The Cost of Routing Orders to High Frequency Traders

We use a novel dataset to examine the impact of exposing institutional orders to electronic liquidity providers (ELPs). We present empirical evidence that marketable pieces of large parent orders are routed to ELPs, seemingly to avoid paying liquidity fees on exchanges. This routing decision results in lower net effective spreads for these child orders, but leads to higher execution shortfall for the parent order. We obtain causal evidence by utilizing the parent orders of investors who disallow the broker to route their child-orders to ELPs. Our analysis suggests this cost increase is due to information leakage about the parent order.