The Value of Intermediation in the Stock Market

Marco Di Maggio, Mark Egan and Francesco A. Franzoni
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Marco Di Maggio: Harvard Business School; National Bureau of Economic Research (NBER)
Mark Egan: Harvard University - Business School (HBS); National Bureau of Economic Research (NBER)
Francesco A. Franzoni: USI Lugano; Swiss Finance Institute; Centre for Economic Policy Research (CEPR)

No 21-01, Swiss Finance Institute Research Paper Series from Swiss Finance Institute

Abstract: Brokers play a critical role in intermediating institutional transactions in the stock market. Despite the importance of brokers, we have limited information on what drives investors’ choices among them. We develop and estimate an empirical model of broker choice that allows us to quantitatively examine each investor’s responsiveness to execution costs, access to research, and order flow information. Studying over 300 million institutional trades, we find that investor demand is relatively inelastic with respect to trading commissions and that investors are willing to pay a premium for access to formal (top research analysts) and informal (order-flow information) research. There is also substantial heterogeneity across investors. Relative to other investors, hedge funds tend to be more price insensitive, place less value on sell-side research, and place more value on order-flow information. Using trader-level data, we find that investors are more likely to execute trades through intermediaries who are located physically closer and are less likely to trade with those that have engaged in misconduct in the past. Lastly, we use our empirical model to investigate soft-dollar arrangements and the unbundling of equity research and execution services related to the MiFID II regulations. We find that the bundling of execution and research potentially allows hedge funds and mutual funds to under-report management fees by 10%.

Keywords: Financial Intermediation; Institutional Investors; Research Analysts; Broker Networks; Equity Trading (search for similar items in EconPapers)
JEL-codes: G14 G23 G24 L11 (search for similar items in EconPapers)
Pages: 53 pages
Date: 2021-01
New Economics Papers: this item is included in nep-cwa, nep-fmk and nep-mst
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Citations: View citations in EconPapers (4)

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Persistent link: https://EconPapers.repec.org/RePEc:chf:rpseri:rp2101

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