Working Paper: CEPR ID: DP13936
Authors: Marco Di Maggio; Mark Egan; Francesco Franzoni
Abstract: Brokers continue to play a critical role in intermediating institutional stock market transactions. More than half of all institutional investor order flow is still executed by high-touch (non-electronic) brokers. Despite the continued 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 and access to research and order flow information. Studying over 300 million institutional trades, we find that investor demand is relatively inelastic with respect to commissions and that investors are willing to pay a premium for access to top research analysts and order-flow information. There is 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. Furthermore, using trader-level data, we find that investors are more likely to trade with traders who are located physically closer and are less likely to trade with traders that have misbehaved in the past. Lastly, we use our empirical model to investigate the unbundling of equity research and execution services related to the MiFID II regulations. While under-reporting for the average firm is relatively small (4%), we find that the bundling of execution and research allows some institutional investors to under-report management fees by up to 15%.
Keywords: financial intermediation; institutional investors; research analysts; broker networks; equity trading
JEL Codes: L11; G14; G23; G24
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| broker choice (L85) | trading volume (G15) |
| brokerage fees (G24) | trading volume (G15) |
| access to top research analysts (G24) | transaction value (D46) |
| access to any research analyst (G24) | transaction value (D46) |
| informed order flow (C69) | brokerage fees (G24) |
| execution quality (C69) | investor decisions (G11) |
| misconduct among traders (K42) | trading volumes (G15) |