The Impact of Electronic Commerce on the Retail Brokerage Industry

Electronic commerce has enjoyed great success in the retail brokerage industry. Attracted by commission savings, consumers' use of on-line brokerage firms has grown. However, brokerage customers may have difficulty comparing total trading costs, which consist of both the commission the broker charges and the cost of executing a trade. This paper reports on an experiment to examine whether order handling practices by traditional voice brokers and on-line brokerage firms lead to differences in the quality of trade execution. We test two hypotheses; the first is that execution quality differs among brokers and is positively related to commission rates, and the second is that total trading costs are converging as might be expected in a stable market. In the experiment, we conducted 196 trades, simultaneously purchasing or selling 100 share lots of stock using a voice-based broker, a "brand-name" online broker and a deep discount online broker in each trial. We found 36 percent of our orders received price improvement, a measure of execution quality. The differences among brokers in obtaining price improvements were (weakly) statistically significant for NYSE-listed shares only. The brokers do exhibit statistically significant differences in total trading costs; at a volume of 100 shares commission costs dominate execution quality. We discuss implications for larger lot sizes and speculate on the ability of full-service brokerage firms to maintain high commission charges. The paper concludes that electronic commerce is having a major impact on the brokerage industry, and has the potential to affect pricing in other industries with bundled products and services.