Investment Behaviour of Online Investors

Transcription

1 RESEARCH Downloaded By: [Schmelich, Volker] At: 14:41 16 March 2010 Transaction Costs and Investment Behaviour of Online Investors Empirical Evidence from the Swiss Market TEODORO D. COCCA INTRODUCTION For the banking world, Internet use and the demographic features of Internet users are of great importance and the Internet is ascribed the power to radically change the nancial services industry (e.g., Economides 1999 and UBS 2000). Considered from this perspective, there is great interest in the availability of empirical data on the use of the Internet for investment purposes. Of particular importance are the demographic features of typical Internet users and the kind of behavioural patterns that can be observed. This paper examines the features of online investors and demonstrates the importance of the Internet throughout the investment process. It begins by giving a brief review of the literature on the subject and de ning the research objectives. This is followed by empirical evidence on the investment process, the development of a typology of online investors and their characterization based on demographic and behavioural features. As an empirical basis for these issues, the data used are taken from a representative study on share ownership in Switzerland. The ndings are then analysed in the light of information processing costs and the particular characteristics of nancial market information. Review of literature The demographic features of typical Internet users and their behavioural patterns are a relatively recent phenomenon in economic literature. Various analyses and hypotheses have been produced on this subject but they are often not supported by a statistically relevant base of data. Satisfying this need must be of particular concern to science (Hong 2000 and Mantel 2000). A number of authors (see Brynjolfsson and Smith (2000) and Cocca (2002: 118)) discuss the effects of the Internet on transaction costs. There are also numerous studies describing the typical (mostly demographic) characteristics of Internet users. However, if the focus is con ned to transactions on nancial markets, the number of scienti c papers available is much less substantial. Because of the lack of empirical data some authors base their analysis of the possible effects of the Internet on the behaviour of investors on theoretical considerations. There is no extensive body of academic work in the area of online trading. Some authors approach the subject from the behavioural nance angle. Dasgupta (1998) gives an overview of the success of e-commerce in various sectors and discusses online stock trading in detail as a particularly successful example. Barber and Odean (2001) examine the effects of the Internet on investors A b s t r a c t Using data from a recent survey of Swiss investors a typology of online investors and their characterization based on demographic and behavioural features is presented. The findings are then examined in the light of information processing costs (transaction costs) and the special characteristics of financial market information. The analysis supports a theory of higher information processing costs for the selfdirected investor than have been assumed so far. The characterization of online investors as naive does not apply to the Swiss market, on the contrary, early adopters of the Internet for online trading can be considered professionals. A u t h o r Teodoro D. Cocca (teococca@isb.unizh.ch) is a senior research assistant at the Swiss Banking Institute, lecturer at the University of Zurich and research associate of the National Centre of Competence in Research (NCCR). He worked for Citibank Switzerland in investment and private banking for three years. He has published numerous contributions on Internet banking and e-commerce, and has worked on various Internet projects for Swiss banks in an advisory capacity. His main areas of research are nancial intermediaries in electronic markets and shareholders investment behaviour. He has recently published The Role of Financial Intermediaries on the Internet and the study Equity Ownership in Switzerland. Further information on publications is available at: assis/tcocca.htm. Keywords: transaction costs, asymmetric information, banking, consumer behaviour, electronic banking, financial services, information broker Copyright 2002 Electronic Markets Volume 12 (4):

