Financial Intermediaries and Agency Problems With and Without Vertical Incentives

I study the role of vertical incentives between upstream issuers and downstream brokers in the retail bond market when there exist agency problems. Although arms-length transaction regulations require that vertical incentives not influence their activities, I show that both upstream issuers and downstream brokers are sensitive to vertical incentives. I then present a structural model in order to measure the degree of vertical incentives for downstream brokers, controlling for the extent of agency problems. The structural estimates show that brokers are willing to give up one dollar of their own profit if their vertically integrated issuer’s profit goes up by 1.25 dollars. This paper was accepted by Victoria Ivashina, finance. Supplemental Material: The online appendix and data files are available at https://doi.org/10.1287/mnsc.2023.03572 .