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The Value of Intermediation in the Stock Market

Author

Listed:
  • 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))

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%.

Suggested Citation

  • Marco Di Maggio & Mark Egan & Francesco A. Franzoni, 2021. "The Value of Intermediation in the Stock Market," Swiss Finance Institute Research Paper Series 21-01, Swiss Finance Institute.
    • Handle: RePEc:chf:rpseri:rp2101
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    Citations

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    Cited by:

    1. Justin Birru & Sinan Gokkaya & Xi Liu & René M. Stulz, 2022. "Are Analyst Short‐Term Trade Ideas Valuable?," Journal of Finance, American Finance Association, vol. 77(3), pages 1829-1875, June.
    2. Toni M Whited, 2023. "Integrating Structural and Reduced-Form Methods in Empirical Finance," Journal of Financial Econometrics, Oxford University Press, vol. 21(3), pages 597-615.
    3. Paul J. Irvine & Egle Karmaziene, 2023. "Competing for Dark Trades," Tinbergen Institute Discussion Papers 23-020/IV, Tinbergen Institute.
    4. Liang, Haoshen & Chen, Keyu & Wang, Yun & Ni, Likun, 2024. "The impact of rural revitalization policies on the diversification benefits of listed agricultural companies," Finance Research Letters, Elsevier, vol. 60(C).

    More about this item

    Keywords

    Financial Intermediation; Institutional Investors; Research Analysts; Broker Networks; Equity Trading;
    All these keywords.

    JEL classification:

    • L11 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Production, Pricing, and Market Structure; Size Distribution of Firms
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
    • G23 - Financial Economics - - Financial Institutions and Services - - - Non-bank Financial Institutions; Financial Instruments; Institutional Investors
    • G24 - Financial Economics - - Financial Institutions and Services - - - Investment Banking; Venture Capital; Brokerage

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