The term free float is used interchangeably with diffused ownership by the existing literature. Ragazzi (1981, p. 262) defines the free float or diffused firm ownership as ‘the one where a firm’s shares are owned by several individuals who cannot take control of the firm or is not able get any benefits other than those available to other shareholders and whose top managers do not receive either direct or indirect benefits other than a market salary’. In this regard, existing literature show a negative relationship between ownership concentration and free float shares in the market (Bhide 1993; Holmstrom & Tirole 1993; Bolton & Von Thadden 1998). Holmstrom & Tirole (1993) argue that dispersed shareholders have fewer incentives for information production if the float on a stock is smaller. Similarly, Bolton & Von Thadden (1998) document that the threat of takeovers is reduced when the float share is small. Moreover, Bhide (1993) explores that large holding by active stockholders will reduce the float of stock that is free to trade, which would result in less active and continuous trading, and as a result, the market maker will widen the bid-ask spread.
The existing literature also documents that retail shareholders are unlikely to be informed, which is expected to increase market liquidity. For instance, Comerton-Forde & Rydge (2006) suggest that retail shareholders ownership has a positive relationship with turnover ratio and negative relationship with the bid-ask spread. However, the relationship is weak. This finding supports the view that when retail shareholders trade, they trade for liquidity reasons which would mean that they are uninformed investors. Moreover, previous literature has documented that the larger the market capitalisation of a stock, the greater its market liquidity and if the market participants are subjected to information asymmetry, then the number of investors willing to invest in a particular stock, in expectation of the potential gains from the trade (Bolten & Von Thadden 1998).
43
Nevertheless, when a firm has controlling shareholders, the number of shares available for trading reduces, which may reduce market liquidity. In other words, ownership concentration can cause a separation between free float and market capitalisation and as a result, when this happens, then fewer shares are traded in the market, which eventually reduces market liquidity. In addition, given the assumption that blockholders may have private information regarding the firm, a higher probability of informed trading will cause the bid-ask spread to widen. In line with these arguments, Ginglinger & Hamon (2012) examine the free float or trading hypothesis on a sample of 918 firms traded on the French stock exchange for the period 1998-2003. They argue, that as there is a positive relationship between free float and market liquidity, their results suggest a significantly lower liquidity for firms with large insider blockholders ownership.
The above-mentioned discussions suggest that existing evidence on the relationship between owners’ identity and market liquidity is limited and inconclusive, which specify gaps in the literature. In addition, the review indicates the need for this study in the UK since most of the above-mentioned studies are based on the US and other markets (Barabanov & McNamara 2002; Fehle 2004; Naes 2004; Ginglinger & Hamon 2012; Poon et al., 2013) with only Park (2009) covering the UK market. However, as discussed before, there are differences in corporate governance mechanisms, disclosure requirements and regulations, between countries, which would justify the need for more country-specific studies, in particular, in the context of the UK.
Further, the discussion of the empirical papers indicates that the evidence from the insider owners’ identity is limited. With the exception of Heflin & Shaw (2000) most of the published studies in this area mainly focus on outsider owners’ identity only and ignore the insiders’ identity (Barabanov & McNamara 2002; Fehle 2004; Park 2009; Poon et al., 2013). I would thus argue that this study is the first of its kind in the UK that investigates the effect of owners’ identity for both insider and outsider market on market liquidity.
The ownership structure literature has also documented that ownership variables are endogenously determined (Naes 2004; Poon et al., 2013; Rubin 2007). Further, Poon et al. (2013) argue that endogeneity in the ownership structure-liquidity relationship arises from two sources, unobserved heterogeneity and simultaneity. The authors add that most of the empirical papers control for unobserved heterogeneity and simultaneity. Therefore, the estimation method used in examining the ownership structure on market liquidity is very important. The normal estimation methods such as OLS and fixed effect fail to control for all the endogeneity sources (Poon et al., 2013). Thus, part
44
of the inconclusive results could be attributed to the methodological issue. For instance, the empirical review reveals that some papers do not control for the endogeneity problem at all (Chiang & Venkatesh 1988; Kini & Mian 1995). Furthermore, none of the above studies employs a pooled OLS dummy year and industry in the estimation method. Recently, however, Poon et al. (2013) did employ the pooled OLS dummy year and industry in their study. In this study, and following Poon et al. (2013), the analysis is performed using pooled OLS dummy year and industry.
Few studies have linked the owners’ identity with market liquidity. Moreover, in the UK to the best of the author’s knowledge Park (2009) is the only study that examines the effect of outsider blockholders’ identities on market liquidity measured by quoted and relative bid-ask spread, and Amihud (2002) illiquidity ratio. In particular, he tests the effect of free float shares, foreign holding, investment companies, pension fund, government, employee, cross holding and other holding on the above-mentioned measures of market liquidity. Using a 156 FTSE 100 and 250 from May 2002 to April 2009, he documents that there is a negative relationship between free float shares and quoted and relative bid-ask spread and Amihud (2002) illiquidity ratio. In contrast, he reports a negative relationship between foreign holding, investment companies, pension fund, government, employee, cross holding and other holding and quoted bid-ask spread, relative bid-ask spread, and Amihud (2002) illiquidity ratio.
In addition, few papers examine the impact of free float on market liquidity (Jacoby & Zheng 2010), while the rest of the papers focus on blockholders. The findings are mixed and inconclusive, which highlights the need for more work on this topic. Further, all the mentioned studies are conducted in the US, which implies the need for more investigation using a sample from the UK corporate boards. To the author’s knowledge, this is the first study in the UK that examines the effect of ownership level, concentration and owners’ identity on market liquidity. Accordingly, this study aims to extend this literature and provide evidence from the UK public listed firms. The sample of this study is more comprehensive as it includes all the small and large firms listed in the FTSE All-Share Index.
2.7 Ownership Level, Concentration, Owners’ Identity and Market Liquidity during the