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THE EFFECTS OF FREE FLOAT RATIOS ON MARKET PERFORMANCE: AN EMPIRICAL STUDY ON THE ISTANBUL STOCK EXCHANGE

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  • Altınbaş University

Abstract and Figures

This study aims to examine the effects of free float ratios (i.e. the quantity of shares available to public) on market performance of stocks in Turkey. The data contains 199 listed firms on Istanbul Stock Exchange for the year 2007. The relationship between free float ratio and the dependent variables average daily closing price, price volatility and average daily trading activity is measured by regression models. Findings suggest that the market rewards higher floating ratio, that is, average daily closing price and trading activity is significantly higher for stocks with higher free float ratio. However, the price volatility or risk of a stock increases with free float ratio. Finally, the effect of free float ratio on these variables is measured by controlling size of firms through a multi variable regression model. According to regression results effects of floating ratio do not increase or decrease as the firm size increase or decrease.
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The ISE Review Volume: 12 No: 45
ISSN 1301-1642 © ISE 1997
THE EFFECTS OF FREE FLOAT RATIOS ON
MARKET PERFORMANCE: AN EMPIRICAL STUDY
ON THE ISTANBUL STOCK EXCHANGE
Faruk BOSTANCI*
Saim KILIÇ**
Abstract
This study aims to examine the effects of free float ratios (i.e. the quantity of
shares available to public) on market performance of stocks in Turkey. The
data contains 199 listed firms on Istanbul Stock Exchange for the year 2007.
The relationship between free float ratio and the dependent variables average
daily closing price, price volatility and average daily trading activity is
measured by regression models. Findings suggest that the market rewards
higher floating ratio, that is, average daily closing price and trading activity is
significantly higher for stocks with higher free float ratio. However, the price
volatility or risk of a stock increases with free float ratio. Finally, the effect of
free float ratio on these variables is measured by controlling size of firms
through a multi variable regression model. According to regression results
effects of floating ratio do not increase or decrease as the firm size increase or
decrease.
I. Introduction
The law and finance studies show that countries can have greater stock markets
in proportion to national incomes when the legal system protects efficiently
corporate shareholders. The findings of these studies suggest that the common
law tradition is in favour of capital markets whilst civil law tradition fails to
stimulate capital market development. In common law countries corporations are
__________________________________________________________________________________________________________________________________
* Faruk Bostancı, Deputy General Manager of BOTAŞ (was an expert at the Capital Markets Board
of Turkey). BOTAŞ, Bilkent Plaza A-2 Blok Bilkent/Ankara, Turkey.
Tel: 0312 297 20 00 E-mail: Faruk.Bostanci@botas.gov.tr.
** Dr. Saim Kılıç, PhD and Head of Inspection and Surveillance Board of Istanbul Stock Exchange
(was a senior expert at the Capital Markets Board of Turkey).
Tel: 0212 298 21 00 E-Mail: saim.kilic@imkb.gov.tr
Key Words: Free float ratio, market performance, ownership structure, ISE
JEL Classification: G14, G35
2 Faruk Bostancı & Saim Kılıç
characterized by diffused ownership structure which lead to “agency problem”
between managers and owners whereas the concentrated ownership structure of
firms lead to “expropriation problem” between controlling owners and minority
shareholders in civil law countries. Therefore, an ownership structure study is
context dependent.
The relation between ownership structure and corporate performance has
been a popular subject for the researchers. Ownership structure studies mainly
focus on firm performance like accounting profit or other variables related to
financial statements of firms. On the other hand, free float ratio studies are
essentially interested in the market performance of stocks like return on asset or
liquidity. Free float ratio provides shortcut information about the ownership
structure of a company. Low free float ratio indicates the concentrated ownership
structure as well as a small shallow market for stocks of that company.
Therefore, there are two possible types of effect of floating ratio: first, if the
ownership is concentrated (or free float ratio is low) investors avoids from that
stock because of the possibility of expropriation under the weak corporate
governance structure; second, lower free float ratio means lesser quantity of
shares is floating in the market which may lead to illiquidity in the market of that
stock. Investors dislike illiquidity too. As a result, small floating ratio is likely to
have value reducing effect on stocks with the insufficient demand of investors.
Turkey is a typical civil law country and provides appropriate settings to
study effects of ownership structure in a less developed capital market. Turkish
capital market is characterized by highly concentrated ownership structure of
family firms or business groups, and relatively low level of investor protection.
Initial owners of the firms are reluctant to offer more shares to the public in order
not to lose their control. This decreases the quantity of shares available to public
(free float shares) in the market. The free float ratios of listed companies are
relatively low like other civil law countries and low floating ratio can be seen as
symptom of weak investor protection.
In spite of the interest of investment community, there are limited numbers
of academic studies which focus directly on the effects of free float ratio though
there are numerous studies on ownership structure and firm performance. To our
knowledge, this is the first published study that explores the relationship between
free float ratio and stock market performance in Turkey. Within this framework,
the rest of the paper is organized as follows. Section 2 reviews related literature.
Section 3 identifies the hypotheses of the model. Section 4 explains data and
The Effects of Free Float Ratios on Market Performance: 3
An Empirical Study on the Istanbul Stock Exchange
methodology. Section 5 summarizes the findings of the study. Section 6
concludes.
II. Literature Review
The recent law and finance studies show that the legal tradition of a country is
the fundamental determinant for the efficiency of capital market in that country.
