Price Impact of Block Trading on the Bombay Stock Exchange [Dagger] (2015)

IntroductionThere are many small, medium and large companies listed on any given stock exchange. Each of these companies may have millions of shareholders which may each own relatively few shares. In percentage terms, their individual holdings are insignificant as to play any meaningful role in the working of the company. On the other hand, many of these public limited companies may have sizeable share blocks that are owned by the promoters and other non-promoter block holders in the form of institutional investors such as corporates, brokerage houses, mutual funds, pension funds, and private equity investors, etc., who often play an important role in the corporate governance of such companies. Small shareholders are the focus of the corporate governance system, with strong regulations often designed to protect their interests over those of large shareholders. Therefore in such a system a great deal of disclosure of corporate information is normally required by the law.Outside block shareholders may be efficiently able to monitor the management of such companies and may also contribute by rendering expert advice leading to a reduction in agency problems between shareholders and managers. Reducing agency problems can lead to an increase in firm value as reflected by an increase in stock price. While phenomenal research work in the west has been concentrated in the area of corporate ownership and control, the developing economies have seen very less research in this area. The behavior of stock prices around large transfer of shares is of paramount importance for the market regulators on the one hand and for large institutional investors on the other. Market regulators are concerned with overseeing the fairness in transactions, ensuring liquidity and safeguarding the interests of investors particularly the smaller ones. Large institutional investors are concerned about the impact costs involved in undertaking large trades.The price impact of block trades has been the subject of considerable research. Most of the previous studies examining block trades investigate the American stock markets and the well-developed European markets. Existing research documents that equity block transfers result in a substantial increase in stock prices resulting in positive excess returns and therefore they are seen as value enhancing events (Barclay and Holderness, 1989, pp. 371-395; and Sudarsanam, 1996, pp. 295-314). Except for a few studies (Atanasov, 2005, pp. 191-234; and Trojanowski, 2008, pp. 217-238), little research has been done on this issue in emerging stock markets. Therefore it is not clear whether the results of such studies are meaningful for much smaller and emerging markets with an altogether different market structure. This study looks into the effect of block trades on equity share prices on the Bombay Stock Exchange (BSE), which is the oldest stock exchange in India. Our results also lend support to the evidence documented in the literature as we find that stock prices generally increase on average around 1.32% on the date of block trades. Thus, the Indian stock markets also react positively to block deals.Institutional SettingWith a view to regulating large share transactions, the Indian stock market regulator, the Securities and Exchange Board of India (SEBI), felt that there was a need for the stock market to execute large trades through a single transaction easily without putting the buyer or the seller in a disadvantageous position. Therefore, in order to facilitate execution of such large trades, the stock exchanges were permitted to provide a separate trading window under the guidelines on block deals brought out by SEBI in 2005. These guidelines define a block deal as through a single transaction on this separate window of the exchange.1 The guidelines also distinguish a block deal from a bulk deal which is defined as all transactions, in a scrip (on an exchange) where the total quantity of shares bought/sold is more than 0. …