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

46 Pages Posted: 1 Jun 2018 Last revised: 22 Aug 2018

See all articles by Yakov Amihud

Yakov Amihud

New York University - Stern School of Business

Shai Levi

Tel Aviv University

Date Written: August 20, 2018

Abstract

We propose that corporate investment is a declining function of stock illiquidity, which raises the firm’s cost of capital. This relation holds even for firms that are not financially constrained. Consequently, higher illiquidity induces firms to select a production process that is less capital intensive: they have higher output per unit of capital or higher marginal productivity of capital, lower capital/labor ratio, and lower operating leverage that means greater reliance on variable costs. The negative illiquidity-investment relation holds for an exogenous liquidity event – the 2001 decimalization – and remains after accounting for endogeneity by instrumental variable estimation.

Keywords: Liquidity, investment, production

Suggested Citation

Amihud, Yakov and Levi, Shai, The Effect of Stock Liquidity on the Firm's Investment and Production (August 20, 2018). 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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