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Brokerage Commissions and Institutional Trading Patterns

  • Michael Goldstein
  • Paul Irvine

    ()

  • Eugene Kandel

    ()

  • Zvi Wiener

Why do brokers charge per-share commissions to institutional traders? What determines the commission charge? We examine commissions and order flow for a sample of institutional orders and find that most per-share commissions are concentrated at only a few price points, primarily 5 and 6 cents per share. Further, we find that the prior-period commission, rather than execution costs, is the strongest determinant of next period's commission. These results are inconsistent with negotiation of commissions on an order-by-order basis or with the impression of a continuous transaction cost that is deduced from the distribution of percentage commissions, suggesting that commissions are not a marginal cost of execution. We also find that institutional clients concentrate their order flow with a small set of brokers, and that small institutions concentrate more than large institutions. Collectively, our results suggest that brokers and their institutional clients enter into long-term agreements where the per-share commission is constant, and the order flow routed to a particular broker is used to maintain the required payment for an institution's desired level of service. Commissions, therefore, constitute a convenient way of charging a predetermined fixed fee for broker services.

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Paper provided by The Federmann Center for the Study of Rationality, the Hebrew University, Jerusalem in its series Discussion Paper Series with number dp356.

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Length: 51 pages
Date of creation: Apr 2004
Date of revision:
Handle: RePEc:huj:dispap:dp356
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