Traditionally, financial theory has offered little guidance to managers who must choose whether to list their stock on an exchange or allow it to continue trading over-the-counter. Recent developments in market microstructure theory allow a more careful analysis of the exchange listing decision. Market microstructure theory implies that firms list their stocks on exchanges to reduce transaction costs to their investors. A major component of the cost of trading common stocks is the bid-ask spread. Several differences exist between the trading arrangements, or microstructure, of the New York Stock Exchange and NASDAQ that may contribute to differences in bid-ask spreads for a given stock depending on where it is traded. At first glance, the NYSE is a monopoly dealer market and NASDAQ is a competitive dealer market. On the NYSE, only the exchange-appointed specialist may make a market in a stock and each stock has only one specialist. Competition among NASDAQ market makers should reduce bid-ask spreads. However, the NYSE specialist faces competition from members of the public. Brokers representing the public can bypass the specialist and trade directly with each other at prices between the specialist's bid and ask quotes. Also, members of die public may place limit orders that supersede the specialist's quotes, thereby tightening the spread. Overall, the degree of effective competition in market making may be as great on the NYSE as it is on NASDAQ. Stock exchange regulations require specialists to stabilize prices more than unregulated dealers would, but NASDAQ market makers have minimal obligations. Price stabilization by NYSE specialists and the monitoring of specialists and trading by the exchange may induce firms to list. In this article, we examine the characteristics of a large sample of firms that listed on the NYSE or qualified to list but voluntarily remained in the NASDAQ over-the-counter system. Small, thinly traded NASDAQ stocks with relatively few market makers should be most likely to benefit from the increased public interaction and specialist stabilization on the New York Stock Exchange. Large, actively traded stocks with relatively many market makers are likely to have enough competitive quotes on NASDAQ to minimize spreads. On the other hand, small stocks may receive little benefit from listing because specialists have incentives to concentrate their attention on the stocks that generate the most trading volume. The results show that firms that move tend to have smaller stock market capitalization, fewer shareholders, fewer market makers and lower share prices than NASDAQ firms in the same industry that could list but do not. Listing firms have larger relative volume per day, on average, than qualified nonlisting firms, but the dollar size of the average trade is smaller for listing firms. Firms with larger unexpected bid-ask spreads, after adjustment for the relationship in the broader NASDAQ market between spread and microstructure characteristics, are most likely to move. The results are consistent with the idea that firms list on the NYSE in search of a more liquid market for their stock. Firms that move to the exchange tend to have been qualified to move for a shorter time than other firms in the same industry that could move but do not. We interpret the period of qualification as a measure of how much information is available about the firm. Listing firms are less likely than other qualified firms to have dual classes of traded common stock. Firms may choose not to list to avoid being forced to equalize voting rights across classes. Thus, the costs of an exchange listing, as well as the benefits, appear to be unequally distributed among qualified firms. Our results support the idea that NASDAQ firms that qualify for a listing on the NYSE are not all equal in their ability to benefit from exchange listing. Managers of such firms should consider whether NASDAQ provides as liquid a market as can be expected given the size of the firm, the ownership structure, the share price level, the industry in which the firm operates, and the other factors. If the answer is affirmative, it may be better to remain in the NASDAQ system. Listing on the NYSE will not automatically provide better liquidity.
