Institutional Ownership and Stock Liquidity: International Evidence

• Published date: 01 February 2018
• DOI: http://doi.org/10.1111/ajfs.12202
• Author: Thanh Huong Nguyen,Thi Thuy Anh Vo,Tung Lam Dang,Nguyen Tram Anh Tran
• Date: 01 February 2018

Institutional Ownership and Stock Liquidity:

International Evidence*

Tung Lam Dang**

Faculty of Finance, The University of Danang, Vietnam

Thanh Huong Nguyen

Finance Discipline Group, University of Technology Sydney, Australia

Nguyen Tram Anh Tran

Faculty of Finance, The University of Danang, Vietnam

Thi Thuy Anh Vo

Faculty of Finance, The University of Danang, Vietnam

Received 14 March 2016; Accepted 21 August 2017

Abstract

This paper investigates the relation between institutional ownership and stock liquidity, and

explores whether this relation differs across institutional settings. Using a comprehensive data

set across 41 countries from 2000 to 2010, we find that institutional ownership is positively

correlated with stock liquidity. Importantly, the positive association between institutional

ownership and stock liquidity is stronger (weaker) for firms in countries with opaque (trans-

parent) information environments or poor (good) institutional characteristics. Our additional

analysis reveals that the positive association between institutional ownership and liquidity is

attributable to non-block institutional investors.

Keywords Institutional ownership; Stock liquidity; Information asymmetry; Trading effect

JEL Classification: G14, G15, G23

*The authors are grateful to Professor Hee-Joon Ahn, an associate editor, two anonymous

reviewers, seminar participants at the University of Economics–The University of Danang

(UE-UD), conference participants at the International Conference on Accounting and

Finance 2016 (ICOAF 2016), and members of the UE-UD Teaching and Research Team in

Corporate Finance and Asset Pricing (TRT-CFAP) for their helpful comments and sugges-

tions. They would like to thank Fariborz Moshirian and Bohui Zhang for sharing their data.

Tung Lam Dang acknowledges financial support from the Ministry of Education and Train-

ing, Vietnam (Grant number: KT-04) for this project. All errors remain the authors’ own.

**Corresponding author: Faculty of Finance, University of Economics, The University of

Danang, 71 Ngu Hanh Son, Danang, Vietnam. Tel: +84-915-858-458, Fax: +84-236-383-6255,

email: dangtlam@due.edu.vn.

Asia-Pacific Journal of Financial Studies (2018) 47, 21–53 doi:10.1111/ajfs.12202

©2018 Korean Securities Association 21

1. Introduction

Institutional ownership has been significantly increasing globally over the last few

decades. According to the International Monetary Fund (2005), institutional inves-

tors around the world manage financial assets exceeding US$45 trillion, with over

US$20 trillion in equities. Given the dramatic growth of institutional investors in

global capital markets, it is important to determine whether and how institutional

ownership affects firm value, corporate decision making, and stock market liquidity

worldwide. This study focuses specifically on the relation between institutional own-

ership and stock liquidity, an important indicator of the smooth functioning of

equity markets.

Although there are several mechanisms through which stock liquidity is corre-

lated with ownership structure, researchers often concentrate on two hypotheses:

the adverse selection hypothesis (information effect) and the trading hypothesis

(trading effect) (Rubin, 2007). The adverse selection hypothesis suggests that the

presence of informed traders induces information asymmetry, which in turn reduces

stock liquidity (Grossman and Stiglitz, 1980; Copeland and Galai, 1983; Glosten

and Milgrom, 1985; Kyle, 1985; Easly and O’Hara, 1987; Easley and O’Hara, 2004).

In contrast, the trading hypothesis suggests that competition among informed tra-

ders reduces information risk, leading to improved informational efficiency and

making them more likely to trade, which helps improve stock liquidity (Admati

and Pfleiderer, 1988; Subrahmanyam, 1991; Holden and Subrahmanyam, 1992; Fos-

ter and Viswanathan, 1996; Agarwal, 2007). In addition, when investors trade more

frequently, transaction costs are reduced, which increases stock liquidity (Demsetz,

1968; Merton, 1987).

