Preferencing, internalization, best execution, and dealer profits

The practices of preferencing and internalization have been alleged to supp ort collusion, cause worse execution, and lead to wider spreads in dealersh ip style markets relative to auction style markets. For a sample of London Stock Exchange stocks, we find that preferenced trades pay higher spreads, however they do not generate higher dealer profits. Internalized trades pay lower, not higher, spreads. We do not find a relation between the extent o f 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.