Does Financial Market Structure Impact the Cost of Raising Capital?

We examine the impact of secondary market structure and liquidity on the cost of raising capital. In the 1990s trading on Nasdaq transformed from a dealer-oriented over-the-counter market to a market where investors could directly interact with each other. The Order Handling Rules (OHR) reforms that accomplished this were phased in across Nasdaq stocks over time allowing for identification of their impact on firms’ cost of capital. We find that OHR significantly reduced the underpricing of seasoned equity offerings by one to two percentage points from a pre-OHR average of 3.6 percent. Using the staggered introduction of the OHR as an instrument shows improved secondary market liquidity drives the reduction in underpricing. * Brugler is at the Department of Finance, University of Melbourne. Comerton-Forde is at the School of Banking and Finance at the UNSW Business School. Hendershott is at the Haas School of Business, University of California. We thank Jeff Smith at Nasdaq for assistance in identifying and understanding the implementation of the Nasdaq reforms. We also thank Frank Hatheway, Ross Levine, Dan Li, Joel Hasbrouck and participants at the FINRA and Columbia University Market Structure Conference, the Australian National University Research Summer Camp and the NBER Conference on Competition and the Industrial Organization of Securities Markets for helpful comments.