Abstract
We show that social capital has a strong mitigating effect on financial adviser misconduct in the United States. Moreover, advisers who have committed misconduct are also more likely to relocate to counties with a relatively lower level of social capital than that of his previously residing county. These findings provide support for both the deterrence and displacement effects of social capital on financial adviser misconduct, and are robust to tests that address potential endogeneity concerns. Our results shed new light on social capital as an informal governing and monitoring mechanism against individual unethical behavior.
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Notes
Source: Boston Consulting Group: https://www.bcg.com/publications/2019/global-asset-management-will-these-20s-roar.aspx.
For example, seven percent of registered advisers have misconduct records, with the number doubling at the largest firms (Gurun et al., 2018).
Charoenwong, Kwan, and Umar (2019) document an approximately one-third increase in client complaints against mid-size advisers after a regulatory jurisdiction shift from the SEC to state-securities regulators. Kowaleski, Sutherland, and Vetter (2020) show that training on ethics is associated with a one-fourth reduction in advisers’ propensity to commit misconduct.
Egan et al. (2019) report an increase in misconduct being disclosed in the aftermath of the recent financial crisis.
For example, if a firm located in a high social capital area provides better quality financial reports (Jha, 2019), it is not clear whether the tendency for transparent disclosure comes from the corporate culture fostered in a rich social environment or is due to the managers’ personal code of conduct shaped by local social expectations. In other words, firm level evidence cannot conclusively determine whether social capital affects firm culture or individual managers’ behavior.
Gennaioli et al. (2015) suggest that professional managers may exploit trust investors put on them and attribute such trust to investors’ behavioral bias. Our paper suggests that trust exerted by social norms plays a disciplinary role on investment professionals.
In a perfect world, all people are able to follow social norms and create societies that require no regulations or law enforcement. In reality, however, since not all individuals are willing to hold themselves and one another to the highest standards, formal monitoring by authorities is practically necessary.
Nonetheless, social capital may also carry possible negative consequences such as coercion or inequality by social exclusion. Sometimes the pursuit of the greater good may not necessarily be commensurate with the pursuit of individual goals (see Ayios et al., 2014).
We thank Mark Egan, Gregor Matvos, and Amit Seru for kindly sharing this dataset with us. Egan, Matvos, and Seru (2019) collect information for all financial advisers in the United States from FINRA’s BrokerCheck database.
Please see more details at http://eganmatvoserru.stanford.edu/index.php/download-adviser-level-data/
This dataset does not have exactly the same coverage as that used in Egan et al. (2019). In particular, while the IAPD dataset covers a majority of Investment Adviser Representatives, it only includes a fraction of the individuals who registered with the Financial Industry Regulatory Authority (FINRA) as Registered Representatives (i.e., “brokers”). Nonetheless, Egan et al. (2019) note that similar inferences were obtained when using the IAPD dataset.
Data is downloaded from https://aese.psu.edu/nercrd/community/social-capital-resources.
For example, in our sample, the 2005 and the 2009 versions of the RGF index have a correlation of approximately 95%.
It is important to note that, while we use “county” and “community” interchangeably in this paper, we acknowledge that subcommunities, based on characteristics such as religious affiliations, age groups, or socio-economic backgrounds, may exist within each county, and it is possible for social norms to vary across these subcommunities even within a county. However, the county-level social capital measure is the most granular that is available.
Income per capita, population, and population growth data comes from the Bureau of Economic Analysis (BEA). The religiosity data comes from the Association of Religion Data Archives (ARDA). Population over 65 and college education data comes from the U.S. Census Bureau.
Similarly, Laamanen et al. (2012) use the Heckman’s procedure to study corporate cross-border relocations of headquarters. The first stage regression is a probit model to predict the decision “whether to relocate”. The inverse Mills ratio obtained from the first stage is then included in the second stage model to estimate “where to relocate”.
Our definition of regions is based on Jha & Chen (2015).
As a robustness check, we control for two-dimensional fixed effects such as firm-year fixed effects, region-year fixed effects, and firm-region fixed effects with the following rationale. Firm-year fixed effects control for attributes of advisory firms that may vary over time, such as the evolution of firms’ culture and leadership. Region-year fixed effects capture changes in geographic and demographic characteristics (e.g., the passage of legislation or the flow of labor force) in a region. Firm-region fixed effects account for the possibility that firms with geographically dispersed operations may adopt policies that are location-specific. Our results are robust to these alternative fixed effects.
In untabulated robustness checks, we cluster standard errors by financial adviser or by county and financial adviser, and obtain very similar results.
Since all specifications include fixed effects, we no longer report the constant in the table. We also subsume the constant in subsequent tables wherever it is appropriate.
In untabulated analysis, we find that including the lagged value of $$Misconduct$$ as an additional control variable has no material effect on the economic and statistical significance of RGF. The sample size is reduced by about 18% in this analysis.
