Activism, Strategic Trading, and Liquidity

50 Pages Posted: 23 Nov 2016 Last revised: 7 Mar 2017

Kerry Back

Rice University - Jones Graduate School of Business and Department of Economics

Pierre Collin-Dufresne

Ecole Polytechnique Fédérale de Lausanne - Ecole Polytechnique Fédérale de Lausanne; National Bureau of Economic Research (NBER)

Vyacheslav Fos

Boston College - Department of Finance

Tao Li

City University of Hong Kong (CityUHK) - Department of Economics & Finance

Alexander Ljungqvist

New York University (NYU) - Department of Finance; National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR); European Corporate Governance Institute (ECGI); Research Institute of Industrial Economics (IFN)

Multiple version iconThere are 2 versions of this paper

Date Written: March 2017

Abstract

We analyze dynamic trading in an anonymous market by an activist investor who can expend costly effort to affect firm value. We obtain the equilibrium in closed form for a general activism technology, including both binary and continuous outcomes. The optimal continuous trading strategy is independent of the activism technology. Activism, prices, and liquidity are jointly determined in equilibrium. Variation in noise trading volatility can produce either positive or negative effects on both efficiency and liquidity, depending on the activism technology and model parameters, because future effort depends on the realized amount of noise trading. The ‘lock in’ effect emphasized in previous literature (e.g., Coffee (1991), Bhide (1993) and Maug (1998)) holds only for special forms of the activism technology. Reducing the uncertainty about the activist’s position improves market liquidity, but the effect on efficiency depends on the specification of the effort cost function. Variation in the activist’s productivity produces a negative cross-sectional relation between efficiency and liquidity as the possibility of more activism exacerbates the risk of adverse selection.

Keywords: Strategic Trading, Shareholder Activism, Stock Liquidity, Continuous Time

JEL Classification: G34, G14

Suggested Citation

Back, Kerry and Collin-Dufresne, Pierre and Fos, Vyacheslav and Li, Tao and Ljungqvist, Alexander, Activism, Strategic Trading, and Liquidity (March 2017). European Corporate Governance Institute (ECGI) - Finance Working Paper No. 497/2017. Available at SSRN: https://ssrn.com/abstract=2873840 or http://dx.doi.org/10.2139/ssrn.2873840

Kerry Back

Rice University - Jones Graduate School of Business and Department of Economics ( email )

6100 South Main Street
P.O. Box 1892
Houston, TX 77005-1892
United States

Pierre Collin-Dufresne

Ecole Polytechnique Fédérale de Lausanne - Ecole Polytechnique Fédérale de Lausanne ( email )

Quartier UNIL-Dorigny, Bâtiment Extranef, # 211
40, Bd du Pont-d'Arve
CH-1015 Lausanne, CH-6900
Switzerland

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Vyacheslav Fos (Contact Author)

Boston College - Department of Finance ( email )

Carroll School of Management
140 Commonwealth Avenue
Chestnut Hill, MA 02467-3808
United States

Tao Li

City University of Hong Kong (CityUHK) - Department of Economics & Finance ( email )

83 Tat Chee Avenue
Kowloon
Hong Kong

Alexander Ljungqvist

New York University (NYU) - Department of Finance ( email )

Stern School of Business
44 West 4th Street, Suite 9-160
New York, NY 10012-1126
United States
212-998-0304 (Phone)
212-995-4220 (Fax)

HOME PAGE: http://pages.stern.nyu.edu/~aljungqv

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Centre for Economic Policy Research (CEPR)

77 Bastwick Street
London, EC1V 3PZ
United Kingdom

European Corporate Governance Institute (ECGI)

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

Research Institute of Industrial Economics (IFN) ( email )

Box 55665
Grevgatan 34, 2nd floor
Stockholm, SE-102 15
Sweden

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