Testimony on H.R. 1053: The Common Cents Stock Pricing Act of 1997
Lawrence Harris, April 17, 1997.
Summary
Decimalization is a significant issue only to the extent that it affects the size of the minimum price increment, or tick. If the tick is too large, spreads will be too large. Traders will not be able to effectively compete on price. If the tick is too small, front-runners will exploit investors who offer to trade.
Investors protect themselves against front-running by hiding their orders. They will display less size, they will employ more floor brokers, they will break up their orders, and they will shift their trading strategies towards market orders from limit orders. All these responses increase their transaction costs and make markets less liquid and less transparent. Empirical research shows that markets are less transparent when the tick size is small.
All oral auctions have significant price increments to protect traders from others who would unfairly obtain precedence by improving price by a trivial amount.
These issues apply only to oral auction markets like the NYSE and AMEX that use order precedence rules to arrange trades. Tick sizes in dealer markets like Nasdaq do little more than set a minimum bound on bid/ask spreads. Tick sizes should therefore be smaller in Nasdaq.
The bill does not mandate that any market adopt a one penny tick, but in practice all must if any one does. Congress must therefore consider carefully the issues raised by this bill because the exchanges and the SEC will not be able to correct any mistakes made here.
Estimates of the benefits to the public from decimalization are grossly overstated. They overcount the volume that would benefit from smaller quoted spreads. They do not adjust for the expected decline in the size of price improvements. They ignore the increase in commissions that will ultimately result from a decrease in payments for order flow. They do not estimate the increased costs that large traders will have to pay to avoid front-runners.
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Last revised 4/17/97.