Controlling Institutional Trading Costs

Analysis of institutional trading costs typically assumes that profit–maximizing fund managers seek to minimize trading costs. The authors suggest that the bundling of non–trading services into institutional trading commissions is far too pervasive for this assumption to hold generally. Bundling reflects an endemic principal–agent problem in the operation of collective investment schemes that acts to discourage efficient implementation of portfolio decisions taken on behalf of fundholders. Bundling results in excessive trade intermediation, generating higher market impact costs and discouraging the use of more efficient trading platforms (particularly for NYSE stocks). Furthermore, the authors argue that the widespread use of inefficient internal trading cost benchmarks, such as VWAP, makes it hard for institutions to detect the damage to fund performance that results from bundling.