There are two legal traditions that countries follow one or another, namely,
common law tradition which is popular among Anglo-American countries and
civil law tradition which is followed by many continental Europe countries such
as France, Italy, and Spain. Some countries are in between the two legal
traditions such as Germany and the Scandinavian countries though they are
closer to civil law countries. La Porta, Lopez-de-Silanes, Shleifer, and Vishny
(hereafter LLSV, 1998) show that the laws in common law countries are the
most successful in protecting shareholders, whereas the laws in French civil law
countries provide the least protection. The most basic prediction is that poor
investor protection discourages the development of financial markets. When
investors are not protected from expropriation, they pay less for securities,
making it less attractive for entrepreneurs to issue these securities. This is a
reasonable explanation for why some countries have more valuable stock
markets, larger number of listed companies per capita (LLSV, 2000).
In French civil law countries corporations typically exhibit concentrated
ownership structure, generally, families or business groups hold the majority of
the shares and thus the control through pyramidal structures and/or dual class
shares. Therefore, the Anglo-American “agency problem” between owners and
managers is replaced by “expropriation problem” between controlling
shareholders and minority shareholders in civil law countries (Ararat and Ugur,
2003). Concentration of ownership is one of the offered solutions for the former
problem whereas diffusion of ownership may be a remedy for the latter problem.
Therefore, the relation between corporate performance and ownership structure
is context dependent. The legal and institutional differences among countries
lead to different governance problems and the remedies are varying according to
context of country.
The law and finance studies enable us to understand the international
differences among markets. However, findings of these studies need to be
strengthened further by new evidences from emerging markets. Turkey is a
typical civil law country (LLSV, 1998) in the sense that Turkish capital market is
characterized by highly concentrated ownership structure of family firms or
4 Faruk Bostancı & Saim Kılıç
business groups, and relatively low level of investor protection (Orbay and
Yurtoglu, 2006). Pyramidal structures, cross-ownership, privileged shares and
various other control mechanisms are used to control the firms by major
shareholders (OECD Report, 2006). Initial owners of the firms are abstaining to
offer more shares to the public in order not to lose their control. This decreases
the quantity of shares available to public (free float shares) in the market. Thus,
Turkey provides appropriate settings to study effects of ownership structure in a
less developed capital market.
Yurtoglu (2000) examines the effects of ownership structure on Turkish
firm performance for years 1990-1996. Three performance variables are
employed for a sample of 126 non financial companies of ISE. These variables
are the ratio of annual net profit to total assets, the market value of the firm to
total assets and the dividend payout ratio which is, Yurtoglu argues, important in
determining the return of investment made by minority share holders. Yurtoglu
(2000) concludes that there is a statistically significant negative relationship
between the three performance measures and the ownership concentration.
In another study on the relationship between performance and ownership
structure for Turkish firms, Ozer and Yamak (2001) use the data of 204 firms
listed on Istanbul Stock Exchange for the year 1999. These firms are
characterized by highly concentrated ownership structure. On the average the
largest shareholder has the 53.2 % of these firms. The financial companies are
excluded from the initial data since they differ in terms of their operations and
accounting standards. After this exclusion, they ended up with a final sample of
153 non-financial companies with concentrated ownership structure. They use
ownership concentration, market control and owner identity as independent
variable and debt pressure as control variable. The proportion of the shares that
held by the largest shareholder is used as a measure for the ownership
concentration. Market control variable is calculated as the percentage of
dispersed ownership which may act as market control in companies with
concentrated ownership. For owner identity variable dummy variables are used
to identify the effects of different types of owners such as individuals, holdings,
financial institutions, non-financial companies and so on. The control variable,
the debt pressure which has a possible influence on ownership performance
relation through the monitoring function of debt holders, is measured as the ratio
of the debt-to-equity. Finally, performance which is the dependent variable of the
study refers to return on asset, return on equity, sales profitability, sales growth
and asset turnover of the companies under investigation.
The Effects of Free Float Ratios on Market Performance: 5
An Empirical Study on the Istanbul Stock Exchange
The findings of Ozer and Yamak’s (2001) study indicate that ownership
characteristics have statistically significant effect only on return on asset, return
on equity and partially on asset turnover. However, the effect is not significant
on the other performance measures, namely, on the sales profitability and sales
growth. For this set of data, performance seems to be not affected by the
ownership level at all. The sample includes only highly concentrated ownership
companies and beyond a certain level ownership concentration may not affect
performance of a firm. Market control seems not to have disciplinary effects on
firms’ performance as opposed to expectations. As the ownership structure
diffuses the return on asset and the return on equity measures of performance
decrease significantly. Identity of owner seems to be significant effect on
performance, for example, if the controlling shareholder is a holding company
this has positive effect on performance of the company. In addition to holding
companies, foundations, cooperatives and state agencies have positive effect on
performance when they are controlling shareholder.
Yurtoglu (2003) analyses the ownership structure of listed companies on the
ISE for the year 2001. The findings of this study are as follows: First, the
companies exhibit highly concentrated ownership structure, families own
directly or indirectly 80 % of all companies and control 242 of 305 listed
companies. The control over firms is achieved through complex pyramidal
ownership structures and through dual-class shares. Holding companies are the
common form of company that controls several companies together. Holding
companies have on the average 47 % of all the shares. Yurtoglu (2003) states
that:
“…twenty-nine company charters allow for superior dividends for classes
of shares held by controlling family and there are 16 companies, whose charters
treat the controlling owners better than minority shareholders in case of
bankruptcy. In 126 companies the absolute majority of the board of directors can
solely be nominated by controlling owners and 52 companies allow their insiders
to determine the composition of the supervisory board. The incidence of these
additional mechanisms to enhance the corporate control underlines the fact that
control is valuable and insiders are keen to protect it firmly
Yurtoglu (2003) reports that the higher control and voting rights reduce the
market values of companies whereas the higher cash flow rights lead to higher
market values.
