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The Effect of Stock Liquidity on the Firm’s Investment and Production

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Listed:
  • Yakov Amihud
  • Shai Levi
  • Itay Goldstein

Abstract

We propose that stock market liquidity affects corporate investment and production. Illiquidity, which raises firms’ cost of capital, lowers investment in capital assets, R&D, and inventory. This effect holds after we control for endogeneity using exogenous liquidity events, the 2001 decimalization, and the 1997 Nasdaq reform and after employing instrumental variable estimation. Illiquidity affects investment regardless of firms’ financial constraints. Consequently, illiquidity induces firms to adopt less capital-intensive production processes. Illiquid firms have higher marginal productivity of capital, greater labor input increases for given increases in assets, and lower operating leverage, which means lower reliance on fixed costs.

Suggested Citation

  • Yakov Amihud & Shai Levi & Itay Goldstein, 2023. "The Effect of Stock Liquidity on the Firm’s Investment and Production," The Review of Financial Studies, Society for Financial Studies, vol. 36(3), pages 1094-1147.
    • Handle: RePEc:oup:rfinst:v:36:y:2023:i:3:p:1094-1147.
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    File URL: http://hdl.handle.net/10.1093/rfs/hhac036
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    More about this item

    JEL classification:

    • D24 - Microeconomics - - Production and Organizations - - - Production; Cost; Capital; Capital, Total Factor, and Multifactor Productivity; Capacity
    • E22 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Investment; Capital; Intangible Capital; Capacity
    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
    • G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Fixed Investment and Inventory Studies
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill

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