Does Stock Liquidity Enhance or Impede Firm Innovation?
87 Pages Posted: 24 Jan 2011 Last revised: 12 Feb 2015
Date Written: May 29, 2013
We aim to tackle the longstanding debate on whether stock liquidity enhances or impedes firm innovation in this paper. This topic is of particular interest to firm stakeholders and regulators, because innovation is crucial for firm and national level competitiveness and stock liquidity can be altered by financial market regulations. We use a difference-in-differences approach that relies on the exogenous variation in liquidity generated by regulatory changes in the cost of trading stocks and find that an increase in liquidity causes a reduction in future innovation. We then identify two possible mechanisms through which liquidity impedes innovation: increased exposures to hostile takeovers and higher presence of institutional investors who do not actively gather information about firm fundamentals or monitor. Both could result in a cut in investment in innovation to boost current earnings. Our paper shows a previously under-identified adverse consequence of liquidity: its hindrance to promoting firm innovation.
Keywords: Stock Liquidity, Innovation, Hostile Takeover, Institutional Ownership
JEL Classification: G12, G19, G34, G38, O31
Suggested Citation: Suggested Citation