Content area
Full text
Abstract
We study the effect of trading consolidation by examining the response of liquidity and stock price to the exercise of deep in-the-money corporate warrants. This enables a relatively clean test of the value of trading consolidation. The exercise at the warrant expiration is fully anticipated and has no information content. An effect can come from the value of trading consolidation that improves liquidity. Indeed, we find that liquidity and stock prices both increase significantly at warrant expiration. Further, the price increase is positively related to the pre-exercise extent of fragmentation, to post-exercise improvement in stock liquidity, and to the proportional increase in the number of shares following the warrant exercise.
I. Introduction
The U.S. securities markets are characterized by multiple trading venues for the same, or closely related, securities. The same stock may be traded on the New York Stock Exchange (NYSE), five regional exchanges, and alternative trading systems such as Instinct, Archipelago, and ITG's Posit. NASDAQ stocks are typically traded also on market makers' internal execution systems and on alternative trading systems like Instinct and Island.1 The Chicago Board of Trade and eSpeed trade closely related futures contracts with the blessing of the Commodity Futures Trading Commission. Advocates of multiple trading venues argue that they encourage competition, put a downward pressure on the cost of trading, and enable new market mechanisms to emerge.
Several studies, however, show that fragmentation can hurt market performance. Cohen, Maier, Schwartz, and Whitcomb (1982) study the effect of having, in addition to the main market, order execution in satellite markets off the exchange floor. They show that while off-exchange execution is beneficial for brokers, it can result in larger bid-ask spreads and greater price volatility than a consolidated market. Along similar lines, Cohen, Conroy, and Maier (1985) show that in a fragmented market there is a lower chance that an order will find a trading counterpart, an increase in the expected time a limit order has to wait until it is executed, and a wider bid-ask spread. Mendelson (1987) shows that the overall gains from trade decline as the market becomes more fragmented. Thus, theory suggests that fragmentation reduces liquidity.
Is the fragmentation of trading actually harmful to liquidity and, consequently, does it lower stock values? The...