Review of Quantitative Finance and Accounting, 22: 275–292, 2004
2004 Kluwer Academic Publishers. Manufactured in The Netherlands.
Bid-Ask Spreads and Institutional Ownership
Barclays Global Investors and University of South Carolina, Columbia, SC 29208, USA
Abstract. This paper examines the relation between bid-ask spreads, measured both as effective and specialist-
posted spreads, and institutional ownership. For the overall sample, spreads are negatively related to institutional
ownership share. The paper suggests that this effect may be due to some institutions being restricted in their
trading, which reduces bid-ask spreads. The paper shows that for certain types of institutions, namely banks and
investment managers, the above relation reverses. The results are robust to the inclusion of other ﬁrm-speciﬁc
variables such as size, leverage, and ﬁnancial distress measures.
Keywords: bid-ask spread, institutional ownership, specialist
JEL Classiﬁcation: G10, G19
The adverse selection component of bid-ask spreads, which is due to information asymmetry
between dealers and informed traders, is well established in the ﬁnance literature. At the
same time, it is often casually argued that institutional investors have information advantages
over private investors suggesting a link between institutional ownership and bid-ask spreads;
this paper provides an empirical analysis of this potential link. Contrary to the suggested
relation, the main ﬁnding of the paper is that bid-ask spreads decrease with the overall
level of institutional ownership; however, the suggested relation is found for certain types
of institutional owners, which implies that not all but only some types of institutions may
cause increases in adverse selection costs.
The ﬁnance literature dealing with the topic of bid-ask spreads distinguishes between
posted (or quoted) and effective spreads. Usually the posted spread is deﬁned as the dif-
ference between the price at which a dealer is willing to sell and the price at which he is
willing to buy a certain security. The effective spread is the difference between the high-
est price at which a security can be sold and the lowest price at which it can be bought
among all market participants.Onaverage, effective spreads should be smaller than posted
spreads, since market participants may engage in trading without the dealer inside the posted
spread. However, one can expect that posted spreads affect effective spreads, in the sense
that (for trade sizes within the dealer’s quoted depth) they put an upper bound on effective
Address correspondence to: Frank Fehle, Assistant Professor of Finance, BFIRE, Moore School of Business,
University of South Carolina, Columbia, SC 29208. Phone: (803) 777 6980. Fax: (803) 777 6876.