HIGH TRADING COSTS' HARM TO SMALL COMPANIES
Skip to main content
pilogo-NEW
Subscribe
  • Subscribe
  • My Account
  • login
  • NEWS
    • Asset owners and the coronavirus
    • Alternatives
    • Consultants
    • Coronavirus
    • Defined Contribution
    • ESG
    • Frontlines
    • Hedge Funds
    • Investing / Portfolio Strategies
    • Money Management
    • Pension Funds
    • People Moves
    • Private Equity
    • Real Estate
    • Searches & Hires News
    • SECURE Act
    • Special Reports
    • WorldPensionSummit
    • Ron Schmitz
      Pandemic drives faster transition for Virginia to private markets
      Mubadala Investment Co. logo
      Mubadala draws on portfolio in coronavirus fight
      T.J. Carlson
      Texas Muni reduces downside risk during pandemic, finding opportunities now
      Scott Davis
      ‘Triage plan’ at Indiana system helped stem losses
    • BentallGreenOak agrees to acquire Metropolitan Real Estate Equity
      watch video
      0:45
      Private funds weathered 2020 turmoil
      Daniel McHugh
      Aviva Investors promotes from within for real assets CIO
      Marc Rowan
      More alts managers seek expansion to retail market
    • Kieran Mistry
      Hymans Robertson picks head for new non-traditional risk transfer unit
      Troy Saharic
      NEPC brings on director of new business development
      Bill Foley
      Foley-backed SPAC agrees to $7.3 billion deal with Alight
      Jason Schwarz, chief operating officer of Wilshire,
      New owners have big plans for future of Wilshire
    • A pharmacist administers a dose of the COVID-19 vaccine in Mountain Brook, Ala., on Feb. 21, 2021
      Business optimism grows as vaccinations spread – Fed
      watch video
      0:59
      Coronavirus and the S&P 500: February 2021
      Multiemployer pension measures cleared for relief bill vote
      The Charging Bull statue is covered in snow near the New York Stock Exchange on Feb. 11, 2021
      Bain: Private equity managers finish 2020 strong
    • DCALTA releases daily valuation tool for alts in DC plans
      PSCA: Employee participation in non-qualified deferred comp plans rising
      Profile of backlit woman against at TV monitor with female symbols on it
      Women outperform men in managing DC plans – Morningstar
      A  Malaysia flag flies in Putrajaya on Sept. 23, 2020
      Malaysia’s EPF ends 2020 up 7.9% at almost $250 billion
    • Michael Herskovich
      BNP Paribas Asset Management names global head of stewardship
      TPT Retirement taps into low-carbon strategies
      Gary Gensler
      Nominee Gensler backs SEC climate risk disclosure
      Emissions from a smokestack in Poland
      Asset managers facing more scrutiny on ESG issues – report
    • 2 U.K. pension execs take on ESG investing in new podcast
      Donation illustration
      Jefferies will use trading commissions to do good
      Michael Arougheti
      SPACs ride wave as latest investment darling
      Spirit winners
      Prudential honors young people who are helping out
    • Robert 'Rob' Shafir listens during a Senate Permanent Subcommittee on Investigations hearing in Washington on Feb. 26, 2014
      Sculptor hedge fund hits sixth straight year of outflows
      The WallStreetBets forum on the Reddit Inc. website on a laptop computer and the GameStop logo on a smartphone in an arranged photo.
      GameStop frenzy has hedge fund managers rethinking next moves
      Gabe Plotkin, chief investment officer and portfolio manager of Melvin Capital Management, speaks during the Sohn Investment Conference in New York on May 6, 2019
      Citadel, Point72 back Melvin with $2.75 billion after losses
      Shanghai skyline
      Global hedge funds struggle even in a more open China market
    • Amanda Agati
      PNC chooses new CIO for asset management group
      Full suite of concerns add complexity to 2021 proxy season – ISS
      Chicago Policemen plans search for index fund manager
      A pharmacist administers a dose of the COVID-19 vaccine in Mountain Brook, Ala., on Feb. 21, 2021
