Stock Liquidity and Corporate Diversification: Evidence from China's Split Share Structure Reform
64 Pages Posted: 27 Jun 2018 Last revised: 3 Nov 2020
Date Written: November 18, 2017
We establish that stock liquidity is conducive to less corporate diversification. Two potential channels are identified: the financial constraint channel and the corporate governance channel. Specifically, we find that the negative effect of liquidity on diversification is stronger among financially-constrained firms, since higher liquidity helps firms improve external capital markets and thus reduces the need to broaden the internal capital markets through diversification. Moreover, we find that the effect of liquidity on diversification is strengthened among firms with severe information asymmetry, since enhanced price informativeness caused by increased liquidity promotes market monitoring on managers' decisions. Meanwhile, we rule out the alternative explanation that liquidity deters diversification by facilitating blockholder control. Our results suggest that stock liquidity plays a positive role in corporate decision making.
Keywords: Stock Liquidity, Corporate Diversification, Financial Constraint, Agency Problem, Corporate Governance, Share-Splitting Reform, China
JEL Classification: G14, L25, G30
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