Middleman trading costs cause Main Street businesses to slow their expansion and hiring. Suppose you owned a small firm and went to the bank to borrow money for expansion. Instead of borrowing at an expected 10 percent, you are told that 20 percent is your cost of borrowed capital because of an extraordinarily large surcharge. Consequently, you borrow less or nothing at all. It works the same way in the stock market.
Investors price stocks to achieve a satisfactory return after paying taxes and trading costs.
High trading costs are a surcharge that lowers stock prices. This signals management that their cost of equity capital is higher, resulting in less expansion and hiring. With new electronic ways to trade stocks, buyers and sellers can avoid middleman markups, and equity capital for small firms is spared the surcharge. In practice, such a system blocks the development of trading mechanisms that facilitate direct contact between buyers and sellers. It is noteworthy that Wall Street trading abuses occur because of the opportunities for self-dealing by middlemen who stand between buyers and sellers.