As a robustness check, we construct an alternative racial heterogeneity measure based on a Shannon index (\(-\sum {k}_{i}\mathrm{ln}\left({k}_{i}\right))\), Race_1970_Shannon, and find very similar result.
In an untabulated analysis, we include Experience2 in the second stage regression, and find its coefficient estimate to be statistically insignificant, suggesting that the exclusion restriction is satisfied.
As a robustness check, we further control for the distance between relocated financial advisers’ current location and previous location as well as the cosine similarity in county characteristics between the two locations and find consistent results.
Given that the average area of U.S. counties is 1,091 square miles and assuming counties are square-shaped, 50 miles is roughly the length of the diagonal of a county (more precisely, \(\sqrt{2\times 1091 }=46.7\)).
The main effect of Crisis is absorbed by fixed effects.
The fourteen survey questions regard club meetings attended, community projects worked on, times entertained at home, times volunteered, time spent visiting friends, agreeing that most people are honest, serving on committees for local organizations, servicing as officer of clubs or organizations, attending meetings on town or school affairs, organizations per capita, mean number of group memberships, agreeing that most people can be trusted, civic and social organizations per 1,000 population, and voter turnout. Putnam’s (2000) measures of the different attributes of social capital are downloaded from http://bowlingalone.com/bowlingalone.com/.
Note that rare event Logit model does not comply with fixed effects.
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Acknowledgements
We are grateful to Mark Egan, Gregor Matvos, and Amit Seru for kindly sharing with us their data on financial adviser misconduct and other adviser characteristics. We thank Nicole Boyson, Xavier Giroud, and seminar participants at Northeastern University for helpful comments and suggestions. Priya Garg provided excellent research assistance.
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Appendix: Key variable definitions
Appendix: Key variable definitions
Misconduct | Following Egan et al. (2019), Misconduct is defined as a dummy variable that equals one in a year if a financial adviser has engaged in actions that have led to criminal, regulatory, internal, civil or customer-related investigations that were resolved against the adviser, and zero otherwise. For ease of presentation of regression coefficients, we multiply the dummy variable by 100. Accordingly, the summary statistics of Misconduct shown in Table 1 are interpreted as percentage points |
RGF | RGF is a county-level index of social capital obtained from a principal component analysis on individual participation in associational activities, presidential elections voter turnout, census response rate, and the number of tax-exempt non-profit organizations. For more details, please refer to Rupasingha et al. (2006). The RGF measure is obtained from the Northeast Regional Center for Rural Development in the College of Agricultural Sciences at Pennsylvania State University. The data is publically available at https://aese.psu.edu/nercrd/community/social-capital-resources. This county-level social capital index is available for the years 1990, 1997, 2005, and 2009. For the years with missing data, we assume that the social capital value in a given county remains the same until new data becomes available |
Move to Different County | A dummy variable that is equal to one if a financial adviser has moved to a different county in a given year, and zero otherwise |
Move to Lower SC County | A dummy variable that is equal to one if a financial adviser has moved to a lower social capital county in a given year, and zero otherwise |
Adviser-level controls | |
Experience | The number of years since the adviser first started working with an investment adviser firm |
Male | A dummy variable indicating whether an adviser is a male or nota |
Series 63/65/66 | A dummy variable indicating whether an adviser holds a series 63/65/66 license or not |
County-level controls | |
Income Per Capita | The natural logarithm of income per capita in a county. Data comes from the Bureau of Economic Analysis (BEA) |
Population | The natural logarithm of population in a county. Data comes from the Bureau of Economic Analysis (BEA) |
Population Growth | population growth rate in a county. Data comes from the Bureau of Economic Analysis (BEA) |
Religiosity | The number of adherents divided by the population in a county. Data comes from the Association of Religion Data Archives (ARDA) |
Population Over 65 | The percent of population older than 65 in a county. Data comes from the U.S. Census Bureau |
College | The percent of college-educated population in a county. Data comes from the U.S. Census Bureau |
Instruments | |
Race_1970 | Race_1970 is calculated as \(\left(1-{\sum }_{k}{s}_{ki}^{2}\right)\), where i represents state, and k represents the following races: (i) Black, (ii) White and other races. Each term in \({s}_{ki}\) represents the share of race \(k\) in the population of state i. The data are obtained from the U.S. Census Bureau |
Distance | The natural logarithm of the closest distance between a U.S. county and the US-Canadian border. County coordinates are obtained from https://www.census.gov/geo/maps-data/data/gazetteer2017.html Coordinates of country borders are obtained from http://www.mappinghacks.com/data/ |
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Bai, J.(., Shang, C., Wan, C. et al. Social Capital and Individual Ethics: Evidence from Financial Adviser Misconduct. J Bus Ethics 181, 495–518 (2022). https://doi.org/10.1007/s10551-021-04910-4
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DOI: https://doi.org/10.1007/s10551-021-04910-4