      Business optimism grows as vaccinations spread – Fed
    • Amanda Agati
      PNC chooses new CIO for asset management group
      Robert C. Doll
      Bob Doll to retire from Nuveen
      WisdomTree adds U.K. institutional sales director
      Bonaccord takes minority stake in Monroe Capital
    • Illinois pension fund liability jumps 19%
      Xerox to send $130 million to global pension plans
      Evergy to boost pension plans with $132 million contribution
      Occidental Petroleum to pour $170 million into pension plans
    • Amanda Agati
      PNC chooses new CIO for asset management group
      Robert C. Doll
      Bob Doll to retire from Nuveen
      WisdomTree adds U.K. institutional sales director
      Des Mac Intyre
      Channel Capital teams up with former Mellon CEO to launch incubator firm
    • The Charging Bull statue is covered in snow near the New York Stock Exchange on Feb. 11, 2021
      Bain: Private equity managers finish 2020 strong
      Carlyle secures $4.1 billion ESG-related credit facility
      Hamilton Lane raises $3.9 billion for fifth secondary fund
      PSG closes first Europe-focused fund at $1.5 billion
    • AEW chooses head of fund operations and debt finance
      Sebastiano Ferrante and Jocelyn de Verdelon
      PGIM Real Estate turns to staff to fill new roles
      European managers key in on specialist strategies
      Ingrid Jacobs
      Jones Lang LaSalle brings on head of diversity and inclusion
    • Retirement cartoon
      Hopes rising for retirement readiness in 2021
      Neal and Brady
      Retirement security could be only issue both sides accept
      Shawn O'Brien
      Annuities coming to target-date funds, but not right away
      David Ireland
      Sponsors returning to questions about in-plan annuities
    • Charging Bull, sometimes referred to as the Wall Street Bull or the Bowling Green Bull, a bronze sculpture that stands on Broadway just north of Bowling Green in the Financial District of New York City
      Top-performing managers Q4 2020
      P&I 1,000 largest retirement plans: 2021
      Retirement in emerging markets
      Outlook 2021
    • U.S. still a key market for investors
      Collected coverage of P&I's 2020 WorldPensionSummit
      Pedestrians pass a large advertisement on the Arndale Center shopping mall reading 'Act now to avoid a local lockdown' in Manchester, England
      COVID-19 puts new opportunities and risks on the agenda - WPS panelists
      Screens display stock price information over the trading floor of the NYSE Euronext exchange in Paris
      Private assets will continue to grow in portfolios – WPS panelists
  • Data
    • Research Center
    • Searches & Hires Database
    • Searches & Hires News
    • RFPs
    • Charts / Infographics
    • Sponsored Research
    • Trackers
    • Q2 2020 searches and hires overview report
      Q2 2020 money manager M&A activity summary
      Q2 2020 legal overview report
      Q1 2020 searches and hires overview report
    • Chicago Policemen plans search for index fund manager
      North Dakota builds on infrastructure investment with $200 million commitment
      Iowa Municipal Fire & Police reveals $95 million in commitments
      ACCESS pool chooses Minerva Analytics for ESG advice
    • Chicago Policemen plans search for index fund manager
      North Dakota builds on infrastructure investment with $200 million commitment
      Iowa Municipal Fire & Police reveals $95 million in commitments
      ACCESS pool chooses Minerva Analytics for ESG advice
    • Financial Auditing Services
      Actuarial Services
      Emerging Market Equity Manager Services
      Securitized Credit Manager Search
    • Taiwan Semiconductor’s No. 1 in the emerging markets book
      U.S. fixed-income returns post another positive year
      Nasdaq delivers an impressive year
      U.S. dollar's recent decline continues
    • Institutional Investors: Shared Expectations, Divergent Paths