6 Faruk Bostancı & Saim Kılıç
Gursoy and Aydogan (2002) study the relationship between ownership
structure and the performance of non-financial firms listed on Istanbul Stock
Exchange for the period of 1992-1998. They employ two groups of variables to
measure the performance: the first group of variable is accounting based,
namely, they are return on equity, return on total assets; the second group of
variable is the market based variables, namely, they are price-to-earnings ratio
and stock returns. They find that ownership concentration is positively related
with market based variables but negatively related with the accounting based
variables. In other words findings of this study suggest that as the ownership
concentration of a company increases its accounting profit decreases but the
market prices of stocks rise. Price return on equity is lower for family owned
firms than the government owned firms. They observe that the total risk is higher
for concentrated companies than the diffused companies whereas the market risk
is lower for the former.
Gonenc and Hermes (2008) examine propping activities of business groups
of Turkey. They use the data of the companies listed on the ISE for the period of
1991-2003 and divide the sample into two sub-periods as 1991-1999 and 2000-
2003. They find that Turkish business groups use propping especially when the
economy faces macroeconomic instability between 1991 and 1999. Their
findings support the idea that private benefit of control is high for the countries
where investor protection is weak.
Recently free float ratio is used to measure the relationship between
ownership structure and firm performance. Previous ownership structure studies
mainly focus on firm performance like accounting profit or other variables
related to financial statements of firms while free float ratio studies are
essentially interested in the market performance of stocks like return on asset or
liquidity. Although there are numerous definitions of free float ratio, it can be
simply defined as the ratio of a company’s outstanding shares, which is available
to the public in the market without any restriction on trading, to the total shares
of the company. In some cases this definition is further narrowed by extracting
the outstanding shares held by static owners like institutional investors or the
government who are unlikely to sell their shares frequently in the market. In any
case, free float ratio provides quick information about ownership structures of
companies. In a cross country comparison of free float ratios, for example, the
US and UK have the highest free float ratios 93.9% and 95.1% respectively, the
average ratio for the developed world is 86.4% and 77.5% for the emerging
markets as of 2001 (Gao, 2002). On the average 36.93 % of European shares are
The Effects of Free Float Ratios on Market Performance: 7
An Empirical Study on the Istanbul Stock Exchange
free to trade, this percentage decreases to 14 % for France (Ginglinger and
Hamon, 2007). This ratio is 32 % for the Turkish companies as of 2008.1
Starting from the late 1990s the global index providers have been taking
into account the free float ratios of stocks. First, Morgan Stanley Capital
International (MSCI) has changed the way of calculating the weights for its
indexes in 2000 after experiencing the negative effects of ignoring free float ratio
during East Asia financial crisis (Aggarwal, Klapper and Wysocki, 2005). Before
the adjustment market indexes were weighted directly by the market
capitalizations of stocks, omitting the proportion of stocks actually traded in the
market. The free float ratio of stocks is used as a weight in calculating the market
capitalizations of firms. The weight of a firm in the index increases in parallel to
free float ratio of that firm. In this calculation MSCI calculates the free float by
excluding the shares held by controlling shareholders such as family members,
group firms, governments, investment funds, and management from the total
shares outstanding. The details of MSCI’s methodology of construction index are
available on the official web site www.msci.com. The basic justification of the
change in method of weight calculation is the negative impact of low free float
ratios on liquidity. In some indexes, low free float stocks are directly excluded,
for example, MSCI Global Investable Market Indices exclude the securities with
free float ratio less than 15%.
Following the success of Morgan Stanley conversion, Standard and Poor’s
(S&P) adjusted US indexes according to free float market capitalizations of
stocks in 2004. The S&P 500, S&P MidCap, S&P Small Cap were all affected
by this adjustment (Matturri, 2004). Before that change, market capitalization
used in S&P 500 was calculated by multiplying the number of outstanding shares
and the price of stock, after the adjustment, market capitalization is calculated by
considering only the amount of shares that are freely tradable in the market
(Biktimirov, 2008).
Introduction of free float adjustments in global indexes is expected to be
significant effects on fund managers. For example, passive investors are
supposed to be more active and to re-adjust their portfolios according to new
index adjustments and the active investors are forced to re-weight the stocks and
sector positions due to these adjustments. The effects will be more prominent for
the markets where floating shares are relatively low level. As a consequence, in
these markets concentrated ownership structure will be relaxed by states,
families or business groups (Nestor, 2000).
__________________________________________________________________________________________________________________________________
1 Istanbul Stock Exchange web site www.ise.org
8 Faruk Bostancı & Saim Kılıç
Lins and Warnock (2004) explore why the free float ratio is important for
the international investors. They find that international investors consider the
governance structure of the firm and the country when they are taking the
investment decisions. They basically avoid from investing companies whose
governance structure pave the way for expropriation, especially in the countries
where investors are less protected. There are two possible reasons for this
avoidance. First, investors avoid the expropriation risk because it is the risk of
reduction in expected cash flow. Second, information asymmetry is greater for
the firms which are controlled by a major shareholder which makes the firm
more risky to invest. Therefore, low free float ratio or high ownership
concentration is perceived as bad signal to invest.
