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

59 Pages Posted: 1 Jun 2018 Last revised: 12 May 2019

See all articles by Yakov Amihud

Yakov Amihud

New York University - Stern School of Business

Shai Levi

Tel Aviv University

Date Written: April 15, 2019

Abstract

We propose that stock market liquidity affects corporate investment and production decisions. Illiquidity raises the required return and the firm’s cost of capital and thus negatively affects investment in fixed assets, in R&D and in inventory. The negative investment-illiquidity relation holds even for firms that are not financially constrained. Consequently, illiquidity induces firms to adopt a production process that is less capital intensive. Illiquid firms have higher marginal productivity of capital, more labor input for a given increase in capital, and lower operating leverage that means a lesser reliance on fixed costs. These effects hold after controlling for endogeneity by the instrumental variables method and for an exogenous liquidity event, the 2001 decimalization.

Keywords: liquidity, investment, production

Suggested Citation

Amihud, Yakov and Levi, Shai, The Effect of Stock Liquidity on the Firm's Investment and Production (April 15, 2019). 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 )

44 West 4th Street
Suite 9-190
New York, NY 10012-1126
United States
212-998-0720 (Phone)
212-995-4233 (Fax)

Shai Levi (Contact Author)

Tel Aviv University ( email )

Tel Aviv, 69978
Israel

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