ASIC today released two reports of behavioural economics (BE) research experiments conducted as part of its push to better understand market and consumer behaviour.

The behavioural experiments conducted by the Queensland Behavioural Economics group (QuBE), were commissioned to explore:

• possible behavioural ‘biases’ impacting consumer decisions about investing in hybrid securities rather than bonds or shares. A hybrid security is one that looks like debt but has the risk characteristics of equity, and
• how to improve ASIC’s communication with directors of firms in liquidation to increase their compliance with the law.

ASIC Chairman Greg Medcraft said, ‘Undertaking evidence-based studies about how people think and behave in the real world is going to be increasingly important to smarter regulation. These studies provide valuable insights into how people make decisions and how ASIC can improve outcomes.’

Report 427 Investing in hybrid securities: Explanations based on behavioural economics (REP 427) provides insight into people’s decision making when investing in hybrid securities rather than in bonds and shares. In the experiment QuBE found participants who were subject to an ‘illusion of control’ or ‘overconfidence’ bias relatively increased their hybrid allocation in a mock portfolio.

This research complements ASIC’s work on understanding how hybrids are sold to investors and increasing investor education about hybrid risk. The findings are also consistent with earlier research showing a desire for control is a strong driver among SMSF investors when deciding to set up and manage their own super fund. About two-thirds of Australian hybrid investors are SMSF investors.[1]

BE insights can also be used to help ASIC’s communication by presenting information in a way people can process more easily.

Report 428 Improving communication with directors of firms in liquidation (REP 428) suggests even small alterations to communication, such as the order of messages in a letter to directors of companies in liquidation, can increase compliance. The report highlights there are likely to be two types of directors who fail to comply: those wishing to comply but who are overwhelmed and those intentionally non-compliant. It identifies opportunities to increase compliance through targeted ‘nudges’ and help for those wishing to comply.

ASIC’s further BE work

ASIC is committed to applying behavioural economics insights to identify consumer problems and to detect when firms take advantage of consumer biases. As well as the QuBE reports, ASIC is:

• developing its first field-based randomised control trial;
• employing behavioural insights in reviewing and improving the Report as to Affairs form directors of failed companies must complete, and
• running trials with industry to test innovative disclosure models, recognising that new technologies and digitisation are changing the way people are presented with and respond to information (refer: 14-317MR).

‘As ASIC continues to develop insight into how and why people behave the way they do, we will be in a better position to develop responses that are potentially less interventionist whilst having greater impact,’ Mr Medcraft said.

Download the reports below, along with ASIC’s Strategic Outlook, which signals ASIC’s move towards increased use of behavioural economics.

Background: Behavioural economics and regulation

Behavioural economics is based on decades of empirical research across different fields including finance, economics and psychology. It is increasingly being employed by regulators and policy makers in many different fields in Australia and internationally. Behavioural economics departs from economic models that assume that people behave ‘rationally’ and seeks to understand the different – and often unconscious – biases that drive decision making and behaviour.

The financial services sector is known to be a particularly rich environment for consumer and investor decision biases. For example, humans are sensitive to the way options or decisions are framed and are generally poor at making decisions involving uncertainty. This can lead to poor insurance and investment decisions.

ASIC has incorporated behavioural research and approaches into our work for many years, however we are now looking to more systemically apply behavioural economics across our regulatory business.

The Government’s Financial Systems Inquiry report also found behavioural biases can be detrimental to participants and financial system efficiency, and that regulatory frameworks should be designed with these biases in mind.