The Economics of Soft Dollars: A Review of the Literature and New Evidence from the Implementation of MiFID II

53 Pages Posted: 24 Aug 2020 Last revised: 2 Mar 2021

See all articles by Howell E. Jackson

Howell E. Jackson

Harvard Law School

Jeffery Zhang

Board of Governors of the Federal Reserve System

Date Written: August 11, 2020

Abstract

For nearly half a century, the bundling of research services into commissions that paid for the execution of securities trades has been the focus of both policy discussion and academic debate. The practice whereby asset management firms make use of investor funds to cover the costs of research, known as “soft dollar” payments in the United States, resembles a form of kickback or self-dealing. The payments allow asset managers to use investor funds to subsidize the cost of the asset managers’ own research efforts even though those managers charge investors a separate and explicit management fee for advisory services. So why does this form of kickback continue to exist? Over the years, defenders of the practice have argued that soft dollars mitigate principal-agent problems between the investment manager and the broker, improve fund performance, and provide a public good in terms of the increased production of research on public companies. This article evaluates these theoretical arguments through the lens of academic work done in the past as well as an emerging new body of empirical studies exploring the impact of MiFID II, a European Union Directive that severely restricted the use of soft dollar payments in European capital markets as of January 2018. The weight of empirical evidence, including recent evidence coming out of Europe, suggests that the theoretical arguments in favor of soft dollars are not robust. In particular, MiFID II’s unbundling of commissions appears to have, on balance, improved European market efficiency by eliminating redundancy and producing information that is of greater value to investors.

Keywords: Soft Dollars, MiFID II, Bundled Commissions, Fiduciary Duties, Securities Regulation, Global Capital Markets, Institutional Investors

JEL Classification: A11, D02, D14, D61, D82, F65, G18, G20, G21, G23, G24, G28, K22, K23

Suggested Citation

Jackson, Howell Edmunds and Zhang, Jeffery, The Economics of Soft Dollars: A Review of the Literature and New Evidence from the Implementation of MiFID II (August 11, 2020). Available at SSRN: https://ssrn.com/abstract=3673470 or http://dx.doi.org/10.2139/ssrn.3673470

Howell Edmunds Jackson (Contact Author)

Harvard Law School ( email )

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United States
617-495-5466 (Phone)
617-495-5156 (Fax)

Jeffery Zhang

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

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