The Effect of Stock Liquidity on the Firm's Investment and Production

Review of Financial Studies, Amihud, Y., and S. Levi. (2023) Stock liquidity, the firm’s investment and its production. Review of Financial Studies 36(3), 1094–1147.

71 Pages Posted: 1 Jun 2018 Last revised: 30 May 2023

See all articles by Yakov Amihud

Yakov Amihud

New York University - Stern School of Business

Shai Levi

Tel Aviv University

Date Written: February 1, 2023

Abstract

We propose that stock market liquidity affects corporate investment and production. Illiquidity, which raises firms’ cost of capital, lowers investment in capital assets, R&D, and inventory. This effect holds after we control for endogeneity using exogenous liquidity events, the 2001 decimalization and the 1997 Nasdaq reform, and after employing instrumental variable estimation. Illiquidity affects investment regardless of firms’ financial constraints. Consequently, illiquidity induces firms to adopt less capital-intensive production processes. Illiquid firms have higher marginal productivity of capital, greater labor input increases for given increases in assets, and lower operating leverage, which means lower reliance on fixed costs.

Keywords: liquidity, investment, production

Suggested Citation

Amihud, Yakov and Levi, Shai, The Effect of Stock Liquidity on the Firm's Investment and Production (February 1, 2023). Review of Financial Studies, Amihud, Y., and S. Levi. (2023) Stock liquidity, the firm’s investment and its production. Review of Financial Studies 36(3), 1094–1147., Available at SSRN: https://ssrn.com/abstract=3183091 or http://dx.doi.org/10.2139/ssrn.3183091

Yakov Amihud

New York University - Stern School of Business ( email )

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Shai Levi (Contact Author)

Tel Aviv University ( email )

Tel Aviv, 69978
Israel

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