      Global Investor Study 2016
      Workplace Financial Wellness
    • U.S. Endowment Returns Tracker
      Pension Fund Returns Tracker
      Earnings Tracker
      Corporate Pension Contribution Tracker
  • Insights
    • Opinion
    • White Papers
    • Industry Voices
    • Letters to the Editor
    • Partner Content
    • Publisher's Update
    • Tesla cartoon
      Don’t confuse wealth creation with retirement saving
      Top 1000 cartoon
      Top 1,000 retirement plans weather storm just fine
      Infrastructure cartoon
      You must go big on infrastructure, Mr. President
      Retirement cartoon
      Hopes rising for retirement readiness in 2021
    • Investment Trends: Looking Ahead Across Equity Sectors
      Rethinking Market and Reference Data Management
      China is embarking on a new stage of growth
      Gold Outlook 2021
    • Sameer Shalaby
      Commentary: Why should investors care about treasury management?
      David Blitzstein
      Commentary: Without a national retirement policy, Americans face a future of pension crises
      Lawrence Cunningham
      Commentary: Gensler should keep Clayton’s pragmatic proxy adviser rules
      My-Linh Ngo
      Commentary: Pension funds and the role of the debt market in the fight against climate change
    • Writer using a typewriter
      OCIO industry needs to adopt GIPS
      Writer or journalist workplace. stock illustration
      Even as it assails China, Trump administration emulates it
      Skeptical of Main Street support for proxy adviser proposal
      Focus on manager diversity pushes asset owners’ to walk the talk
    • P&I Content Solutions
      How will gold react?
      To people shaking hands
      P&I Content Solutions
      Lessons From 2020: Today’s OCIO Model Passes a Major Test of Governance
      Sponsored Content By MassMutual
      Leveraging Data to Manage Risk
      Sponsored Content By iShares
      ETFs are becoming a cornerstone of insurance equity portfolios
    • Help us help you by supporting quality journalism
      You Must Believe in Spring
      Everything Must Change
      Tomatoes & Investments
  • Multimedia
    • Videos
    • Webinars
    • Polls
    • Slideshows
    • Charts / Infographics
    • watch video
      0:45
      Private funds weathered 2020 turmoil
      watch video
      0:59
      Secure choice and other retirement plans at a state level
      watch video
      3:33
      P&I 1,000 by the numbers 2021
      watch video
      1:33
      A look at hiring activity in 2020
    • Emerging Markets: Expanding Investors’ View
      2021: A Fixed Income Odyssey
      Technology is the New Oil: The Changing Nature of Emerging Markets
      Powering the Change: The power of diversity and inclusion
    • POLL: Working after the pandemic
      POLL: The year ahead for the 1,000 largest U.S. retirement funds
      POLL: The Biden administration’s economic plans
      POLL: Retirement issues in 2021
    • view gallery
      9 photos
      Coronavirus and the markets
      view gallery
      22 photos
      The 1,000 largest retirement funds: 2020
      view gallery
      10 photos
      Outlook 2020
      view gallery
      10 photos
      2019 as seen through the eyes of Roger
    • By the Numbers for February 2021
      Top Performing Managers of Domestic Balanced, 4th Quarter 2020
      Top Performing Managers of Domestic High-Yield Fixed Income, 4th Quarter 2020
      Top Performing Managers of Domestic Long-Duration Fixed Income, 4th Quarter 2020
  • Events
    • Conferences
    • Webinars
    • Defined Contribution Spring Virtual Series
      DC Investment Lineup Virtual Series
      ESG Investing Virtual Series
      Private Markets Virtual Series
    • Emerging Markets: Expanding Investors’ View
      2021: A Fixed Income Odyssey
      Technology is the New Oil: The Changing Nature of Emerging Markets
      Powering the Change: The power of diversity and inclusion
  • Careers
  • Research Center
MENU
Breadcrumb
  1. Home
  2. Print
July 25, 1994 01:00 AM

