Corporate Governance and Stock Market Liquidity in India

Abstract

Corporate Governance encompasses processes for board effectiveness and enhanced transparent disclosures. Both these requirements result in improved quality and quantity of information made available to investors. This information flow is expected to result in informed trading, reduce information asymmetry and improve market liquidity.

We examine the relationship between the firm level corporate governance and stock liquidity in Indian market. We constructed corporate governance index through content analysis of corporate governance reports published annually as a part of annual report of the Indian listed companies. We used Illiquidity Ratio suggested by Amihud (2002) and its modified form used by Bortolotti et al. (2007) to measure the stock liquidity. We empirically observe that corporate governance had a positive impact on stock liquidity. Better governed companies had higher liquidity. This is positive finding for the cross section of governance players (both for policy makers as well as the listed companies) that a decade of governance reforms provides benefit for the firms' adhering good governance practices. Our results are in support of arguments made by Welker (1995) and Chung (2010). We also examine the relationship between the ownership pattern and the stock liquidity. We found that higher promoter holdings reduce stock liquidity. We strengthen the belief that foreign institutional investors and their investments provide liquidity to emerging stock markets like India.