2 Electronic Markets Vol. 12 No and nancial markets (see also Glew et al. (1998)). Konana et al. (1999 and 2000) explore some special aspects of the use of online brokers (e-brokers). The role of costs during online trading, such as cost expectations prior to trading and the observable and unobservable costs after trading, is discussed from the investor s perspective. Despite all the changes to the order submission process many of the processes critical for market ef ciency remain unaltered. The lack of transparency in the way electronic brokerages execute transactions may hide unobservable costs. Issues such as lack of advice and value-adding services (e.g., yearend reporting), market fragmentation and institutional regulations also impact investor costs. Hong (2000) asks whether online stock trading provides online investors with greater bene ts than does traditional broker-based trading. His paper describes how information-processing costs in online trading can neutralize the bene ts of lower commission costs where the focus is on naive online investors who have little investment experience and market knowledge and are thus likely to have a greater need for information processing. Barber and Odean (1999) examine changes in the stock trading behaviour and investment performance of investors who switch from phone-based to online trading. They nd that those who switch to online trading experience unusually strong performance prior to going online, beating the market by more than 2% annually. After going online, they trade more actively, more speculatively, and less pro tably than before, lagging the market by more than 3% annually. The increase in trading and reduction in performance of online investors can be explained by overcon dence compounded by a selfattribution bias and the illusion of knowledge and control. RESEARCH QUESTION AND OBJECTIVES The analysis centres on the question of how investors use the Internet to buy shares and what conclusions can be drawn from this with regard to transaction costs (in particular information processing costs). In Schmid s (1999) framework model for electronic markets, the transaction phases represent an important structural dimension. 1 The market transaction considered here purchasing equities can be presented as a logical sequence of transaction phases (investment process). These differ slightly from Schmid s original model: 2 Information phase: the investor procures the necessary information for the decision-making process from various sources. Decision phase: having processed the information gathered, the investor makes a decision with respect to the type of investment, the moment of purchase, the volume to purchase and the price. Trading phase: the purchase or sale order is transferred by a particular medium to a nancial intermediary, who in turn directs the order to the stock exchange. Performance measurement: the investor monitors his or her investment by measuring its performance. A number of factors in uence how the transaction phases, or rather, the related decisions, are shaped: the investor s level of knowledge; his or her general classi cation as a certain type of investor; and his or her demographic features. The connections between these factors, the transaction phases and the resulting investment portfolio are illustrated in Figure 1. This model serves as a basis for the following discussion. First, the various phases are examined and the most important ndings from the analysis of the empirical data presented. (Performance measurement will not be discussed further here.) 3 Finally, the information and trading phases are combined so that a categorization by investor type can be made in relation to Internet use. METHODOLOGY As an empirical basis for the issues mentioned above, data used are taken from a representative study on share ownership in Switzerland. 4 This study was carried out on behalf of the Association of Swiss Commercial and Investment Banks with the support of the SWX Swiss Exchange. Its aim was to assess the share of direct and indirect equity owners in Switzerland and to gain a detailed picture of investment behaviour. With a random sample of 2,000 interviewees and an extensive questionnaire (52 questions), this research denotes the most extensive evaluation of data in this area in Switzerland. The telephone interviews were conducted by the market research agency IHA/GfM between May and July RESULTS (AND FINDINGS) A presentation of the most important empirical ndings pertaining to the investment phases information, decision and trading follows. Information phase. The main source of information for investment and business matters is the press 92% of shareholders use this medium. 63% of those surveyed get their information from the television and 40% from the Internet (see Table 1). The latter gure indicates the rapidity with which the Internet has gained importance. A comparison according to age category shows that young investors increasingly use the Internet for information procurement. This occurs mainly at the expense of television, but also the press. Furthermore, the Internet is particularly used by investors with high incomes. Whereas business programmes and the Internet are consulted on average three to four times a week, the press serves as an information source ve to six times a week. The percentage of Internet users (40%) gains particular importance as the information procurement

3 Figure 1. Investment Process Table 1. Information Medium According to Age and Income (CHF = Swiss Francs) Press TV Internet (%) (%) (%) Total respondents Age Income less than CHF 3, CHF 3,000 to <4, CHF 4,500 to <6, CHF 6,000 to <8, CHF 8,000 to <10, CHF 10,000 to <15, CHF 15,000 to <20, CHF 20,00 and above behaviour of these investors varies from those who inform themselves using other media. Procurement of nancial information from the Internet requires active search behaviour. This is in direct contrast with information from the television or newspapers, which is often consumed passively. Independent of age category, those surveyed said they spend on average around 20 minutes a day for business queries and 40 minutes a week to assess their own investments. The time used by Internet users is much longer (29 and 71 minutes respectively). In addition to media products, other sources of information are also used (see Table 2). Although share prices are most frequently followed in newspapers, the Internet is mentioned as the second informational source. Particularly in the youngest age categories, almost every second respondent said that he or she uses the Internet for information on share prices. Decision phase. This study shows that a clear majority decide for themselves when, how and in which equities they invest (see Table 3). Second to this come discussions with friends and acquaintances. Bank-independent investment advisors are distinctly less involved in the investment decision. The nal category, exclusively with an investment advisor, was seldom mentioned by respondents. Trading phase. Table 4 shows that the direct route via the bank and order placement by telephone dominate for all age categories. More than a quarter of year olds place their orders via the Internet. Investor typology A number of questions in the survey were aimed speci cally at the use of the Internet. Generally, investors use the Internet to procure information and/or to execute a transaction. From the answers to the questions in the areas of procurement and execution, a matrix can be formed which gives the picture shown in Figure 2: Teodoro D. Cocca Transaction Costs and Investment Behaviour of Online Investors 254

