Brokerage Commissions and Information Allocation
Posted: 11 Mar 1997
Date Written: December 1996
This paper contributes to the literature on the sale of information by studying contracts between brokers and investors. Brennan and Chordia (1993) had shown that commission is frequently a superior contract, since it allows for optimal risk sharing between a risk neutral broker and a risk averse investor. We show that in a more general setting where investors are heterogeneous and their types are unknown to brokers, the commission is always the optimal contract, yet for a different reason. In such an environment commission contracts allow extraction of quasi rents which are due to the fixed costs of trading; the role of commission as risk sharing device is eliminated. We then present the actual commissions schedules and show that the full-service brokers' commission rates are ''too high'' to be explained by either this model or by Brenann and Chordia (1993) alone. Consequently, we introduce another aspect of information sale - the timing of information release, and argue that commission schedule allows brokers to essentially auction the early access to information among their clients. The predictions of the augmented model are consistent with the observed brokerage commission schedules.
JEL Classification: G2, D3
Suggested Citation: Suggested Citation