Despite the growing interest of investment community in free float ratios of
companies, there are limited numbers of academic studies which accounts
directly the effects of free float ratios on firm performance. Among these studies,
Wang and Xu (2004) examine the determinants of Chinese stock market returns
by considering the free float ratio of publicly traded Chinese companies. In
Chinese market higher free float means less government control or less
uncertainty about the shares held by government. Since there is a possibility that
the government sells the stocks that it holds, this situation increases likelihood of
supply shock in the market of that share. In addition to the direct effect, they
argue that higher floating ratio may be a signal of better governance since the
minority owners are more likely to exercise their rights. If this is the case, better
governance has positive impact on firm performance, thus, it is expected that
higher float ratio is accompanied by higher returns. As a result they employ free
float as a variable explaining the stock return with the other variables. They
show that their three-variable model (market factor, size and free float) can
explain 90 percent of the change in portfolio returns and the free float ratio is
positively related with the expected stock returns. In another study of Chinese
market, Cui and Wu (2007) expose that the expected returns of stocks are
affected by firm size as well as floating ratio of shares (tradable shares). Higher
free float ratio makes the market of stock more liquid and given the firm size, it
leads to lower return in equilibrium. They explain the inconsistent result with
previous study of Wang and Xu (2004) as the different models applied in the two
studies. That is, Cui and Wu (2007) control for the size of all firm while Wang
and Xu (2004) control for the size of tradable shares. Cui and Wu (2007) claims
that as long as the total size of the firm is considered the free float ratio can
become a measure of liquidity. Therefore, their results suggest that when the
The Effects of Free Float Ratios on Market Performance: 9
An Empirical Study on the Istanbul Stock Exchange
model includes the liquidity effect of floating ratio the corporate governance
effect is dominated by the liquidity effect.
The Hong Kong Monetary Authority (HKMA, Hong Kong’s central bank)
intervened in the stock market in 1998 by purchasing the shares and declared not
to sell the shares after the intervention. The government intervention caused a
dramatic decrease in the amount of the shares in the market. For Kalok et al.
(2004) this situation provides an opportunity for examining the effects of a
decline in floating shares. They find out that the trade volume of stocks, whose
free float shares are contracted by the HKMA intervention, substantially declines
in 1999 relative to the other shares of Hong Kong Stock Exchange. They use
trade volume as a proxy for liquidity and this finding shows that government
intervention leads to a negative impact on liquidity of stocks, though they do not
find a similar relation between free float ratio and the price increase of the
stocks.
Kaserer and Wagner (2004) use the data of German stock market and find a
significant positive relation between the degree of free float and management
benefit. They classify the German companies as little free float companies and
high free float companies; in the comparison of the two types of companies they
find that the absolute and relative increase in the management benefit is more
significant for the high free float companies than the little free float companies.
This result supports the idea that there is a greater agency conflict between
principals (shareholders) and the agents (managers).
Ginglinger and Hamon (2007) use the data of French market to explore the
relation between ownership concentration and market liquidity. They test the
hypothesis that low free float ratio leads to low liquidity in the market. The first
rationale behind the hypothesis is that when the floating ratio is small then the
availability of shares in the market is small in quantity participation of investors
will be limited, which reduces the trade activity (liquidity) in turn. Secondly, the
low free float ratio means existence of block holder which has more access to
insider information, the high probability of insider trading discourage the outside
investor to invest and thus reduces the liquidity of the stock. They find that
liquidity is significantly is low for small floating firms in the French stock
market.
In the light of previous studies two effects of free float ratio on a stock’s
market can be identified. First, the low free float ratio may be interpreted as a
signal for the weakness of firm level governance by investors who would pay
less for the companies whose governance is weak. In this sense, stock price
10 Faruk Bostancı & Saim Kılıç
returns reflect the investors’ assessment towards a stock and it is a good indicator
of how a firm perceived by the market (Gursoy and Aydogan, 2002). Second,
free float ratio determines the market structure of the stock, that is, high free float
ratio means more stock in quantity which increases trading activity (liquidity) in
the market of that stock.
III. Hypotheses
The previous studies suggest that free float ratio significantly affect the market
of a stock. Specifically, Wang and Xu (2004) show that floating ratio is
positively related with the expected stock returns; Cui and Wu (2007) underline
the liquidity effect of floating ratios in Chinese market. Kalok et al (2004) find
that decreasing floating ratio substantially contracts the liquidity of stocks in
Hong Kong market. Ginglinger and Hamon (2007) use the data of French market
to investigate the relationship between free float ratio and liquidity. They
conclude that this relationship is positive in French stock market. The free float
ratio is a crucial concept for underdeveloped capital markets where the floating
ratio difference among stocks is strikingly clear. In the same stock market while
all shares of some firms are listed, some firms are represented by small number
of shares. The distribution of free float ratios among stocks is much more
homogenous for the developed capital markets (Gao, 2002).
The relation between ownership structure and firm performance has been
subject of many studies. In fact, free float ratio is another way to look at
ownership concentration, that is, low level of floating shares means high level of
ownership concentration. Low free float ratio has two possible effects: the first
effect is related with the corporate governance regime. It is expected to
discourage investors to invest a firm with small floating ratio under the weak
corporate governance structure because ownership concentration increases the
probability of expropriation by controlling owners. The second effect is related
with the market structure of the stock, that is, low free float ratio means small
number of shares available in the market and thus a thin market structure for that
stock. Following the previous studies, in this study the hypotheses are formulated
by considering the two effects of free float ratio on Turkish stock market.
