The Value of Trading Consolidation: Evidence from the Exercise of Warrants

Abstract

JSTOR is a not-for-profit service that helps scholars, researchers, and students discover, use, and build upon a wide range of content in a trusted digital archive. We use information technology and tools to increase productivity and facilitate new forms of scholarship. For more information about JSTOR, please contact support@jstor.org.. Cambridge University Press and University of Washington School of Business Administration are collaborating with JSTOR to digitize, preserve and extend access to The Journal of Financial and Quantitative Analysis. AbstractWe study the effect of trading consolidation by examining the response of liquidity and stock price to the exercise of deep in-the-money corporate warrants. This enables a relatively clean test of the value of trading consolidation. The exercise at the warrant expiration is fully anticipated and has no information content. An effect can come from the value of trading consolidation that improves liquidity. Indeed, we find that liquidity and stock prices both increase significantly at warrant expiration. Further, the price increase is positively related to the pre-exercise extent of fragmentation, to post-exercise improvement in stock liquidity, and to the proportional increase in the number of shares following the warrant exercise. *Amihud, yamihud@stern.nyu.edu, Stern . We thank Hank Bessembinder (associate editor and referee) and Jon Karpoff (the editor), for comments and suggestions that helped improve the paper. Financial support from the Israel Institute for Business Research of the Recanati Business School at Tel-Aviv University is gratefully acknowledged.Island is an electronic communication network (ECN) that serves as an electronic marketplace. In 2001, about 20% of NASDAQ volume was traded on Island. 829 This content downloaded from 128.235.251.160 on Sat, 3 Jan 2015 14:27:49 PM All use subject to JSTOR Terms and Conditions 830 Journal of Financial and Quantitative Analysis exchange floor. They show that while off-exchange execution is beneficial for brokers, it can result in larger bid-ask spreads and greater price volatility than a consolidated market. Along similar lines, Cohen, Conroy, and Maier (1985) show that in a fragmented market there is a lower chance that an order will find a trading counterpart, an increase in the expected time a limit order has to wait until it is executed, and a wider bid-ask spread. Mendelson (1987) shows that the overall gains from trade decline as the market becomes more fragmented. Thus, theory suggests that fragmentation reduces liquidity. Is the fragmentation of trading actually harmful to liquidity and, consequently, does it lower stock values? The answer is important for the design and regulation of securities markets. This issue took center stage since the Securities and Exchange Commission (SEC) pressured the NYSE to relax its Rule 390, which prohibited member firms from executing trades in NYSE-listed stocks off the Exchange floor.2 In 1980, the SEC enacted Rule 19c-3 that allows member firms to trade stocks of...

Locked and crossed markets on NASDAQ and the NYSE

“…Specifically, 15.16% of NBBOs in the NASDAQ inter-market (Table 2 Overall, more non-positive spreads occur on the more fragmented NASDAQ than on the more consolidated NYSE inter-market. If we believe that non-positive spread periods are detrimental to market quality, the abundance of zero spreads on NASDAQ adds to the argument of Amihud, Lauterbach, and Mendelson (2003) who argue that consolidated markets benefit from better liquidity and pricing; as well as reinforces the evidence of Bennett and Wei (2003) who show that the NYSE provides better market quality than NASDAQ. On the other hand, as shown by Klock 8 The abundance of quotes coming from the Pacific Stock Exchange as well as the fact that the venue executes trades of smaller sizes seem to be indicators of ECN activity.…”

Liquidity and Asset Prices

“…The greater breath of ownership led to significant increases in stock liquidity and in stock prices. 13 Amihud et al (2003) examine the increase in stock liquidity that follows the exercise of outstanding stock warrants, which increases the stock's float without changing anything else in the firm. They find that this led to a decline in stock illiquidity (measured by Roll's (1985) bid-ask spread) and that stock prices abnormal returns being positively and significantly associated with the improvement in liquidity.…”

Order Consolidation, Price Efficiency, and Extreme Liquidity Shocks

“…Admati and Pfleiderer (1988), Foster and Viswanathan (1990), and Barclay and Hendershott (2004) examine how traders can benefit by consolidating their trading in time. Garbade and Silber (1979), Mendelson (1987), Pagano (1989), Amihud, Lauterbach, and Mendelson (2003), and Hendershott and Jones (2005) analyze how liquidity externalities can also arise when traders consolidate across markets and securities. Of the papers on consolidation across markets, only Hendershott and Jones (2005) focus on price efficiency, and their results arise from a regulatory shock to consolidation, not from a comparison of different market structures.…”