The Value of Intermediation in the Stock Market

Brokers continue to play a critical role in intermediating stock market transactions for institutional investors. More than half of all institutional investor order flow is still executed by high-touch (non-electronic) brokers. Despite the importance of brokers, we have limited information on what drives investors' choices among brokers. We systematically examine over 80 million trades to examine how investors trade. We develop an empirical model of intermediary choice to investigate how institutional investors trade across different brokers. We analyze investors' responsiveness to the fees paid, the broker's ability to efficiently execute the trades, as well as access to better research analysts and order flow information. We find that investors are relatively insensitive to commissions, but on average value research, execution, and access to information. Furthermore, using trader-level data we find that investors are more likely to trade with brokers who are physically located closer and are less likely to trade with brokers whose traders have misbehaved in the past. There is also significant heterogeneity across investors, with the best performing investors placing a higher value on order flow information and less value on research. We use the model to analyze several counterfactuals surrounding the unbundling of equity research and transaction services