4 Table 2. Other Sources of Information According to Age Total (%) Age (%) (%) (%) (%) (%) Discussions with investment advisor Discussions with friends/acquaintances Investment club Research reports/investment recommendations from bank Research reports/investment recommendations from non-banks Annual reports Specialist literature Table 3. Who Usually Makes the Investment Decision? (According to Age, Multiple Answers Possible) Downloaded By: [Schmelich, Volker] At: 14:41 16 March 2010 Total (%) Age (%) (%) (%) (%) (%) You alone You in consultation with friends/acquaintances Together with an investment advisor from a bank Together with a non-bank investment advisor Investment advisor alone Table 4. How do you Place Your Investment Order? (Multiple Answers Possible) Total (%) Age (%) (%) (%) (%) (%) Telephone/mobile In writing by fax In writing by mail Via Internet/telebanking Personally at the bank Electronic Markets Vol. 12 No % of the investors surveyed use the Internet for stock exchange transactions, but not as a source of information (Internet Trader only). 13.9% of those questioned use the Internet as a source of information as well as to execute transactions (Internet Investor). 26% inform themselves using the Internet, but do not execute transactions using this medium (Internet Informer only). 58.5% use the Internet for neither information nor transactions (Old Fashioned Investor). The demographic features of these investor types are presented in Figure 3. The respective features show those characteristics that are, statistically speaking, over-represented (divergence from expected value). No conclusive statements can be made on the category Internet Trader only, as the sample is too small. Behaviour-based features of investor types The Old Fashioned Investor conducts his or her transactions for the most part directly at the bank (52%). Besides this: 55% use an investment advisor, which represents the highest value of the four types of investors; 38% also gather information from friends and acquaintances; 30% use research reports from banks; and 65% use the television as their source of information. On average, two transactions per year are executed. Characteristic of this type of investor

5 Figure 2. Matrix of Internet Use (random sample: 592 surveyed shareholders) Figure 3. Demographic Features According to Investor Type is that he or she rests a decision on the opinion of the bank. This is done by making use of bank investment advisors or research reports. These aspects indicate that great con dence is placed in the traditional banking system. The Internet Informer only uses bank research reports more often than average and frequently consults annual reports. This type of investor also has con dence in traditional banking institutions, in particular private banks, but shows more initiative and a strong desire to actively inform him or herself on nancial matters. This type of investor executes ve transactions per year. Teodoro D. Cocca Transaction Costs and Investment Behaviour of Online Investors 256

