing on recent mandatory deferral and clawback requirements restricting incentive compensation of material risk‐takers in the financial sector. Moderate deferral requirements have a robustly positive effect on risk‐management effort only if the bank manager's outside option is sufficiently high; otherwise, their effectiveness depends on the dynamics of information arrival. Stringent deferral requirements unambiguously backfire. Our normative analysis characterizes whether and how deferral and clawback requirements should supplement capital regulation as part of the optimal policy mix.