The first hypothesis tests the relationship between floating ratio and stock
price returns. A similar hypothesis is tested by Kalok et al. (2004) for Hong
Kong stock market though their findings do not indicate a significant relationship
between the two variables. The rationale behind this hypothesis is that if floating
ratio of a stock is small, then, both domestic and international investors would
The Effects of Free Float Ratios on Market Performance: 11
An Empirical Study on the Istanbul Stock Exchange
not demand this stock because either small floating ratio is a signal for bad
corporate governance or small number of floating shares in the market reduces
liquidity. The lesser demand for small floating shares is then reflected by lower
price returns in the market. Therefore, the first hypothesis is formulated as
follows:
H1: Lower free float ratio causes lower price returns in the market.
The previous studies indicate that low level of floating ratio leads to a thin
and shallow market structure for a stock. In such a market structure it is expected
that small variations in trade volume may produce large variations in price
returns of that stock. In other words, prices are expected to move up fast in the
case of a demand push when there are small numbers of shares in the market.
Similarly, a firm based negative shock would be more influential for the stocks
with low free float ratio. Hence, the second hypothesis tests the relationship
between floating ratio and price volatility and formulated as follows:
H2: Lower free float ratio causes higher price volatility.
The findings of the aforementioned studies of floating ratio show that free
float ratio clearly positively affect liquidity of a stock. The relatively high
number of shares increases the availability of shares to the investors, in turn,
which makes the market of that stock more liquid. There are different proxies for
liquidity but trade volume is most widely used to measure liquidity. In this study,
number of contract is used to measure trade activity which is used
interchangeably with concept of liquidity. The reason behind this choice is
detailed in the methodology section. Consequently, like the other markets, the
trading activity is expected to increase with floating ratio in the Turkish stock
market and thus the third hypothesis is:
H3: Lower free float ratio causes lower trade activity measured by number
of contracts.
The fourth and the last hypothesis deals with size effect in relation to
previous hypotheses. That is to say, floating ratio is not the only determinant of
the market size of a stock, rather, it should be considered together with the
market value of a firm. Small floating ratio can be tolerated if the market value
12 Faruk Bostancı & Saim Kılıç
of a firm is large enough but for small firms adverse effects of small floating
ratio can be greater. Therefore, the fourth hypothesis is formulated as follows:
H4: The hypothesized relations above are more prominent for small size
firms.
IV. Data and Methodology
The raw data on stocks have been obtained directly from the ISE2. The data
contains daily closing prices, traded value, traded volume and number of
contracts of all stocks in 2007. Although there are 319 stocks listed on the ISE in
2007, the following stocks are excluded from the analysis:
i) those which are not traded in “National Market” (or those which are
traded in “Second National Market”, “New Economy Market”, “Watch List
Companies Market”)
ii) those which are not traded in all trading days throughout 2007. Some
stocks were delisted for variety of reasons and some were newly listed in some
day in 2007.
iii) those of which floating ratio has changed during 2007.
iv) those which belong to investment funds.
v) those which do not represent the ordinary shares, i.e., those which are
privileged shares such as “A” class or “B” class shares.
The first exclusion ensures that all the stocks are traded in the same market
and thus it eliminates the possibility that stock performance is affected by the
different market structure. National market is the main market of the ISE and the
stocks are normally traded in this market as long as they meet the listing
requirements. The listing requirements are lowered for the companies which are
listed on “Second National Market” or “New Economy Market” and “Watch List
Companies Market” was established to list temporarily stocks of companies
under special surveillance due to extraordinary situations related to the company.
There are 27 stocks in total trading out of the National market in 2007. The
second and third exclusions make the data homogenous, whilst the former is
used to have same number of observations for all individual stock; the second
one eliminates the double effect if the floating ratio of a stock has changed
within the year. The investment fund stocks are also excluded because
investment funds are established mainly to manage the stock portfolios and the
__________________________________________________________________________________________________________________________________
2 The raw data is available on the official website of ISE, www.ise.org , see daily bulletins.
The Effects of Free Float Ratios on Market Performance: 13
An Empirical Study on the Istanbul Stock Exchange
all investment fund certificates (share of the investment fund company), by their
very nature, are open to public trading in the market. Finally, some stocks are
representing the privileged shares and they are occasionally traded in compare to
ordinary shares. Hence, these stocks are excluded from the data and
representation of those companies is left to ordinary shares which coexist in the
market with the other class shares.
After these exclusions, there are remaining 199 companies and thus the
analysis of the free float ratio is based on these sample stocks. These data
contains stocks from almost all sectors and sufficiently represent the Istanbul
Stock Market. There are 249 trading days in 2007. Therefore our sample is made
up of 49,551 observations, representing stocks of 199 companies.
This analysis aims to measure influence of floating ratios of stocks on their
average price changes, price volatility and trade activity. Floating ratios of stocks
are subject to change as the block holders buy or sell the shares, though this kind
of transaction is, by definition, unlikely to happen frequently. The ISE indices
are weighted by the free float ratios of stocks. ISE defines free float ratio as: “the
ratio found by dividing the sum of nominal value of publicly held shares to the
total nominal value of the all shares of the corporation”. In this study these free
float ratios are used as a single value for each stock as an independent variable
by calculating the average free float ratio of the beginning, mid and end of the
year. However, if the average free float ratio of a stock had changed
significantly, that is, more than 5% in comparison to mid-value of the year, then
this stock is excluded from the analysis.
