Incremental Differences
Chevron closed at 63 7/8 on Monday, up 1 5/8, and Microsoft rose 2 3/8 to 97 3/8.
If that sentence doesn’t strike you as odd, blame the Spanish Empire.
Almost alone in the world, U.S. stock exchanges quote stock prices in eighths. Just about everybody else uses the decimal system.
Historians say the eccentric U.S. practice is a holdover from the 1700s, when Spanish gold was America’s leading currency and you made change by physically breaking a dollar coin into eight equal slices, like a pie. (The coins were deeply scored for that purpose.) Hence the expression “pieces of eight.” That’s also how a quarter came to be called two bits.
It may be an amusing connection to days of yore, but it’s one some experts say may be costing investors billions of dollars a year in stock purchase prices that might otherwise be lower.
Legislation now being considered in Congress would require U.S. stock exchanges to switch to the decimal system and give stock prices in simple dollars and cents.
Proponents cite three main reasons: The rest of the world does it; ordinary folk would understand the market better that way; and it would narrow the “spreads” between “bid” and “asked” (“sell” and “buy”) prices for stocks, saving big money for investors.
On the other side are experts who contend that rejiggering the exchanges’ and investment community’s computers would be expensive, that spreads are already being narrowed without decimalization, and that if the world’s leading stock-trading center ain’t broke, don’t fix it.
Whereas the rest of the world uses a metric--or decimal--system, the United States still measures key distances in units of 12 inches or 5,280 feet, key weights in units of 16 ounces or 2,000 pounds, and key volumes in units of 32 fluid ounces or four quarts. This hasn’t hurt U.S. economic competitiveness, the leave-it-alone camp argues. And in industrial applications, particularly if the export market is important, U.S. firms have had no trouble adopting the metric system when necessary.
But under legislation introduced by Rep. Michael G. Oxley (R-Ohio) and others, the U.S. Securities and Exchange Commission would be instructed to order the stock exchanges to switch to decimals by a fixed deadline, possibly one year.
If such a change is mandated, a key decision for the SEC would be choosing the size of a “tick,” or minimum price movement, under the decimal system. Currently, stocks traded on the New York, American and Nasdaq exchanges are quoted in increments of one-eighth, or 12.5 cents.
Stocks are always quoted according to minimum tick size but can trade--and close--in smaller increments. A trade could be made at many spots between a “bid” and “asked” price. Stocks occasionally close in thirty-seconds, sixty-fourths and even one-hundred twenty-eighths.
Private electronic trading systems, such as Reuters’ Instinet, enable investors to trade at these smaller fractions, but as a practical matter, one-eighth is still the smallest price increment available to most investors for most stocks.
Both the Amex and Nasdaq recently decided to move to a tick size of one-sixteenth, or 6.25 cents. (Nasdaq stocks valued at $10 and under are already quoted in sixteenths.) The smaller the tick size, the thinking goes, the smaller the potential spread and thus the better the price for the investor.
Under a decimal system, even a tick as big as a dime would be smaller than an eighth. Similarly, a nickel tick would be less than a sixteenth, and a penny would be less than a thirty-second or even a sixty-fourth.
The tick size doesn’t dictate the size of the spread, of course. Actual spreads are set by market participants in response to competition. Under the existing fractional system, for example, little-known, thinly traded stocks might have spreads of one-quarter or even one-half, whereas popular, high-volume stocks can have quoted spreads of one-eighth.
Proponents of decimalization say that the big savings for investors would be made in the biggest and most heavily traded stocks.
Oxley, chairman of the House Commerce Committee’s subcommittee on finance and hazardous materials, is in the midst of hearings on his decimalization bill. “The mandated minimum spread of 12.5 cents per share punishes investors and rewards traders,” Oxley said.
Junius W. Peake, a finance professor at the University of Northern Colorado in Greeley and a former Nasdaq board member, testified during last Thursday’s opening session of the hearings that, with 300 billion shares changing hands per year in U.S. equity markets, “each 1 cent saved per share on average will benefit investors as much as $3 billion annually.”
SEC Commissioner Steven M.H. Wallman, who also testified, declared his personal support for decimalization but noted that he was not speaking for the commission. He noted that the Toronto Stock Exchange, which switched to decimals in April 1996, has since then seen $150 million in savings to investors on trades in the 35 largest stocks, a slight volume increase, only “minimal conversion costs,” and no apparent decline in “quality,” or willingness of market makers to trade.
“This is the single most important measure we can take to improve the competitiveness of our markets,” Wallman concluded.
One prominent academic who opposes the move to decimalization is Larry Harris, professor of finance at the University of Southern California. Harris, in an interview last week, said stock traders and other active market participants have no problem understanding fractions.
“Mom and pop don’t trade stocks,” he said. “I cannot imagine that trading in fractions is hurting our markets,” he added. “They’re the biggest and most envied in the world.”
Harris said a one-penny tick size could actually hurt ordinary investors because it would favor those who monitor trading constantly and leap to take advantage of tiny price changes.
If, for example, an individual investor places an order to buy 100 shares of XYZ stock at $20, an alert electronic trader who thought the stock was moving up could leap in front with a bid of $20.01. By the time the ordinary investor learned his or her order had not been accepted and tried to reenter the market, the price might have moved significantly higher, Harris said.
The three big U.S. exchanges themselves have adopted what might be called an agnostic position on decimals: Prove it works and we’ll support it.
Typical is this statement by Frank G. Zarb, new chairman of the National Assn. of Securities Dealers, which oversees the Nasdaq exchange: “NASD strongly believes that if decimalization is demonstrated to be in the best interest of investors, it should occur.”
Rep. Rick Lazio (R-N.Y.), echoing concerns raised by the securities industry, warned that imposing such a change could be highly disruptive to the markets. He said the panel will ask the SEC for a study.
As to whether the public prefers decimals, the San Francisco Chronicle last November began publishing daily stock tables in decimal form, becoming the first major newspaper to do so. Business Editor Lois Kazakoff testified last Thursday that the Chronicle took the step because a poll showed that 62% of its readers favored it.
“Readers have applauded our move to dollars-and-cents listings, only asking, ‘What took you so long?’ ” she said.
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Thomas S. Mulligan can be reached via e-mail at thomas.mulligan@latimes.com
