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Should Indirect Brokerage Fees Be Capped? Lessons from Mutual Fund Marketing and Distribution Expenses

Published online by Cambridge University Press:  21 April 2017

Natalie Y. Oh ,
Jerry T. Parwada  and
Eric K. M. Tan
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Abstract

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Theory predicts that capping brokers’ compensation exacerbates the exploitation of retail investors. We show that regulated caps on mutual fund 12b-1 fees, effectively sales commissions, are associated with negative equity fund performance, but only after a structural shift toward maximum permitted levels of the fees around 2000. Past this break point, flow–performance sensitivity shifts from the middle- to the highest-performing funds, suggesting that the fee cap increases performance-chasing behavior by constraining brokers’ incentives to learn about lower-ranked funds. The policy implication is that regulators must reevaluate the efficacy of caps on brokerage fees.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 52 , Issue 2 , April 2017 , pp. 781 - 809
Copyright
Copyright © Michael G. Foster School of Business, University of Washington 2017 

Footnotes

1

The authors thank Vikas Agarwal, Dumitrescu Ariadna, Karen Benson, Stephen Brown (the editor), Kingsley Fong, Fabian Irek, Ron Masulis, Stefan Ruenzi, Charles Trzcinka (the referee), and seminar participants at the 2010 European Financial Management Association Meeting, the 2011 Financial Management Association European Conference, and the 2011 Asian Finance Association Meeting for helpful comments.

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