The first dependent variable, average daily price change (PC), is calculated
for all stocks as follows. The daily closing price changes are calculated as a
percentage increase or decrease of stock prices according to the previous day,
then, the average value is calculated for all the trading days of 2007. For
example, the average daily price change is -0,004% for the ACIBD stock, this
means price of ACIBD decreases by -0,004 percent daily basis on the average in
2007. Thus, the formula for average daily price change is:
PC = Average Daily Price Change (%) = Sum of Daily Price Changes (%) /
Number of Trading Days
The second dependent variable, the price volatility (PV) of stocks, is
obtained for all stocks by calculating the standard deviation of daily closing price
changes for 2007. Thus, the formula for the price volatility is:
14 Faruk Bostancı & Saim Kılıç
PV = Price Volatility = Standard Deviation of Daily Price Changes (%)
The third dependent variable, the trade activity (TA) is measured as the
number of contracts for each stock. The number of contracts is a better indicator
of trade activity than the traded volume or traded value since it is not affected by
the size (quantity or monetary value) of the transaction as opposed to traded
volume or value. The number of contracts of a day gives the number of times
that the buying or selling occurs in that day. The trade volume is about the
magnitude of the trade but it does not tell about the number of buying and selling
that constitutes the trade volume. For example, 100 unit of trade volume can be
reached by one turn (one contract) or by 10 contracts each includes 10 unit of
stock on the average. Obviously, there exists more trading activity in the latter
case. Therefore, number of contract is used in this study to measure trading
activity. The average of daily number of contracts is calculated for all the stocks.
Thus, the formula for the trade activity is:
TA = Trade Activity = Total number of contracts / Number of Trading Days
Hypothesis 1 predicts that free float ratio (FR %) coefficient is positively
associated with average daily price change (PC %). To test this hypothesis, the
following simple regression model is employed:
PCi % β1 + β2*FRi % + εi
Hypothesis 2 predicts that free float ratio (FR %) coefficient is negatively
associated with price volatility (PV %) of stocks. To test this hypothesis, the
following simple regression model is employed:
PVi % β1 + β2*FRi % + εi
Hypothesis 3 predicts that free float ratio (FR %) coefficient is positively
associated with trade activity (TA) of stocks. To test this hypothesis, the
following simple regression model is employed:
TAi β1 + β2*FRi % + εi
The Effects of Free Float Ratios on Market Performance: 15
An Empirical Study on the Istanbul Stock Exchange
Hypothesis 4 predicts that the relations in the previous hypotheses are more
prominent for small size firms than the large size firms. In order to test the fourth
hypothesis, the firms are categorized as small, medium and large sizes according
to their market values. Like the free float ratios the market values are calculated
as the average market values of firms at the beginning, mid and end of the year
2007. The first and third quartiles of market values of firms are calculated and
the market values below the first quartile are defined as “Small”, the market
values between the first and third quartile are defined as “Medium” and the
market values greater than the third quartile are defined as “Large”. To test this
hypothesis, the following dummy variable regression models are employed:
PCi β1 + β2*FRi + β3*DLARGE + β4*DSMALL + β5*FRi*DLARGE +
β6*FRi*DSMALL + εi
PVi β1 + β2*FRi + β3*DLARGE + β4*DSMALL + β5*FRi*DLARGE +
β6*FRi*DSMALL + εi
TAi β1 + β2*FRi + β3*DLARGE + β4*DSMALL + β5*FRi*DLARGE +
β6*FRi*DSMALL + εi
For robustness, dummy (0/1) variables DLARGE and DSMALL are used to
indicate whether or not the size has significantly effect on the relation between
the floating ratio and the dependent variables. The model measures the effects of
size on both the intercept and the slope of the regression line. The dummy
variables DLARGE and DSMALL are employed to measure the effect of size on
the intercept of the regression line while FR*DLARGE and FR*DSMALL are
present to measure the same effect on slope of the regression line. In all
equations the regression line is drawn owing to the data of medium size firms,
that is, β1’s and β2’s are the coefficients of medium size firms. Therefore, other
coefficients (β3, β4, β5, β6) are about the positions of small or large size firms in
relative to medium size firms.
V. Results
Table 1 reports the descriptive statistics for variables under investigation. Table
indicates that the floating ratio distribution is slightly positively skewed as the
mean market value of free float ratio (36.5%) is slightly greater than the median
value (32.3%). The distributions of all the dependent variables also exhibit
16 Faruk Bostancı & Saim Kılıç
slightly positive skew since in all the three distribution means are greater than
the medians.
Table 1: Summary Descriptive Statistics for Variables
Variable Definition Min Max. Median Mean S.D. N
FR Free Float Ratios 1.0% 100.0% 32.3% 36.5% 20.3% 199
PC Average Daily Price Change -0.389% 0.738% 0.065% 0.100% 0.149% 199
PV Price Volatility 1.339% 6.062% 2.523% 2.601% 0.681% 199
TA Trade Activity 21 2,578 218 321 346 199
Table 2 provides descriptive statistics for the firm size. The most striking
information provided by the Table is that sample firms vary significantly in firm
size which is measured by market valuations. The average size in the large firm
size class is 125 times greater than the average size in the small size class.
Table 2: Firm Size Measured by Market Valuation (Million YTL)*
Firm Size Definition Min Max Median Mean S.D. N
Small < First Quartile** 9.37 57.41 28.57 31.00 15.48 50
Medium > First Quartile; < Third Quartile 61.73 704.00 186.75 247.79 175.18 99
Large > Third Quartile 721.05 22,286.67 1,560.99 3,879.00 4,899.14 50
* YTL: New Turkish Lira, ** Q1= 59.57 million YTL, Q3= 712.53 million YTL
Table 3 presents the summary of results of the regression of price change
(PC %) on free float ratio (FR %). These results support the idea predicted in the
Hypothesis 1, that is, average daily price change is positively related with the
floating ratios of stock. First, the high F-value indicates robustness of the model.
