Free-Float Liquidity and Trading Constraints: Increasing Informational Efficiency in Family Firms’ Financing Decisions

Abstract

Volume-based liquidity ratios suffer from potential measurement bias due to share restriction and may misrepresent actual liquidity. In this paper, we develop a modified metric, the free-float liquidity ratio. We argue that this measure is better suited to estimate liquidity in the presence of trading constraints as can be found in family-owned businesses or closely-held entities. Empirical testing indicates that the free-float liquidity ratio compares favorably with other volume-based methods. Furthermore, we use family firms as a of restricted share setting to demonstrate the empirical validity of the free-float liquidity ratio. The proposed metric provides potential informational gain for family leaders to aid in their strategic financing decisions and for non-family outsiders to guide their investment choice.

Keywords: liquidity ratios; illiquidity; free-float liquidity; share restriction; family-owned firms; dual-class shares; corporate governance

JEL Classification: G12, G14, G15, G35