6 The Internet Investor makes the least use of the services of an investment advisor. The most important aspect pertaining to the investment decision is the discussion with friends and acquaintances. The use of research reports from non-banking institutions is above average. Annual reports and specialist literature also form part of the information sources consulted by the Internet Investor. Accordingly, the individual makes the investment decision alone in 80% of cases surveyed. Nine transactions per year make this the most active of the investor types. It is the Internet Investor who is the furthest from the traditional bank-centred investment process. This type of investor is characterized by his or her active attitude towards information procurement and seldom uses information directly from the bank. The Internet Trader only rarely discusses with an investment advisor or with friends and acquaintances (general statements are dif cult due to the above-mentioned statistical reservations). On average, he or she carries out two transactions per year. Typological ndings The majority of investors (58.5%) do not yet use the Internet in any phase of the investment process. This is rather surprising if one considers the current discussion on the impact of the Internet on the nancial world. On the other hand, 41.5% of investors, who use the Internet in one way or another, show that this medium has quickly become popular. The picture provided by this survey gives a general indication of how the behaviour of bank customers could change. The propositions that are formulated here are based on empirically secured data. This is not the case with future-oriented statements particularly concerning the consequences of the Internet revolution. Moreover, an attempt is made to analyse demand in connection with customer behaviour. This allows better-founded conclusions compared with a descriptive approach. Although the number of transactions effected are directly earnings-relevant for nancial institutions, those investors who simply use the Internet to gather information should not be neglected. This group will develop into future Internet investors. It is plausible to expect that investors go through an evolutionary process, beginning as an Old Fashioned Investor and developing into an Internet Investor (see Figure 4). From this point of view one can expect that the relative importance of the respective investor types will change. Whereas the Old Fashioned Investor is currently dominant, a large number of these investors will develop into an Internet Informer only and in the long-term to Internet Investors. The importance of the individual types could develop as shown in Figure 5. The following ndings are particularly striking: Today s Internet users together form an interesting customer segment. However, this is not due to the size of the segment, but more due to the quality of these groups of investors. As shown above, Internet users are characterized by above-average income and assets, as well as a much higher number of investment transactions. One can therefore not speak of online freaks (Schwaiger and Locarek-Junge 1998). Electronic Markets Vol. 12 No Figure 4. Internet Use and Investor Type (today) (Circle size reflects the proportion of investor type)

7 It is becoming clear that the next generation of Internet users will no longer have the same features (aboveaverage income, large number of transactions). Those companies who enter the market as rst movers and command a section of this very lucrative Internet market will be in a privileged position. This general assumption from Porter (2001), seems clearly con rmed by the empirical data for the online brokerage market. Women can be considered a future market segment with very high potential. Their use of the Internet is still limited and could show high growth rates mid-term. Financial institutions strategic planning and marketing need a new kind of concept to approach these new investor types who are discovering the Internet. The ndings for Switzerland can be compared with the results of other studies (Deloitte & Touche 2001). Although, for example, the use of the Internet in the USA is more advanced than in Switzerland, Internet users have the same qualitative features (Securities Industry Association 1999 and Kennickell and Kwast 1995). The relatively small group of users in Switzerland can be explained by the temporal lead of the USA in the adoption of the Internet. DISCUSSION One of the dominant features of online offerings from banks and brokers are the low stock exchange commissions (taking only Switzerland into consideration, these have decreased by 60%). Various authors (e.g., Brynjolfsson and Smith 2000) have discussed how this cannot be equated with lower transaction costs. Hong (2000) assumes that the advantages of lower online transaction commission rates is eroded by higher information processing costs. The ndings of this study support this theory. 5 The time an Internet investor needs for gathering information is 1.5 times that involved otherwise. The portion of investors who predominantly make the investment decision themselves is 66% for Internet investors much higher than the average for all investors (57%). The question of whether Internet investors can be considered so-called naive investors (Hong 2000) cannot be answered conclusively. On average, Internet investors have 6 years of experience with equity investments, whereas the average for all investors is 10 years. 6 Accordingly, Internet Investors are less experienced. However, if one considers the analysis of data pertaining to equity investment expertise, the theory of the naive investor is not supported. According to this study, Internet Investors have a much better basic knowledge of stocks and shares than average investors. Whether this knowledge or experience in dealing with market phenomena is more important cannot be concluded beyond doubt. The early adopters of Internet technology belong rather to the more professional investors. The latter statement is based on the cluster analysis of the data. 7 The theory of the naive investor seems rather more appropriate for the next generation of Internet Teodoro D. Cocca Transaction Costs and Investment Behaviour of Online Investors Figure 5. Internet Use and Investor Type (predicted scenario) (Circle size reflects the proportion of investor type) 258

