Ebook Ownership Structure And Stock Market Liquidity
A market is liquid if the cost of buying or selling a large number of shares on demand is low. Amihud and Mendelson (1986) show that market participants are willing to pay for liquidity. They measure liquidity by the quoted bid-ask spread and show that there is a positive relation between expected returns and spread. This suggests that the costs of acquiring capital are lower for firms with more liquid securities. Thus, liquidity in the stock market has consequences for a firm's financing/investment policies.
There are a number of factors that can impact stock market liquidity. Glosten and Milgrom (1985) argue that one cause of illiquidity is the presence of privately informed traders. One such group of privately informed traders is the insiders of a firm. For example, Seyhun (1986) shows that insider trades precede abnormal changes in the price of their company's stock. This suggests that the level of insider ownership in a firm may influence the liquidity of the stock.
Bhide (1993) further argues that active stockholders who reduce agency costs by monitoring managers may also reduce stock liquidity by increasing informational asymmetries. Along a similar vein, Kahn and Winton (1985) argue that higher liquidity demands cause share prices to not fully reveal how much monitoring occurs. As a result higher liquidity would be associated with decreased monitoring. In contrast, Maug (1998) suggests that even though a liquid stock market reduces a large shareholder's incentive to monitor because it allows them to exit the stock more easily, it also makes it easier to purchase additional shares and less costly to hold larger stakes. Based on the latter possibility, he finds that liquidity has a positive impact on monitoring by making corporate governance more effective.
Since it is frequently argued in the literature that institutional investors play an important monitoring role, there may exist a relation between the institutional ownership in a firm and the liquidity of the firm’s stock (cf. Wahal, 1996). The influence of institutional investors on stock liquidity may be further reinforced by the influence of their trading practices on stock price (cf. Lakonishok, Schleifer and Vishny, 1992).
This paper empirically examines the relation between the liquidity of a firm’s stock and the fraction of the firm owned by insiders and institutions. The bid-ask spread is a direct cost of transacting and we use it as one measure of stock liquidity. We find for our sample of Value Line firms that after controlling for other determinants of spreads and ownership, spreads are positively related to both insider and institutional ownership. Lee, Mucklow and Ready (1993) point out that, in addition to the bid-ask spread, quoted depth is also part of the stock market quote and that specialists actively manage adverse selection risk by adjusting both spread and depth. Specifically, they show that specialists increase spreads and decrease quoted depth in response to increases in perceived information asymmetry. Consistent with our evidence on bid-ask spreads, we find that the quoted depth is negatively related to the fraction of the firm's stock owned by insiders and institutions.
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