Even Eighths Seemed Odd

Bill Christie, Frances Hampton Currey Professor of Management, was just a junior faculty member at the Owen School in the early ’90s when he and Paul Schultz, a colleague at Ohio State University, stumbled across some data that pointed toward collusion among market makers at NASDAQ.

Christie and Schultz discovered that the majority of the largest and most active NASDAQ stocks were quoted almost exclusively in even eighths, implying a spread of at least a quarter dollar. Unable to find an economic rationale for the exclusive use of even eighths, Christie and Schultz concluded that the use of even eighths was not a function of economic factors but “tacit collusion” among market makers. The artificially high profits, they surmised, disadvantaged investors to the benefit of market makers.

News of the findings was made public in May 1994 and published in the December 1994 Journal of Finance. The amiable relationship between NASDAQ and Owen, nurtured by Financial Markets Research Center Director Hans Stoll, “came to a crashing halt,” Christie remembers.

Stoll, returning from an overseas trip, found an angry telephone message from former NASDAQ CEO Joe Hardiman. “He called me and said, ‘Hans, what do you mean, collusion?’ I explained to him, ‘It’s implicit collusion. It’s an economist’s term.’ He was angry and concerned.” And for a period of time NASDAQ’s participation in the FMRC was severed.

Christie’s theories, however, did prevail, creating lasting change at the company. NASDAQ has since rejoined the FMRC, and Christie was even invited to serve on the company’s economic advisory board. He still marvels that no one else had systematically looked at the raw data before a couple of upstart, untenured faculty members.

“I continue to think that in the end, their market benefited. If we didn’t find it, someone was going to find it. Once they came out the back end of it, they came out a lot more agile, a lot more competitive. They had flexibility to do things they wouldn’t have been able to do under the old structure,” Christie says.

The SEC subsequently has introduced new order handling rules, increasing the level of competition in the system. Investors are now able to compete directly with the dealer when placing buy or sell orders.

“My take on this is that NASDAQ really needed some kind of external intervention. In the end they had the power to go through and restructure and do things to help them be more competitive. That’s part of what allowed them to succeed,” Christie says.

In his file cabinet Christie still keeps a Forbes cover story from 1993 portraying NASDAQ as greedy fat cats taking investors to the cleaners. That article mentioned previous work by Christie showing that sharp reductions in a stock’s spread resulted from a firm moving from NASDAQ to another exchange. A study by Stoll also was cited in the article.

Fast forward to January 2009, and the same magazine was recognizing NASDAQ OMX Group as its “Company of the Year” for its flexibility in managing through the current economic turbulence. An accompanying story, which refers to Christie’s research, suggests the possibility that shrinking spreads may have led Bernie Madoff and others to explore other ways to make money. Madoff has been charged in an elaborate Ponzi scheme.

With the latest Forbes article tucked away in his file cabinet, Christie has returned once again to the quiet academia he claims to prefer, although his life at Owen is anything but staid. He served as Dean of the Owen School from 2000 to 2004. He also has continued his teaching and research, receiving numerous awards for both.

“I don’t mind being kind of quiet in the background and thinking that maybe what we did triggered a change in the end,” Christie says.