Self-Deception Can Guide Financial Advice

A multi-institutional team of researchers explored different scenarios to evaluate the degree of self-deception when financial advisors make recommendations for their clients.

As the new year unfolds, people often revisit their retirement plans, enlisting the help of financial planners to navigate the confusing ins and outs of their portfolios. Clients can only assume agents have their best interests at heart, but do they?

Silvia Saccardo, assistant professor in the Department of Social and Decision Sciences at Carnegie Mellon University, and her team explored the role of self-deception when a financial advisor delivers investment recommendations. The researchers found distorting financial advice comes with psychological consequences. They believe the results offer an opportunity to create interventions that can reduce unethical behavior by ethical-but-biased advisors.

The results are available online in the January issue of the journal Games and Economic Behavior.

“Sometimes [moral transgressions occur in] a grey area and could be justified somehow,” Saccardo said. “Ambiguous or subjective situations might be where unethical behavior happens. People can convince themselves that they are not transgressing.”

Saccardo set up three an experiment in which participants with no financial background mimic the role of a financial advisor. They manipulated the timing at which advisors learned about their incentives. In the first scenario, the participant learns about a commission associated with investment A, before the participant reviews the risks and benefits of two investment packages (A and B). In the second scenario, the participant reviews the risks and benefits of the two investments before learning about the commission associated with investment A. The researchers do not ask the participants to announce their evaluation of the investments out loud or in-writing to reduce perceived judgement by the study personnel. The researchers also set up a control for the study where the participant receives a fixed fee for making a recommendation.

The findings of the study find that incentives bias advisors' recommendations, but only when advisors can convince themselves that their advice is not driven by the commission. That is, when advisors learned about their commission before learning about the risks and benefits of the two investments, a large fraction of recommended investment A – the one that yielded a commission. In this scenario, advisors could easily convince themselves that the product with the commission was the one the client would prefer. However, when they learned about the commission only after having a chance to form an unbiased evaluation of the risk and benefits of the investments, advisors were no longer influenced by the commission. These results suggest how limiting advisors’ ability to self-deceive by delaying the timing at which they learn about their incentives can prevent unethical behavior.

“Self-deception allows people to enjoy the best of both worlds to get the incentives but also allows them to not have a cost to their image.” Saccardo said. “Next, we wanted to test how much ambiguity is needed for self-deception to happen,”

To study this question Saccardo and her team set up additional experiments that progressively reduced the ambiguity over what product would be preferred by the client. In each experiment, investment package B offers a progressively higher return at a progressively lower risk than investment package A.

The researchers found that the level of self-deception decreased in each experiment. When investment B clearly dominated investment A, learning about the commission before evaluating the risks and benefits of the products no longer led to an increase in the fraction of recommendations of investment A. “Eliminating all of the justifications by making investment B obviously better than A eliminated any scope for self-deception”, Saccardo said.

At the end of each experiment, Saccardo and her team asked the participants to pick a financial option for themselves. In line with the self-deception hypotheses, the participants continued to select investment A, despite the fact that this financial package was the less beneficial investment.

According to Saccardo, it all comes down to self-image. Financial advisors care to preserve their identity as ethical but may self-deceive about the ethicality of their behavior to gain incentives. Increasing these self-image costs could be a promising avenue for curbing unethical behavior by individuals who care to perceive themselves as moral.  Saccardo noted that interventions that delay information about commission in the real world and reducing any room for ambiguity and flexibility in judgment could reduce self-deception by financial advisors.

“This work confirms that people have a moral cost for behaving unethically,” Saccardo said. “We need to find a way to make this cost salient.”

Saccardo was joined by Uri Gneezy and Marta Serra-Garcia at the University of California and Roel van Veldhuizen at Lund University, Sweden on the project, titled “Bribing the Self.” The team received support from the Rady School of Management University of California, San Diego and the Handelsbanken Foundation.