Does Stock Liquidity Enhance or Impede Firm Innovation?

87 Pages Posted: 24 Jan 2011 Last revised: 12 Feb 2015

Vivian W. Fang

University of Minnesota - Twin Cities - Department of Accounting

Xuan Tian

Tsinghua University - PBC School of Finance

Sheri Tice

Tulane University - A.B. Freeman School of Business

Date Written: May 29, 2013

Abstract

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

Fang, Vivian W. and Tian, Xuan and Tice, Sheri, Does Stock Liquidity Enhance or Impede Firm Innovation? (May 29, 2013). Journal of Finance, October 2014, 69 (5), 2085-2125.. Available at SSRN: https://ssrn.com/abstract=1746399 or http://dx.doi.org/10.2139/ssrn.1746399

Vivian W. Fang

University of Minnesota - Twin Cities - Department of Accounting ( email )

321 19th Avenue South
Room 3-109
Minneapolis, MN 55455
United States

HOME PAGE: http://www.vivianfang.org

Xuan Tian

Tsinghua University - PBC School of Finance ( email )

No. 43, Chengfu Road
Haidian District
Beijing 100083
China
+86-10-62794103 (Phone)

HOME PAGE: http://xuantian.info/

Sheri Tice (Contact Author)

Tulane University - A.B. Freeman School of Business ( email )

A.B. Freeman School of Business
7 McAlister Drive
New Orleans, LA 70118
United States
504-865-5469 (Phone)
504-865-6751 (Fax)

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