Order flow distribution, bid-ask spreads, and liquidity costs: Merrill Lynch's decision to cease routinely routing orders to regional stock exchanges

Merrill Lynch's decision to redirect order flow in exchange-listed equity s ecurities from regional exchanges to the New York Stock Exchange (NYSE) pro vides an opportunity to examine (1) whether order flow affects market maker s' spread-setting behavior and (2) whether brokers can capture liquidity-co st differences between market centers for their customers. Merrill's market -order customers appear to obtain better prices on the NYSE than on the reg ionals. Consistently with market microstructure theory, the NYSE's quoted s pread for stocks affected by Merrill's decision falls relative to a control sample and decreases absolutely for a subsample of stocks we believe most sensitive to order-flow distribution. Journal of Economic Literature Classi fication Numbers: D40, G10. (C) 1998 Academic Press.