Liquidity Risk and Corporate Risk-Taking

49 Pages Posted: 23 Jan 2018

See all articles by Jing-Zhi Huang

Jing-Zhi Huang

Pennsylvania State University - University Park - Department of Finance

Huayi Tang

Concordia University, Quebec

Yuan Wang

Concordia University, Quebec

Rui Zhong

The University of Western Australia - UWA Business School

Date Written: January 23, 2018

Abstract

We construct a theoretical framework to investigate the impact of liquidity risk, in the secondary corporate debt market, on corporate risk-taking preferences. Using closed-form solutions, our model shows that equity holders choose to adopt high-risk projects upon the arrival of illiquidity shocks. This effect is more pronounced for firms with weaker fundamentals. Empirically, we confirm the positive relationship between liquidity risk and corporate risk-taking. We also document that the impact of liquidity risk on corporate risk-taking preferences is more pronounced for smaller firms and firms with lower profits and higher rollover risk. In addition, we use the introduction of the Trade Reporting and Compliance Engine (TRACE) as a natural exogenous liquidity shock and find a decrease of firms’ risk-taking preferences after the TRACE is implemented. Our findings shed light on the managerial behavior literature, which shows that the frictions of the secondary bond market have a real impact on firms’ risk-taking behaviors.

Keywords: Bond liquidity; risk-taking

Suggested Citation

Huang, Jing-Zhi Jay and Tang, Huayi and Wang, Yuan and Zhong, Rui, Liquidity Risk and Corporate Risk-Taking (January 23, 2018). Available at SSRN: https://ssrn.com/abstract=3107853 or http://dx.doi.org/10.2139/ssrn.3107853

Jing-Zhi Jay Huang

Pennsylvania State University - University Park - Department of Finance ( email )

University Park, PA 16802
United States

HOME PAGE: http://www.personal.psu.edu/jxh56

Huayi Tang

Concordia University, Quebec ( email )

1455 de Maisonneuve Blvd. W.
Montreal, Quebec H3G 1MB
Canada

Yuan Wang (Contact Author)

Concordia University, Quebec ( email )

1455 de Maisonneuve Blvd. W.
Montreal, Quebec H3G 1MB
Canada

Rui Zhong

The University of Western Australia - UWA Business School ( email )

35 Stirling Highway
Crawley, Western Australia 6009
Australia

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