HIGH TRADING COSTS' HARM TO SMALL COMPANIES

By Bartley J. Madden
  • Tweet
  • Share
  • Share
  • Email
  • More
    Reprints Print

    New electronic systems for trading stocks could end the financial abuse suffered by investors when buying and selling NASDAQ market stocks and, in doing so, spur economic growth.

    This new competition facilitates direct contact between buyers and sellers of stock and radically reduces middleman costs, often so high in the over-the-counter market.

    Not only investors but also businesses and their employees benefit from improved securities trading. This improvement is especially relevant for small companies, which are the engine of economic growth and which are hurt the most by Wall Street trading practices.

    Most small stocks trade in the OTC market, where dealers set bid/ask quotes. The bid represents the price at which dealers will buy from an investor; the ask represents the price they will sell to an investor. The larger the bid/ask spreads, the larger the trading costs to investors and the greater the profit to the dealers. New electronic trading systems enable investors to split the bid/ask spread and effectively eliminate the middleman cost.

    From an investor's perspective, how big is the middleman cost? I recently bought an OTC stock for a price that finally became low enough to interest me. With the figures rounded, the quote was 9 bid by 10 ask. This means that a buyer pays $10 but a seller receives only $9. So I paid $10.

    If I hold the stock for one year, and then sell it when the quote is the same 9 bid by 10 ask, I will receive $9. Hence, I lose 10% on my investment even though the quoted stock price did not change. But Wall Street dealers would make money. Smart investors react by lowering the price at which they will buy a stock to compensate for this surcharge of 10% of their original investment.

    Passing on such trading costs results in Main Street businesses slowing their expansion and hiring. Why? Suppose you owned a small firm and went to the bank to borrow money for expansion. Instead of borrowing at an expected 10%, you are told that 20% is your cost of borrowed capital because of an extraordinarily large surcharge. So you borrow less or none at all, depending on what you could earn with the loan.

    It works the same way in the stock market. Lower stock prices signal to management the cost of equity capital is higher, which results in less expansion and hiring, because there are fewer investment opportunities to cover the higher cost of capital.

    It is well known that investments are priced to achieve a satisfactory return after paying taxes and transaction costs. Raising taxes on dividends or capital gains depresses stock prices. Similarly, higher trading costs are a surcharge that also lower stock prices.

    With new electronic ways to trade stocks, instead of a buyer paying $10 and a seller receiving $9, both buyer and seller split the bid/ask spread and trade at $9.50. This mechanism strikes at the heart of the age-old Wall Street argument that less liquid stocks require large bid/ask spreads.

    The established exchanges and dealer networks promote themselves as strong supporters of free-market competition because of their role in raising capital with stock offerings. But with rare exceptions, they seek to protect the status quo by molding regulations to prevent meaningful competition in trading securities. An analogy would be if the large retailers and distributors in 1970 could foretell the success of Wal-Mart Stores Inc. and then argued Wal-Mart's growth should be curtailed by regulations, as this retailing upstart could disrupt the existing national retail system.

    Wall Street asserts a heavily regulated, "national market system" is the best way to "protect" investors. In practice, such a system blocks trading mechanisms that facilitate direct contact between buyers and sellers. As for investor protection, it is noteworthy that Wall Street trading abuses (that is, stealing) occur because of the opportunities for self-dealing by middlemen who stand between buyers and sellers.

    But increasingly in recent years, professional money managers have electronic trading alternatives. The electronic, or so-called proprietary, trading systems, accounted for 1.4% of the New York Stock Exchange share volume and 13.4% of the NASDAQ volume during 1993. The dominant systems are POSIT, owned by Investment Technology Group Inc., Instinet Corp., and the Arizona Stock Exchange.

    In September, ChicagoMatch, a crossing system operated by the Chicago Stock Exchange, is expected to begin trading. Regrettably, the stocks, which benefit the most from circumventing the OTC market makers, have not yet received much attention because of their low volume of trading. But small trades can be "packaged" into sizable volume via electronic auctions at periodic intervals. Hence, a genuine business opportunity exists for one or more of the electronic systems to centralize trading in illiquid stocks. Depending on a stock's trading volume, electronic auctions could be assembled daily or weekly.

    Such periodic auctions would provide unequivocal evidence of substantial reductions in trading costs vs. the existing OTC dealer market. Managements increasingly would learn that their stock prices would be higher when investors in their stock are able to split the bid/ask spread. The result would be that investors radically reduce unnecessary trading costs, companies reduce their costs of equity capital, and OTC dealers awaken to the need for restructuring their industry.

