Little guys, liquidity, and the informational efficiency of price: Evidence from the Tokyo Stock Exchange on the effects of small investor participation

This paper provides an analysis of the equity-market effects of a substantial increase in individual shareholder participation in the market for a firm. The data are based on reductions in lot sizes or Minimum Trade Units (MTUs) on the Tokyo Stock Exchange (TSE). There is a shift in order flow from large to small trades after MTU reductions. Since small, individual investors are generally thought to be noise traders, it may be expected that greater individual investor participation creates greater liquidity, but adds noise to prices, lowering the informativeness of prices and increasing return volatility, as found in studies of stock splits. However, the influx of individual investors, while associated with the presence of more noise traders, lowers the probability of informed trades and results in greater liquidity. Results suggest that greater noise trading induces the informed to trade more aggressively and makes price more informative. Finally, given the benefits of MTU reduction, we ask why all firms do not lower their MTU. The answer appears to be that some firms have characteristics making them better off without an MTU change. For example, firms having strong cross-holdings with other firms, as in keiretsu, value strong relationships with a few suppliers and customers so that having a larger individual shareholder base is not as attractive. In addition, firms that have not experienced a significant increase in their share price have less incentive to lower their MTU.