8 Electronic Markets Vol. 12 No Investors (see the features of the Internet Informer only in the matrix in Figure 3). Risk of an information illusion with nancial market information The size of the Internet Informers group seems to point to the great advantage of the Internet for gathering information. However, this needs to be viewed critically. The Internet offers, in comparison to earlier times, much easier access to information. Does a general decrease in information asymmetry between private and professional investors follow? A narrowing of the information gap is not without cost. The change in bene t for a single economic subject generated by the information gathered is the private value of information. The latter is the decisive factor in uencing an individual s incentive to gather information. If information procurement results in costs, then the rational economic subject will only gather information as long as the value of this information is more than the costs involved in its procurement. The smaller the amount of information that an individual already has, the larger the bene t of additional information. Another aspect that is important for the private value of information is the analytical ability of the individual to process the information (processing capacity). This in turn is in uenced by his or her specialist knowledge or previous knowledge. The gathering costs of additional information increase, as it becomes more dif cult to procure new information and therefore more expensive (Rose 1999). Time is the main factor in uencing the cost of gathering information. The Internet therefore in uences both the cost as well as the value function of the individual. The costs of searching for information show a tendency to decrease. The digitalization of information and its publication on the Internet allows a very ef cient and time-saving search. This ef ciency effect leads to less informational asymmetry compared with the original situation. The private value of information can also change. Information has a private value only as long as it does not belong to the general knowledge of the market. According to the semi-strong form of market ef ciency it is not possible for an investor to achieve a yield advantage on the basis of public information. If information is made accessible to all market participants, then despite this aspect increasing the ef ciency of the market as a whole, it does not allow an individual investor to realize an above-average return. He or she can gather the general knowledge of the market over the Internet and decide on whether it is worth investing in a particular asset. The bene t-inducing effect of the Internet is, therefore, to bring the personal level of information up to the market level. Accordingly, the Internet serves as a level-playing eld. It enables less-informed investors to adapt their knowledge to the level of the entire market. In reality this means that, in particular, small and private investors gain the level of knowledge of professional investors (or at least come closer to this level). An information illusion results when investors believe that the Internet gives them an information advantage over the entire market, simply because they are in possession of more information than before. The private value of the information procured over the Internet can be less than the individual perceives. The information illusion phenomenon has a time restriction. This particularly affects those market participants who are new entrants to the nancial information market via the Internet. For them, their supply of information greatly increases in comparison to their earlier possibilities. In time this effect will weaken. Investors will learn that they do not (cannot) know more than the entire market. If, for example, the stock exchange falls, then investors will learn from painful investment mistakes and will be more aware of the illusion. Additionally, it must be considered that the general accessibility of information is not to be mistaken for equality in the knowledge levels of all market participants. As the aspect of processing capacity has shown, differences in the knowledge endowment of market players create differences in the levels of information. One consequence of the information illusion is that groups of investors that have not yet invested in the market due to high informational asymmetry, will now increasingly do so. 8 The small and private investor groups are those affected by this. It would seem that the Internet reduces informational asymmetry for these market participants to the maximum of that of the level of the entire (professional) market. A tendency towards an adjustment in information endowment between private and institutional investors has been perceived, but this statement is not uncontested. Mahoney (1997) argues that information technology is not in a position to eliminate informational asymmetry through an improved information ow. In his opinion, a reduction of informational asymmetry results indirectly via more ef cient arbitration opportunities. Additionally, it is not the relative relationship between public and private information that would be affected, but the speed with which private information ows into share prices. OUTLOOK With the picture this study provides, one can recognize the self-selecting effect of the Internet as a distribution channel. This predominantly appeals to investors who wish to look after their investments more independently and actively than investors in general. The question is to what extent the future investor generation, who uses the Internet, will exhibit different characteristics. The results of the present analysis give the impression that major changes will occur. Additionally, one can assume that future Internet users will acquire new features (be better-informed, have more basic knowledge) and so be comparable to today s Internet users. The predicted development shows, however, that the Old Fashioned Investor will continue to exist. He or she represents an interesting market segment, which would

