We study the impact of priority rules on market quality and investor welfare. While typically the regulator mandates price priority (e.g., the Securities and Exchange Commission’s Order Protection Rule), price priority does not specify who trades first when multiple venues (or counterparties) have the best-posted price. Order preferencing to a specific venue or broker may then serve as a tie-breaking rule. We compare order preferencing, modeled as price-broker-time priority (PBT), to price-time priority (PT).
When the tick is tight relative to the dispersion in trader valuations, trading rates are higher with PBT whereas investor welfare is higher with PT. The opposite holds for a wide tick. PBT endogenously results when brokers individually choose between PT or PBT. Our model has testable implications regarding systematic patterns in order flow, market depth, trade composition, and market fragmentation.