Ownership dispersion and market liquidity Gady Jacoby a , Steven X. Zheng b, ⁎ a Department of Finance, Stillman School of Business, Seton Hall University, United States b Department of Accounting and Finance, Asper School of Business, University of Manitoba, Canada abstract article info Article history: Received 8 December 2009 Accepted 30 January 2010 Available online 10 February 2010 JEL classification: G10 G32 Keywords: Block ownership Bid-ask spread Quoted depth Information asymmetry PIN We revisit the relationship between ownership dispersion and market liquidity. For ownership dispersion, we consider two dimensions: number of shareholders and blockholder ownership. For market liquidity, we consider four categories of liquidity measures: spreads, probability of informed trading (PIN), depth, and volume. Our sample includes NASDAQ firms in addition to NYSE and AMEX firms. We find several relations that are not documented in the extant Finance literature. Overall, our test results are consistent with the idea that higher ownership dispersion improves market liquidity. © 2010 Elsevier Inc. All rights reserved. 1. Introduction In this paper we examine the relation between ownership dispersion and market liquidity of stocks. It is generally believed that a dispersed ownership leads to better market liquidity (see for example, Booth & Chua, 1996; Bolton & Von Thadden, 1998). However, previous empirical studies of the way in which blockholder ownership affects spreads of stocks listed in the New York Stock Exchange (NYSE) 1 provide mixed results (see Kini & Mian, 1995; Heflin & Shaw, 2000). Therefore, we revisit this issue in this paper. In addition, the following important questions have yet to be answered in the Finance literature: (i) Blockholder ownership is just one di- mension of ownership dispersion. How does the number of share- holders, another dimension of ownership dispersion, affect market liquidity? (ii) How does ownership dispersion affect other aspects of market liquidity, such as probability of informed trading (PIN as in Easley, Kiefer, O'Hara, & Paperman, 1996) and trading volume? (iii). What is the relation between ownership dispersion and market liquidity of stocks in the NASDAQ market? Finally, (iv) How does firm size influence the relation between ownership dispersion and market liquidity? We conduct tests to answer these questions. Kini and Mian (1995) analyze 1985 data on 1063 New York Stock Exchange (NYSE) firms. They find no support for a significant positive relation between spreads and blockholdings. 2 In a later study, Heflin and Shaw (2000) also examine mostly NYSE firms (they use 1988 data for 260 firms: 259 listed on the NYSE and one listed on the American Stock Exchange (AMEX)). They find that increased blockholder ownership is related to higher spreads. The two papers clearly contradict each other. However, the two studies refer to different sample year and sample size. So we cannot exclude the possibility that the different results in the two studies may be sample specific. To address this problem, in this paper we examine a large sample of stocks in 1995. If our results confirm either one of the two studies, we may draw more confident conclusions about the affect of blockholder ownership on spreads. Heflin and Shaw (2000) argue that in a firm with a concentrated ownership structure, the large shareholders have access to private information, and therefore, their trading increases the adverse selection risk faced by market makers. Thus, market makers are forced to increase the bid-ask spreads for this stock and trade less, which reduces the liquidity of the stock (see for example, Glosten & Milgrom, 1985; Easley & O'Hara, 1987, 1992). This argument suggests International Review of Financial Analysis 19 (2010) 81–88 ⁎ Corresponding author. 410 Drake Centre, I.H. Asper School of Business, Faculty of Management, University of Manitoba, Winnipeg MB, Canada R3T-5V4. Tel.: + 1 204 474 7933; fax: +1 204 474 7545. E-mail address: zhengxs@ms.umanitoba.ca (S.X. Zheng). 1 In addition to 259 NYSE firms, Heflin and Shaw (2000) also include one American Stock Exchange (AMEX) in their sample. 2 Kini and Mian (1995) also document a non-positive bid-ask spread – insider ownership relation and conclude that insider trading has no impact on spreads. At the same time, they find a significantly negative relation between the bid-ask spread and institutional holdings. They attribute this result to the lower information asymmetry in the presence of institutional stockholders. 1057-5219/$ – see front matter © 2010 Elsevier Inc. All rights reserved. doi:10.1016/j.irfa.2010.01.008 Contents lists available at ScienceDirect International Review of Financial Analysis