The Effect of Liquidity on Governance

48 Pages Posted: 4 Nov 2011

See all articles by Alex Edmans

Alex Edmans

London Business School - Institute of Finance and Accounting; European Corporate Governance Institute (ECGI); Centre for Economic Policy Research (CEPR)

Vivian W. Fang

University of Minnesota - Twin Cities - Department of Accounting

Emanuel Zur

University of Maryland - Robert H. Smith School of Business

Multiple version iconThere are 2 versions of this paper

Date Written: November 2011

Abstract

This paper studies the effect of stock liquidity on blockholders' choice of governance mechanisms. We focus on hedge funds as they are unconstrained by legal restrictions and business ties, and thus have all governance channels at their disposal. Since the threat of governance, not just actual governance, can discipline managers, we use Section 13 filings to measure governance intent rather than only studying instances of actual governance. We find that liquidity increases the likelihood that a hedge fund acquires a block in a firm. Conditional upon acquiring a stake, liquidity reduces the likelihood that a blockholder governs through voice (intervention) - as evidenced by the greater propensity to file Schedule 13Gs (passive investment) rather than 13Ds (active investment). Liquidity is more likely to lead to a 13G filing if the manager's wealth is sensitive to the stock price, consistent with governance through exit (trading). A 13G filing leads to positive announcement returns, especially in liquid firms. These two results suggest that liquidity does not dissuade blockholders from governing altogether, but instead encourages them to govern through exit rather than voice. We use decimalization as an exogenous shock to liquidity to identify causal effects.

Suggested Citation

Edmans, Alex and Fang, Vivian W. and Zur, Emanuel, The Effect of Liquidity on Governance (November 2011). NBER Working Paper No. w17567. Available at SSRN: https://ssrn.com/abstract=1954494

Alex Edmans (Contact Author)

London Business School - Institute of Finance and Accounting ( email )

Sussex Place
Regent's Park
London NW1 4SA
United Kingdom

European Corporate Governance Institute (ECGI) ( email )

c/o ECARES ULB CP 114
B-1050 Brussels
Belgium

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

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

Emanuel Zur

University of Maryland - Robert H. Smith School of Business ( email )

College Park, MD 20742-1815
United States

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