Preferencing, Internalization, Best Execution and Dealer Profits
Oliver Hansch, Pennsylvania State University
Narayan Y. Naik, London Business School
S. Viswanathan, Duke University

The practices of preferencing and internalization have been alleged to support collusion, cause worse execution, and lead to wider spreads in dealership style markets relative to auction style markets. For a sample of London Stock Exchange stocks, we find that preferenced trades pay higher spreads. They do not, however, generate higher dealer profits. Internalized trades pay lower spreads. We do not find a relation between the extent of preferencing or internalization, and spreads across stocks. These results do not lend support to the “collusion” hypothesis but are consistent with a “costly search and trading relationships” hypothesis. (Accepted Late Spring 1999.)