Brokerage Commissions and Institutional Trading Patterns

The institutional brokerage industry faces ever increasing pressure to lower trading costs, which has already driven down average commissions and shifted volume towards low-cost execution venues. However, traditional full-service brokers that bundle execution with services remain a force and their commissions are still considerably higher than the marginal cost of trade execution. We hypothesize that commissions constitute a convenient way of charging a prearranged fixed fee for long-term access to a broker's premium services. We derive testable predictions based on this hypothesis and test them on a large sample of institutional orders from 1999-2003. We find that institutions negotiate commissions infrequently, and thus commissions vary little with order characteristics. Institutions also concentrate their order flow with a relatively small set of brokers, with smaller institutions concentrating their trading more than large institutions and paying higher per-share commissions. These results are stable, consistent with our predictions, and cannot be explained by cost-minimization alone. Finally we discuss the evolution of the institutional brokerage market within the proposed framework and make predictions about the future developments in the industry