9 justify an appropriate focusing of banks company policies. It is remarkable that the Internet has conquered an important share in the nancial information and brokerage market in such a short period of time (the rst real online brokerage offer was launched in Switzerland in November 1998). A worldwide reduction in the rate of adoption of the Internet for investment trading can be observed (Allnetresearch 2001 and Bordoni and Molignani 2000) also as a result of the adverse trend in the stock markets. However, the fact remains that this new medium is spreading so rapidly that its development cannot be reversed (Bruce 2001). A subject that remains to be examined is to what extent falling markets impact the spread of equity ownership and the connected bene ts of the Internet for investment trading. Additionally, it is of importance to differentiate between the supplier s point of view and the investor s advantage. Although online brokers are currently strongly affected by the market decline, this is related to cyclical uctuations in the volume of stock exchange transactions and is not directly relevant to the investor s choice of information-gathering and order-transmission medium. The current stock market situation, with the associated nancial problems of Internet companies, should not divert attention from the fundamental importance of the Internet for the nancial world of the future. SUMMARY AND CLOSING STATEMENT In the author s opinion, the consideration of buyers actual behaviour in their online dealings adds an important element to the current discussion of the effects of e- commerce on the nancial services sector, both at the purely descriptive as well as technological level. This paper has shown which investor typologies can be gleaned from an analysis of empirical data. Contrary to widespread opinion, current Internet users are an interesting customer segment from a banking point of view. Further, the analysis has supported the theory of higher information processing costs than have been assumed so far. The characterization of the online investor as a naive investor seems, however, not to apply to the Swiss market. On the contrary, early Internet adopters of online share purchasing can be considered professionals. The discussion of a possible investor information illusion is worthwhile pursuing, not least because of future market developments. If the investor is aware of the illusion, this does not necessarily cast doubt upon the Internet as an information medium. There is a greater likelihood that we will observe an increased demand for information intermediaries. ACKNOWLEDGEMENTS The author is grateful to Professor Dr. Rudolf Volkart, Full Professor in Finance and Banking at the University of Zurich and Director of the Swiss Banking Institute, for his many constructive comments as well as to the Association of Swiss Commercial and Investment Banks and the SWX Swiss Exchange for funding the research. This research has been also supported by the Swiss National Science Foundation through the National Center of Competence Financial Valuation and Risk Management. Notes 1. For a de nition of an electronic market see also Bakos (1997: 1677) or Schmid and Lindemann (1998: 2). 2. Adoption of the transaction phases shows that, on the one hand, the speci c circumstances of the transaction must be considered and that, on the other, the investor s perspective, and not that of the nancial intermediary, are of importance. The latter results, for example, in the settlement phases not being part of the process. Schmid arranges the transaction in knowledge, intention, agreement and settlement phases (Schmid 1999). For differing forms of categorization of the transaction phases see Freixas and Rochet (1997: 18), Fuchs (1994: 43), Picot et al. (1996: 16), Richter and Furubotn (1996: 51) or Scholtens (1993: 122). 3. At the time the questionnaire was conducted, online performance measurement tools were not available for the Swiss Market. In the future, however, one can expect that tools to support this phase will be on offer. 4. See Cocca and Volkart (2000). 5. Although a large number of contributions, theoretical as well as empirical, argue with the transaction costs theory, this approach is not uncontested. Brynjolfsson and Hitt (1995) and Bailey and Bakos (1997) assume that measuring the advantage of intermediaries in electronic markets according to transaction costs is unsuitable and suggest: A newer paradigm of customized goods, reduced delivery time, and greater customer satisfaction may be more dif cult to measure, but may be the one appropriate to use for electronic markets, as it is in line with the roles of intermediaries in these markets. See Bailey and Bakos (1997: 13), Brynjolfsson and Hitt (1995) or Sarkar et al. (1995: 4). 6. This statement refers to the question In which year did you purchase your rst shares? The rather low averages can be explained by the huge amount of new investors who rst invested in shares in the 1990s. 7. The result is a homogeneous group, which constitutes some 12% of the equity owners surveyed. This type of investor is distinguished by the fact that he or she mainly consults annual reports, gains the relevant know-how from specialist literature and also reads research reports. Discussion with friends and acquaintances also belongs, if to a lesser extent, to the sources of information used, as does contact with an investment advisor. Based on its procurement of information directly from primary sources (business reports) and above-average know-how, Teodoro D. Cocca Transaction Costs and Investment Behaviour of Online Investors 260

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