An example of a principal-agent triangle that I
have witnessed is the occupation of a financial advisor. This came to mind
because of my aspirations of becoming a financial planner and the experiences
i've had in interviewing for an intern position.
The firm hires a financial planner, which is the
agent for them. The planner then acquires clients who now look at him/her as
their agent. The agent has to lookout for the best interest of his clients
financial lives, the firm being successful, and the planner's own personal
interests. One conflicting aspect that i discovered when interviewing and
looking into financial planning is whether or not the agent earns a salary or
commission. Clients will be hesitant of going with an agent that earns
commission because he/she will have more incentive of self interest when giving
financial advice.
Essentially, if the agent is managing enough clients, regardless of the
extent of their investments, then the firm will be content with the
performance. In this case, then the agent just needs to make sure he/she does
their job and puts their clients in the best financial situation they can be
in. A way to resolve any issues would be to have the agents on salary, but that
brings up an opposition that commission is an incentive for the agent. Some
could argue that the agent would work harder and compete in the market on
commission as opposed to logging hours of work and doing the bare minimum. This
was heavily implied in one of my interviews. I was asked how I felt about being
on commission and how I felt about competing in the open market of potential
clients (principals).
I don’t exactly think that the agent could fail by satisfying one master
because in either view, the agent is doing his or her job. If he/she satisfies
the firm, then they are doing their job correctly and will continue to perform.
If they satisfy their clients, then they are also performing well. Perhaps
there is a situation where a financial planner is satisfying all his/her
clients and isn’t bringing in enough revenue for the firm. In the manager’s
perspective, they might be upset with the agent’s performance. To call this
failing seems extreme though. In my opinion, this would call for a performance evaluation
and urging the agent to reach out to either wealthier clients or to expand the
agent’s clients.
Aside from the differences of salary vs commission agents and a
performance review of quality vs quantity of clients, I haven’t witnessed any
other issues in the occupation. It is a relevant career in todays society of
teaching everyone about financial literacy while also being an example of a
bilateral principal-agent model.
Let me note that salary and commission are different, but not quite as much as you seem to think. Salary increases are performance based, as is promotion and job responsibility. Performance will always matter in some way for how an employee is treated.
ReplyDeleteLet me also note that even a salaried financial advisor will likely face pressure to trade on their client's portfolio, because that generates fees for the firm. Indeed it is generally thought that is one way this particular triangle plays out. There has been quite a bit of research on the subject. If the client is in it for the long term, a wait and hold approach, investing in stock index funds, typically performs as well or better than investing with a financial advisor, because fees are avoided with the latter and otherwise the index funds don't do so bad. For clients who are wanting to make more aggressive investments and hope to make it big in the near term, then the financial advisor route may be preferable. Individuals don't have the information to perform the financial research necessary to identify good risk investments, particularly on newer companies with small capitalization. If you know how to price long shots, you may be able to outperform the market. But there is some skepticism that is possible to do on a consistent basis.
Let me make one more point on this issue of working on behalf of the client or not. When the market is booming, it is pretty easy for the financial advisor to make the client happy. This actually gives the financial advisor space to not fully benefit the client, because the return on the portfolio will still be quite good. When the market is going south, it is harder for the financial advisor to steer the client into undesirable investments, but the incentive to do so will be greater, more so as you said for the financial advisor who operates on a commission.
Previously i hadn't put much thought into the effect the market would have on the agent. The triangle is directly effected by the setting that the agent is in. Then I would question how the client principal would react to a change in the ability of the agent to increase the portfolio. Some clients would be more understanding in that markets can fluctuate and there will be times of growth and possibly stagnant times of investment. Some might be impatient or ignorant and in a stagnant time assume that it is the agent's fault and drop their services. Perhaps a financial advisor should also connect with their principals on an understanding level and educate them that there are short-term and long shot investments and that the utility isn't always a smooth function.
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