RFS Advance Access originally published online on October 24, 2009
Review of Financial Studies 2009 22(12):5175-5212; doi:10.1093/rfs/hhp083
| ||||||||||||||||||||||||||||||||||||||||||||||||||
Brokerage Commissions and Institutional Trading Patterns
Babson College
University of Georgia
Hebrew University and CEPR
Hebrew University
Send correspondence to Paul Irvine, 444 Brooks Hall, Terry College of Business, Athens, GA 30602; telephone: 706-542-3661; fax: 706-542-9434. E-mail: pirvine{at}uga.edu.
JEL Classification: G23, G24
 |
Abstract |
|---|
The institutional brokerage industry faces an ever-increasing pressure to lower trading costs, which has already driven down average commissions and shifted volume toward low-cost execution venues. However, traditional full-service brokers that bundle execution with services remain a force and their commissions are still considerably higher than the marginal cost of trade execution. We hypothesize that commissions constitute a convenient way of charging a prearranged fixed fee for long-term access to a broker’s premium services. We derive testable predictions based on this hypothesis and test them on a large sample of institutional trades from 1999 to 2003. We find that institutions negotiate commissions infrequently, and thus commissions vary little with trade characteristics. Institutions also concentrate their order flow with a relatively small set of brokers, with smaller institutions concentrating their trading more than large institutions and paying higher per-share commissions. These results are stable over time, are consistent with our predictions, and cannot be explained by cost-minimization alone. Finally, we discuss the evolution of the institutional brokerage market within the proposed framework and make informal predictions about future developments in the industry.
We would like to thank Abel/Noser, Greenwich Associates, and the Institutional Broker Estimate Service for providing the data. We also thank Ekkehart Boehmer, Chitru Fernando, Terence Lim, Marc Lipson, Maureen O’Hara, Christine Parlour, Chester Spatt, George Sofianos, Daniel Weaver, seminar participants at the Hebrew University, HEC (France), Tel Aviv University, Texas A&M, the NASDAQ Economic Advisory Board, and participants at the New York Stock Exchange conference, the Yale-Nasdaq conference, and the FIRS Capri conference for their comments. We also thank Granit San for her assistance with the CDA/Spectrum data, David Hunter for his help with Thompson mutual funds data, and Michael Borns for his expert editorial assistance. Goldstein gratefully acknowledges financial support from the Babson College Board of Research; Kandel and Wiener are grateful to the Krueger Center for Financial Research at the Hebrew University for financial support. We apologize for any errors remaining in the article.