Stock Market Liquidity and Firm Value: An Empirical Examination of the Australian Market

Abstract

We document a positive relation between stock liquidity and firm value. We examine the mechanism through which stock market liquidity enhances firm value by dividing firm value, as measured by Tobin's Q, into three components, namely, operating income to price, leverage, and operating income to assets. Using the switch to broker anonymity as an exogenous shock to market liquidity, we show that the increase in liquidity around the shock leads to an increase in firm value. Our results suggest that higher firm value for more liquid stocks seems to stem from enhanced stock prices rather than from better operating performance. JEL Codes: G10; G20; G24 This study investigates whether stock market liquidity affects firm value of stocks listed on the Australian Securities Exchange (ASX). Stock liquidity can influence firm value through various channels. Operating performance-based theories assert that stock market liquidity affects firm performance and profitability and thereby affects firm value. Maug (1998) argues that liquidity allows investors to accumulate large amounts of stocks, become block holders, and capitalize on monitoring activities to boost firm performance. Admati and Pfleiderer (2009), and Edmans and Manso (2011) also propose that market liquidity can positively affect firm performance because in a liquid market, there is a strong 'threat to exit' from blockholders that puts firm managers under high pressure to perform in a diligent manner, especially if management compensation is linked with stock price. On the lines of feedback theories, Subrahmanyam and Titman (2001) and Khanna and Sonti (2004) assert that liquid market stimulates trading of informed investors, which makes prices more informative and facilitates * We are grateful to anonymous referee of the International Review of Finance. We gratefully acknowledge helpful comments from Robert Faff, and seminar participants at Deakin University. We are thankful to the Securities Industry Research Centre of Asia-Pacific (SIRCA) for providing the data used in our study. All remaining errors are our own.

Stock Liquidity and Firm Value: Evidence from a Policy Experiment in India

“…On the whole, the results agree with the view expressed in extant literature (Fang et al ; Cheung et al ; Prommin et al ) which argue that stock liquidity has a positive impact on firms’ value. Our results are more in consonance with the findings of Fang et al (), where the increase in liquidity is improving firms’ value by improving operating performance, unlike the Australian market study by Nguyen et al () where Price‐based causative theories are under play.…”

“…Stock liquidity was primarily captured by Amihud (2002) illiquidity measure and as well with volume based stock liquidity measure. 9 We primarily followed Nguyen et al (2016) and considered firm size, age, and cross-listing 10 as control variables. We also used change in debt to equity ratio of the firms and stock momentum (measured as the last 1-year cumulative average market returns).…”

“…In addition to the DiD regression analysis, we also performed OLS regression on the change in firms' performance (Industry-adjusted Tobin's Q and its subcomponents) with the change in stock liquidity, following Nguyen et al (2016). We also controlled for the change in promoter equity holdings and the change in institutional equity holdings, as they could affect both liquidity and firm value in one way or the other (Gaspar and Massa 2007).…”

“…He found that stock liquidity helps improve firm value through improved operating performance. Later, Nguyen et al () confirmed the liquidity‐value causal relationship with Australian data, but found Price‐based Feedback theories to be the causal mechanism.…”

Market Quality around Macroeconomic News Announcements: Evidence from the US and Canadian Markets

“…These findings are not reported but are available from the authors on request. Prior research, e.g., Nguyen et al (2016), has examined the positive relation between stock liquidity (measured by the bid-ask spread) and firm value.…”