Is Decimalization Good or Bad?

Although commentators have been viewing the Jumpstart Our Business Startups Act as a rollback of 2010’s Dodd-Frank financial reform, it’s been showing itself as much more of an attack on the earlier Sarbanes-Oxley Act. The latest attack is a required report on a possible rollback of decimalization. A decade ago, the SEC and the exchanges moved to have the price of securities quoted in pennies to deliver cost-savings to investors. The JOBS Act offers up the possibility of increasing the tick size for the new class of “Emerging Growth Companies.” The first step was a Report to Congress on Decimalization (.pdf) as required by Section 106 of the JOBS Act.

The report finds many benefits to investors.

Bessembinder finds that the average quoted bid-ask spreads for all companies declined from pre- to post-decimalization in both NYSE and NASDAQ stocks. His study results showed that large capitalization stocks’ equally-weighted quoted spreads on the NYSE declined from 11 cents to 6 cents and on the NASDAQ from 10 cents to 4 cents. Middle capitalization stocks’ equally-weighted quoted spreads on the NYSE declined from 16 cents to 10 cents and on the NASDAQ from 17 cents to 13 cents. In comparison, small capitalization stocks’ equally-weighted quoted spreads declined from approximately 23 cents to 18 cents on the NYSE, and from 26 cents to 23 cents on the NASDAQ. He found that the corresponding decline, as a percentage of trading price for small capitalization stocks, is from 1.75% to 1.16% on the NYSE and from 1.84% to 1.58% on the NASDAQ.

That’s a cost savings to investors and a profit loss to market makers. However Section 106 of the JOBS Act asks “whether there is sufficient economic incentive to support trading operations” in small and middle capitalization companies after decimalization. Both the IPO Task Force Report and a Grant Thornton paper argue that because brokerage analysts have to depend on revenue from trading commissions, they have an incentive to cover only high volume stocks. The concern is that smaller capitalization stocks do not have the trading volume to offer enough profitability for analyst coverage.

Though regulatory decimalization in the market lowered the minimum allowable tick size to $0.01, it did not mandate that market participants quote narrower spreads. Rather, the quoting of narrower spreads appears to have been a result of continued market forces.

That leaves the SEC staff recommending that the Commission not proceed with a rulemaking to increase tick size. Hopefully that will be the end of this for the foreseeable future. This section of the JOBS Act was a blatant grab by Wall Street to regulate for increased profitability.

Sources:

  • Report to Congress on Decimalization (.pdf) (As Required by Section 106) July 20, 2012
  • Bessembinder, Hendrik, 2003, Trade execution costs and market quality after decimalization, Journal of Financial and Quantitative Analysis 38(4), 747-777.

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