    The OTC dealer market's worst nightmare is both retail and institutional investors having a choice, during normal trading hours, of how their orders are executed. Many investors do not need immediate execution, especially since waiting for a periodic electronic auction would eliminate the bid/ask spread and give deeper liquidity.

    Electronic trading is in its infancy. If the bureaucratic process of obtaining Securities and Exchange Commission approvals and the vagueness of existing SEC regulations can be kept manageable, then electronic trading eventually could be available to everyday retail investors, not just institutions. This competitive innovation is capable of improving the OTC market much the same as how competition from Wal-Mart improved the retailing industry.

    Bartley J. Madden is a partner at HOLT Value Associates, Chicago.

    Recommended for You
    Read the print edition of P&I
    Read the print edition of P&I
    Targeting millennials: Author, niece put his latest book to music
    Targeting millennials: Author, niece put his latest book to music
    How low is low? Projections say it's not low enough
    How low is low? Projections say it's not low enough
    Lessons From 2020: Today’s OCIO Model Passes a Major Test of Governance
    Sponsored Content: Lessons From 2020: Today’s OCIO Model Passes a Major Test of Governance
    sponsored
    Events
     
     
    Sponsored
    White Papers
    Rethinking Market and Reference Data Management
    Investment Trends: Looking Ahead Across Equity Sectors
    China is embarking on a new stage of growth
    Gold Outlook 2021
    Shifting DC Times - Winter 2021
    GP-LED OPPORTUNITIES AT THE SMALLER END OF THE MARKET
    View More
    Sponsored Content
    Partner Content
    The Industrialization of ESG Investment
    For institutional investors, ETFs can make meeting liquidity needs easier
    Gold: the most effective commodity investment
    2021 Investment Outlook | Investing Beyond the Pandemic: A Reset for Portfolios
    Ten ways retirement plan professionals add value to plan sponsors
    Gold: an efficient hedge
    View More
    E-MAIL NEWSLETTERS

    Sign up and get the best of News delivered straight to your email inbox, free of charge. Choose your news – we will deliver.

    Subscribe Today

    Get access to the news, research and analysis of events affecting the retirement and institutional money management businesses from a worldwide network of reporters and editors.

    Subscribe
    Connect With Us
    • RSS
    • Twitter
    • Facebook
    • LinkedIn

    Our Mission

    To consistently deliver news, research and analysis to the executives who manage the flow of funds in the institutional investment market.

    pilogo-NEW
    About Us

    Main Office
    685 Third Avenue
    Tenth Floor
    New York, NY 10017-4036

    Chicago Office
    150 N. Michigan Ave.
    Chicago, IL 60601

    Contact Us

    Careers at Crain

    About Pensions & Investments

     

    Advertising
    • Media Kit
    • P&I Content Solutions
    • P&I Careers | Post a Job
    • Reprints & Permissions
    Resources
    • Subscribe
    • Newsletters
    • FAQ
    • P&I Research Center
    • Site map
    • Staff Directory
    Legal
    • Privacy Policy
    • Terms and Conditions
    • Privacy Request
    Pensions & Investments
    Copyright © 1996-2021. Crain Communications, Inc. All Rights Reserved.
    • NEWS
      • Asset owners and the coronavirus
      • Alternatives
      • Consultants
      • Coronavirus
      • Defined Contribution
      • ESG
      • Frontlines
      • Hedge Funds
      • Investing / Portfolio Strategies
      • Money Management
      • Pension Funds
      • People Moves
      • Private Equity
      • Real Estate
      • Searches & Hires News
      • SECURE Act
      • Special Reports
      • WorldPensionSummit
    • Data
      • Research Center
      • Searches & Hires Database
      • Searches & Hires News
      • RFPs
      • Charts / Infographics
      • Sponsored Research
      • Trackers
    • Insights
      • Opinion
      • White Papers
      • Industry Voices
      • Letters to the Editor
      • Partner Content
      • Publisher's Update
    • Multimedia
      • Videos
      • Webinars
      • Polls
      • Slideshows
      • Charts / Infographics
    • Events
      • Conferences
      • Webinars
    • Careers
    • Research Center