The Value of Intermediation in the Stock Market

53 Pages Posted: 2 Aug 2019 Last revised: 9 Aug 2019

See all articles by Marco Di Maggio

Marco Di Maggio

Harvard Business School; National Bureau of Economic Research (NBER)

Mark Egan

Harvard Business School; National Bureau of Economic Research (NBER)

Francesco A. Franzoni

USI Lugano; Swiss Finance Institute; Centre for Economic Policy Research (CEPR)

Multiple version iconThere are 2 versions of this paper

Date Written: August 1, 2019

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 Classification: L11, G14, G23, G24

Suggested Citation

Di Maggio, Marco and Egan, Mark and Franzoni, Francesco A., The Value of Intermediation in the Stock Market (August 1, 2019). Available at SSRN: https://ssrn.com/abstract=3430405 or http://dx.doi.org/10.2139/ssrn.3430405

Marco Di Maggio

Harvard Business School ( email )

Soldiers Field
Baker Library 265
Boston, MA 02163
United States

HOME PAGE: http://https://www.hbs.edu/faculty/Pages/profile.aspx?facId=697248

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Mark Egan (Contact Author)

Harvard Business School ( email )

Soldiers Field Road
Baker Library 365
Boston, MA 02163
United States

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Francesco A. Franzoni

USI Lugano ( email )

Via G. Buffi 13
Lugano, 6904
Switzerland

Swiss Finance Institute

Switzerland

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

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