Second, the value of t-statistics ensures that the independent variable (FR %) and
the dependent variable (PC %) have positive relation at 1% significance level.
Therefore, the regression results suggest that market rewards the high floating
ratios; as the floating ratios of firms increase the price return of their shares also
increase.
The Effects of Free Float Ratios on Market Performance: 17
An Empirical Study on the Istanbul Stock Exchange
Table 3: Summary Output of Regression of Price Change on Free Float
Ratio
Coefficients Standard Error t Stat F R Square Observations
Intercept 0.0003 0.0002 1.4940 13.6963 0.0650 199
FR 0.0019 0.0005 3.7008
Table 4 summarizes the results of regression of price volatility (PV %) on
free float ratio (FR %). The regression results suggest that the relation between
volatility and free float ratio is significant but it is not negative as postulated by
Hypothesis 2. The rationale behind this hypothesis was that small floating ratio
causes a thin market structure in which small variations in trade volume lead to
large variations in price returns. The prediction does not hold, perhaps because
Istanbul Stock Exchange itself so small market that only after certain levels of
floating ratio individual markets of stocks become active and volatile. On the
other hand, this result is compatible with the general principle of “high risk high
return” when it is considered together with the previous results of price return.
As a consequence, Hypothesis 2 is rejected by the regression results placed in
Table 4.
Table 4: Summary Output of Regression of Price Volatility on Free Float
Ratio
Coefficients Standard Error t Stat F R Square Observations
Intercept 0.0228 0.0010 23.7266 14.1116 0.0668 199
FR 0.0087 0.0023 3.7565
Table 5 presents the summary of regression results of trade activity (TA) on
free float ratio (FR %) and they are in consistent with the prediction of
Hypothesis 3. That is, there is a statistically significant positive relation between
trade activity (number of trade contracts) and the free float ratios of stocks at 1 %
level. Not surprisingly, higher floating ratio leads to higher trading activity and
thus more liquid markets for the stocks since it enlarges the market for individual
stock.
18 Faruk Bostancı & Saim Kılıç
Table 5: Summary Output of Regression of Trade Activity on Free Float
Ratio
Coefficients Standard Error T Stat F R Square Observations
Intercept 101.2198 47.4305 2.1341 28 0.1248 199
FR 601.5768 113.5108 5.2997
The following tables, Table 6, Table 7 and Table 8 contain the result of
multiple regression which aims to measure the size effect on the influence of free
float ratio. Table 6 provides the regression results of average daily price changes
(PC %) on the free float ratio (FR %) when the firm size is controlled.
Remember that the model is:
PCi = β1 + β2*FRi + β3*DLARGE + β4*DSMALL + β5*FRi*DLARGE + β6*FRi*DSMALL+εi
Hypothesis 4 predicts that the positive relation between PC and FR is more
prominent for small size firms, because the adverse effects of small floating ratio
is expected to be higher. However, the results in Table 6 do not indicate
statistically significant influence of firm size on the effect of independent
variable (FR). In the model, the signs of intercept coefficients (β3 and β4) are just
as predicted though they are statistically insignificant and the signs of slope
coefficients (β5 and β6) are opposite of what is expected: although it is not
statistically significant large firm size has positive effect on the slope of
regression whereas the positive effect of floating ratio on stock price return is
less prominent for the small size firms and moreover this effect is statistically
significant at 10 % level. Consequently, Hypothesis 4 is rejected in terms of
floating ratio and average price return relationship.
The Effects of Free Float Ratios on Market Performance: 19
An Empirical Study on the Istanbul Stock Exchange
Table 6: Summary Output of Multiple Regression of Price Change
Coefficients Standard Error t Stat F R Square Observations
Intercept 0.00012 0.00029 0.421 4.26896 0.09958 199
FR 0.00229 0.00071 3.228
DLARGE -0.00025 0.00050 -0.502
DSMALL 0.00102 0.00055 1.854
DLARGE*FR 0.00134 0.00132 1.014
DSMALL*FR -0.00243 0.00121 -2.004
Table 7 summarizes the results of the regression which measures the
relation between price volatility and free float ratios when the firm size is
controlled. Remember that the model is:
PVi = β1 + β2*FRi + β3*DLARGE + β4*DSMALL + β5*FRi*DLARGE +
β6*FRi*DSMALL + εi
The regression results do not support the idea that free float ratio is more
effective for small firms in reducing volatility. If Hypothesis 4 holds then
coefficients of large firms and small firms should be in different sign because as
the firm size increases the volatility is expected to decrease. Nonetheless, the
regression produces same signs for both firm sizes although they are not
statistically significant except for coefficient of DSMALL which is significant at
10 % level. Therefore, Hypothesis 4 is rejected in terms of floating ratio and
volatility of stock prices as well.
Table 7: Summary Output of Multiple Regression of Price Volatility
Coefficients Standard Error t Stat F R Square Observations
Intercept 0.02190 0.00131 16.759 6.48148 0.14377 199
FR 0.00887 0.00316 2.812
DLARGE 0.00064 0.00222 0.287
DSMALL 0.00572 0.00245 2.339
DLARGE*FR -0.00368 0.00587 -0.626
DSMALL*FR -0.00416 0.00539 -0.770
20 Faruk Bostancı & Saim Kılıç
Finally, Table 8 presents the regression results of the model that tests the
size effect on the relation between floating ratio and the trade activity.