1

Given that institutional investors may have informational

advantages and tend to trade more often than other groups of investors, the direc-

tion and magnitude of the correlation between institutional ownership and liquidity

depends on the relative importance of the informational effect or the trading effect.

2

To date, this remains an empirical question, particularly in international markets.

In this paper, we investigate whether institutional ownership is related to stock

liquidity and whether this association differs across institutional settings. We use a

comprehensive firm-level data set of institutional ownership and stock liquidity

across 41 countries over the period 2000–2010. This international setting is espe-

cially interesting. It allows us to exploit the rich variation in stock liquidity and

institutional backgrounds across countries, which provides a better understanding

1

Increased trading activity may not necessarily be due to competition among informed tra-

ders for profit. Instead, it may be due to noise traders who trade for liquidity reasons, such

as portfolio rebalancing or risk sharing.

2

Evidence that institutional investors possess superior information includes Szewczyk et al.

(1992), Alangar et al. (1999), Bartov et al. (2000), Parrino et al. (2003), and Bushee and

Goodman (2007). Evidence that institutional investors tend to trade more frequently than

other investors includes Hamilton (1978), Gompers and Metrick (2001), and Rubin (2007).

T. L. Dang et al.

22 ©2018 Korean Securities Association

of the relation between institutional investors and stock liquidity and whether coun-

try-level institutional infrastructure matters to this relation.

Our two key variables are institutional ownership and stock liquidity. We obtain

institutional holding data from the FactSet/LionShares database. Institutional own-

ership is defined as the percentage of a firm’s outstanding shares held by inst itu-

tional investors in a given year. To measure the liquidity of a stock, we rely on two

commonly used proxies in the literature: percentage effective spread and Amihud’s

(2002) illiquidity measure. We also control in our analyses for a variety of firm-spe-

cific characteristics and country-, industry-, and year-fixed effects in order to elimi-

nate the possibility that our results merely reflect omitted correlated variables.

We find that institutional ownership is positively correlated with stock liquidity.

Our results are consistent across subsamples (i.e., the global sample, developed ver-

sus emerging markets, US versus non-US markets, and during a crisis period versus

during a non-crisis period) as well as across alternative measures of stock liquidi ty.

To mitigate the concern that an endogenous relation between institutional owner-

ship and stock liquidity can drive our results, we also employ several alternative

specifications, including firm-fixed effects, controlling for the lagged dependent

variable, and adopting a first-difference approach as additional checks. The results

are robust to these specifications. This finding is consistent with the trading effect

of institutional investors on stock liquidity.

We next examine whether the positive effect of institutional investors on stock

liquidity differs across institutional and information environments. Prior research

suggests that the extent of informed trading by institutional investors is significantly

increasing in countries with greater informational opacity and weaker corporate

governance (Maffett, 2012). In such countries, less publicly available information

can motivate institutional investors to acquire private information and execute

profitable trades (Verrecchia, 1982; Diamond, 1985). To the extent that a country’s

less-transparent information environment and poor institutional infrastructure

encourage the prevalence of informed trading and that institutional investors influ-

ence liquidity through increasing the competition among informed traders and

more trading activity (i.e., the trading effect), we should observe a greater positive

association between institutional investors and stock liquidity in countries with a

lack of transparency or poor protection for investors.

Consistent with this conjecture, we find that the positive relation between insti-

tutional ownership and liquidity is stronger in countries with weak disclosure

requirements, low accounting standards, poor regulatory quality, in countries where

there is likely to be significant self-dealing, and in International Financial Reporting

Standards (IFRS) non-adopting countries.

Although our primary results are consistent with group-specific trading behavior

(Rubin, 2007), taking institutional investors as a homogeneous group may not be

reasonable, because institutional investors’ involvement and incentives in firms, and

thus their informational advantages and trading behaviors, are different depending

on their firm ownership stakes (Rubin, 2007; Brockman et al., 2009; Ng et al.,

Institutional Ownership and Liquidity

©2018 Korean Securities Association 23