Paper: Choking the Recovery: Why New Growth Companies Aren’t Going Public and Unrecognized Risks of Future Market Disruptions

Paper

Choking the Recovery: Why New Growth Companies Aren’t Going Public and Unrecognized Risks of Future Market Disruptions

Harold S. Bradley and Robert E. Litan

Kauffman Foundation, 8 November 2010

We show here that ETFs are radically changing the markets, to the point where they, and not the trading of the underlying securities, are effectively setting the prices of stocks of smaller capitalization companies, or the potential new growth companies of the future. In the process, ETFs that once were an important low-cost way for investors to assemble diversified stock holdings are now undermining the traditional price discovery role of exchanges and, in turn, discouraging new companies from wanting to be listed on U.S. exchanges.

Are Dark Pools a Problem, and If So, What is the Fix?
Their very name — “dark pools” — conjures up images of something sinister that cries out for a ban, or at least some tighter regulation. Yet even in raising questions about these trading venues that do not report transaction information, SEC Chair Schapiro acknowledges that they benefit the customers who use them, by enabling companies to avoid moving the market as much as would be the case if the size of their trades were made public. At the same time, however, as more trades migrate to venues where transaction data are not reported, the public markets lose the ability to accurately price securities, since the customers of dark venues are “free riding” on the public  set prices in one out of four shares traded (see chart 3). In the limit, the equivalent of public transport for equities — the public, regulated exchanges — won’t be profitable to operate if too many “passengers” ride for free.

PDF (88 Pages): Kauffman Choking the Recovery