Remember that the model is:
TAi = β1 + β2*FRi + β3*DLARGE + β4*DSMALL + β5*FRi*DLARGE +
β6*FRi*DSMALL + εi
If the variations in floating ratio on trade activity is more prominent for the
small firms, as predicted in Hypothesis 4, then the coefficients of small size
firms (β4 and β6) are expected to be positive, whereas the coefficients of large
size firms (β3 and β5) are expected to be negative. Nevertheless, the coefficients
of both small and large firms have same sign in relative to medium size firms
according to the regression results. That is to say, the intercept coefficients are
positive but the slope coefficients are negative for both of them and all
coefficients are statistically significant. Therefore, it cannot be said that as the
firm size decreases the influence of floating ratio increases in terms of trading
activity. As a result, once again the regression results do not support the
Hypothesis 4.
Table 8: Summary Output of Multiple Regression of Trade Activity
Coefficients Standard Error t Stat F R Square Observations
Intercept -66.21 63.55 -1.042 10.71946 0.21735 199
FR 1025.03 153.45 6.680
DLARGE 343.43 108.15 3.175
DSMALL 254.17 118.95 2.137
DLARGE*FR -617.97 285.65 -2.163
DSMALL*FR -829.54 262.32 -3.162
To sum up, the regression results suggest first that free float ratios have
significantly positive effect on price return on market. In other words, high free
float ratio is rewarded by the investors in the market. Second, the relationship
between free float ratio and price volatility is positive as opposed to expectation.
The possible explanation is that market values are so small that only after certain
levels of floating ratio the individual stocks have an active market which leads to
volatility. Third, trade activity (the number of trade contracts) is significantly
The Effects of Free Float Ratios on Market Performance: 21
An Empirical Study on the Istanbul Stock Exchange
positively affected by the floating ratio as hypothesized. Finally, the regression
results do not support the idea that influence of floating ratio varies linearly as
firm size increases or decreases.
VI. Conclusion
The relation between ownership concentration and corporate performance has
been a popular subject for the corporate governance researchers. However, the
research area has been dominated largely by studies of Anglo-American
corporations. The law and finance studies show that the effect of ownership
concentration is heavily context dependent. While for common law countries like
the US and UK ownership concentration can be seen as a remedy for the “agency
problem”, for civil law countries like France, Italy, Spain, Turkey etc. ownership
concentration itself leads to “expropriation problem”.
Unlike the common law countries capital market is not primary source of
corporate financing in the civil law countries. Stock markets are not well
developed and market valuations of companies constitute a relatively small
proportion of national incomes. Cross country studies show that relatively weak
investor protection provided by legal system is the main reason for
underdevelopment of capital markets in civil law countries. Investors are
reluctant to invest in fear of being expropriated by major shareholders, which in
turn increases the cost of capital for corporations. Controlling owners hesitate to
go public because, either they do not want lose their control, or they believe that
the insufficient market undervalue their shares. Putting all together, highly
concentrated and centralized ownership structure result in small fraction of
shares are freely floating in the market. Low level of floating shares leads to a
thin and shallow market structure and thus illiquidity. That is why, the global
index providers (Morgan Stanley, Standard and Poor’s) started to use “free float
ratios” as a weighting factor in calculating investability of stocks.
Although the free float ratio gives quick information about the ownership
structure and despite of interest of investment community there are limited
numbers of academic studies which focus on directly effects of floating ratio. In
this study, the direct effects of free float ratio on stock price performance over
the data of a typical civil law country are measured. Indeed, Turkish capital
market provides appropriate settings to study effects of ownership structure in an
underdeveloped capital market where investors are relatively less protected,
ownership is highly concentrated and thus free float ratios are very low.
22 Faruk Bostancı & Saim Kılıç
The data of 199 firms listed on Istanbul Stock Exchange are used to test the
effect of free float ratio on stock price returns, price volatility and trade activity
(liquidity) for the year 2007. Given the weak corporate governance structure of
the market, as free float ratio decreases, willingness of investors, both domestic
and international, to invest is also expected to decrease because either of
increasing probability of expropriation or of tightening liquidity effect of small
floating ratio. Regression results suggest that the relationship between stock
price returns and free float ratio is significantly positive. In other words,
investors of ISE are ready to pay more for the stocks with higher floating ratios.
In addition to this finding, results also suggest that higher floating ratios lead to
significantly higher trading activity (liquidity), which may explain higher
demand of investors for those stocks. However, the risk, measured by price
volatility, rises for the greater floating ratios. On the other hand, a size effect
cannot be identified in the relations among variables. That is to say, influence of
free float ratio on dependent variables does not increase or decrease as the firm
size increases or decreases.
As a conclusion, these findings are compatible with the previous studies and
prove that free float ratio does matter for the investors. Higher floating ratio
implies higher market value for stocks, higher liquidity in the market and low
cost of capital for corporations. Therefore, these results provide empirical
evidence for the growing practice of weighting the stocks according to free float
ratio for indexes. They support designing incentive measures to corporations and
policy makers for higher floating ratios that decrease cost of capital and ensure
capital market development. Although the regression results of this study robust
and clear, the regressions depend on one year data which contains all the sectors
and eliminates the free float variations within a stock, i.e., one floating ratio is
assigned for every firm. Therefore, examining effects of free float ratio for
different sectors or for firms whose floating ratios change substantially within a
time horizon may yield interesting results for further studies.
The Effects of Free Float Ratios on Market Performance: 23
An Empirical Study on the Istanbul Stock Exchange
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