Strategic complexity in investment management fee disclosures
This article develops a measure of complexity of fee disclosures, based on previous work assessing the grade level of language, and validates that measure through a survey where students are asked to independently rate the complexity of fee disclosures. In addition, the article hypothesizes that high fee providers are more likely to engage in strategic complexity in fee disclosures than are low fee providers. We hypothesize that high fee providers use strategic complexity to take advantage of the lack of financial sophistication of many people, making it difficult for them to compare fees across service providers and to understand the level of fees they are paying. [C] 2016 Academy of Financial Services. All rights reserved.
JEL classification: G02; G2
Keywords: Fees; Complexity; Financial literacy; Disclosures
While much attention has been given to financial education for pension participants and their lack of financial sophistication (e.g., Lusardi and Mitchell, 2007; McCarthy and Turner, 2000), less attention has been given to the quality of information they receive from financial service providers. Efforts by pension participants and other investors to learn about financial market products and services may be offset by efforts by financial service providers to obfuscate through complexity in fee structures and in financial disclosures concerning fees.
While transparency is widely viewed as desirable in financial disclosures and in the features of financial products, to take advantage of the lack of financial sophistication of their clients, some advisers may engage in strategic complexity. With strategic complexity, they structure their fees and fee disclosures in complex ways. For example, they may disclose important information in footnotes or use terminology that is not commonly understood by pension participants. Abeler and Jager (2015) comment that there is growing evidence that people often do not respond optimally when they are faced with complex financial information.
Complexity is a multidimensional strategy that we hypothesize is used by some investment management or advisory companies to make it difficult to compare advisory services on the basis of fees, and to determine what level of fees a prospective investor would be paying. The strategy takes advantage of the lack of financial sophistication of many investors, but in some instances even sophisticated investors may not be able to make comparisons or obtain accurate fee information based on the disclosures provided on the Internet. "Financial sophistication" can come about through taking specific courses (e.g., finance class in college), life experience in making financial choices, and/or working in a position that requires financial decision-making. Strategic complexity presumably reduces competition based on fees in the market for advisory services and permits service providers to charge higher fees. Prices and fees are essential information in the functioning of the market for a product or service. Strategic complexity in the disclosure of fees is presumably designed to make a market less competitive to increase the income of service providers.
Strategic complexity raises search costs. It may explain in part the limited search that many people make when shopping for financial services and products because...