Institutional Trading Motives and the Role of Brokers

This dissertation consists of two essays in financial economics. Two essays are in the areas of institutional investors and market mircrostructure. The first essay, included in Chapter 2, studies order submission strategies by institutional investors when trading on private information. By merging institutional daily transactions with original/confidential 13F filings, I separate informed trades from uninformed ones. Informed large orders tend to be split across more brokers and over more days. While same brokers tend to work uninformed large orders over multiple days, the brokers who facilitated early parts of broken-up informed orders rarely receive the remaining parts of the same orders on later days. Institutional investors also provide camouflage for their informed orders by mixing an informed order with other uninformed orders simultaneously sent to the same broker. As a result, a higher degree of shuffling a portfolio of orders is associated with a larger share of informed trading volume. The splitting and shuffling strategies designed to conceal informed trades from brokers and other market participants tend to lower institutional trading costs, especially on informed orders. The second essay, included in Chapter 3 and co-authored with Sanghyun (Hugh) Kim and Vikram Nanda, investigates how institutional brokerage networks of mutual funds can affect their trading performance, especially as measured by the return gap. We argue that institutional brokerage networks facilitate liquidity provision and mitigate price impact of large non-information motivated trades. Using commission payments, we map trading networks of mutual funds and brokers. We find central funds outperform peripheral funds, especially as measured by return gap. The outperformance is more pronounced when trading is primarily liquidity-driven. The centrality premium is strengthened by brokers’ incentives to generate greater revenues and their repeated interactions with funds. By merging daily transactions with quarterly holdings, we confirm that centrality premium is driven by reduced trading costs, rather than higher interim (intra-quarter) trading performance or profitable information from brokers.