information, sell-side research, and market making.pdf

* Information, Sell-Side Research, and Market Making Leonardo Madureira Weatherhead School of Management Case Western Reserve University Shane Underwood Jesse H. Jones Graduate School of Management Rice University This version: February 27, 2007 Abstract The interaction between an investment bank’s research and market making arms may have important implications for the trading of a firm’s stock. We investigate both the timing of the decision to provide market making or research coverage, as well as the impact that research has on the liquidity provided by the bank’s market maker. Utilizing a large sample of Nasdaq firms, we find that banks typically initiate market making coverage first, then add on research coverage at a later date. We then show that market makers whose banks also provide research coverage provide more liquidity and contribute more to price discovery than do market makers without such research coverage. Finally, we show that such “affiliated” market makers are much less affected by uncertainty following earnings announcements. Our results provide new evidence on the sources of liquidity improvements for Nasdaq firms, and suggest that the information produced by banks in the sell-side research process is beneficial to their market makers. JEL classification : G14; G19; G24 Keywords : sell-side analysts; market making; liquidity; p