We show that queue rationing under price controls is one driver of high-frequency trading. Uniform tick sizes constrain price competition and create rents for liquidity provision, particularly for securities with lower prices. The time priority rule allocates rents to high-frequency traders (HFTs) because of their speed advantage. An increase in relative tick size, defined as uniform tick sizes divided by security prices, increases the fraction of liquidity provided by HFTs but harms liquidity. We find that the message-to-trade ratio is a poor cross-sectional proxy for HFTs’ liquidity provision: stocks with more liquidity provided by HFTs have lower message-to-trade ratios. Received September 15, 2015; editorial decision October 7, 2017 by Editor Robin Greenwood.

Do stock prices of publicly listed companies respond to changes in transaction costs? Using the SEC’s pilot program that increased the tick size for approximately 1,200 randomly chosen stocks, we find a stock price decrease between 1.75% and 3.2% for small spread stocks affected by the larger tick size relative to a control group. We find that the increase in the present value of transaction costs accounts for a small percentage of the price decrease. We study channels of price variation due to changes in expected returns: information risk, investor horizon, and liquidity risk. The evidence suggests that trading frictions affect the cost of capital.

Active equity mutual funds managed by insurance companies underperform peer funds by over 1% per year. There is no evidence that insurance funds make less risky investments; instead they have lower risk-adjusted returns and their fund flows are less sensitive to performance when they perform poorly. Across insurance funds, those with heavy advertising, directly established by insurers or using parent firms' brandnames, and those whose managers simultaneously manage substantial non-mutual-fund assets, are more likely to underperform. We conclude that insurers' efforts to cross-sell mutual funds aggravate agency problems that erode fund performance.

Stock exchange operators compete for order flow by setting “make” fees for limit orders and “take” fees for market orders. When traders can quote continuous prices, exchange operators compete on total fee, because traders can choose prices that perfectly neutralize any fee division. The 1-cent minimum tick size, however, prevents traders from neutralizing fee division. The nonneutrality of division between make and take fees (1) allows an exchange operator to establish exchanges that differ in fee structure to engage in second-degree price discrimination and (2) destroys the Bertrand equilibrium, leads to frequent fee changes, and encourages entries of new exchanges. Received May 29, 2016; editorial decision April 19, 2018 by Editor Robin Greenwood.

We investigate odd‐lot trades in equity markets. Odd lots are increasingly used in algorithmic and high‐frequency trading, but are not reported to the consolidated tape or in databases such as TAQ. In our sample, the median number of odd‐lot trades is 24% but in some stocks odd lots are 60% or more of trading. Odd‐lot trades contribute 35% of price discovery, consistent with informed traders using odd lots to avoid detection. Omitting odd‐lot trades leads to inaccuracies in order imbalance measures and makes sentiment measures unreliable. Excluding odd lots from the consolidated tape raises important regulatory issues.

Using data on both fund stockholdings and fund returns, we examine whether actively managed equity mutual funds trade on and profit from the accruals anomaly. We find that few, if any, mutual funds trade on the anomaly. The top 10% of mutual funds that have the highest portfolio weights in low‐accruals stocks have a greater, but still relatively small, exposure to low‐accruals stocks. Nonetheless, these funds make significant profit net of actual transaction costs, exhibiting an average Fama‐French three‐factor alpha of 2.83% per year. We also find that these funds are smaller, less diversified, and exhibit higher fund return volatility and higher fund flow volatility.

This study examines how competition affects the profitability of mutual funds’ trading on the post earnings announcement drift (PEAD). Our results show that among funds actively pursuing this strategy, only those that manage to avoid competition deliver superior performance. Further, we find that funds avoid competition by investing in illiquid stocks. Our analysis shows that the outperformance of these low-competition funds is mainly attributable to their information advantage in identifying mispricing among illiquid stocks.

There is a long-standing debate on whether sell-side analysts learn from their experience to improve earnings forecast skills. This study shows that incentive is an important factor for understanding the “learning by doing” effect by analysts. We examine analysts’ response to a complex type of information – corporate pension underfunding. Pension underfunding negatively impacts future earnings and analysts on average underreact to such information in their earnings forecasts. More importantly, when there is a strong incentive for analysts to deliver accurate forecasts, analyst learning effectively reduces their underreaction to pension underfunding information. On the other hand, when such an incentive is absent, the analyst learning effect is not discernible in the data. Further evidence suggests that analyst learning and incentive jointly reduce stock market mispricing associated with corporate pension underfunding.