February 6, 2013

Spread Too Thin

What if?

Those two words branded with a question mark may rank 2nd all-time behind “what is the meaning of life?”

What if…public companies could set spreads in their own trades?

Before we ponder that, let’s tip hats to IROs Moriah Shilton at Tessera Technology (TSRA) and Kate Scolnick at Seagate (STX), who demonstrated such adroit command of market structure in yesterday’s NIRI webinar on why trading matters in the IR chair (replay available for NIRI members). Expertise like theirs is the future of our profession. Knowledge, as always and ever, is power.

Speaking of knowledge, the SEC yesterday convened a round table on price-spreads in trading, commonly known as “tick-size.” On the panels were finance professors, representatives from major exchanges, venture capitalists, folks from Fidelity and Invesco – and thankfully, David Weild at Grant Thornton/Capital Markets Advisory Partners, and Pat Healy from Issuer Advisory Group, both strong advocates for the interests of public companies.

But there wasn’t a CEO, CFO or IRO from a public company (Moriah Shilton and Kate Scolnick should be on these panels!).

Here’s the issue. Ever since increments between the best prices to buy and sell shares were set by law in 2001 with Decimalization, trading volume has exploded but ranks of public companies and broker-dealers have fallen. In 1997, there were 7,500 public companies. Today there are 3,700 in the National Market System.

At the time, a belief prevailed that small investors couldn’t get a fair shake because brokers and specialists controlled prices in stock markets. So the SEC mandated that prices be set in penny increments. No more trading in eighths or sixteenths of a dollar.

In 1983 there were roughly 450 IPOs in the USA. Thirteen years later in 1996, about 700. The last year US markets remotely approached “hundreds” of IPOs – and thus, hundreds of IR jobs – was in 2000, right before Decimalization.

And intermediaries have disappeared. Of $40 billion raised in US IPOs last year, just seven underwriters – the same too-big-to-fail banks behind everything – had 92% of it. Our typical client has seen a 30% drop in market makers. Few firms cover small-caps. There’s no money in it.

By driving trading increments down to pennies, the economics of committing capital to brokerage and valuable information disappeared. Moving small trades around during the day suddenly offered more return for less risk and so everybody switched horses.

What if, public companies, you could choose the spread between bids and offers in your shares?

Volumes would decline, sure. Contrary to what you hear, even from prospective holders, volume is in fact as relevant to value as rising revenue is when margins don’t improve. It’s just a big number that lacks substance.

In fact, a wider spread means more risk for money that doesn’t care about you, and more reward for money that does.

It’s a question worth asking.

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